Thinking like a property investor

Joshua Varghese, a real estate portfolio manager at CI Investments, has taken a more than passing interest in the going-private transaction at Milestone Apartments REIT.

For starters, funds that he manages used to own the units before turning seller because of concerns about the REIT’s on- going needs for capital expenditure, to raise equity and because of the conflicts, perceived or otherwise, by the presence of an external management contract.

“In my opinion, Milestone’s management, which received more than $ 100 million when the management contract was internalized last year, needs to take more out and give that to unitholders. Starwood should not pay up,” he said.

Varghese, who oversees real estate investing for the Signature High Income Fund and the Signature Diversified Yield Fund, gets there through value investing. That’s the ability to buy stocks at a discount to their net asset value and hold them until they reach that level — a process that takes time to unfold.

It may not be the classic 50- cent dollars ( more like 80- cent dollars) but owning an asset that pays a regular distribution and provides t he opportunity f or i ncreased revenue, in line with inflation, is attractive. “It requires a strong management team which has good capital allocation skills to grow NAV,” he said.

In other words, to generate a return in REITs, investors need to think like a property investor — and not a stock market investor. All of which means that perceived wisdoms — including that REITs are an interest play, higher dividend paying REITs are more attractive investments and REIT returns are macro- driven — need to be expunged.

And not on a whim but on 20- year research conducted on the sector he recognizes is a fraction of the privately held real estate market. “In a market driven ( largely) by private markets, you have a very transparent view of the real estate’s true value.”

As for that true value, Varghese sees a “disconnect” between the private and public view of real estate.

All of which leads to a discussion of Hudson’s Bay Co., which is either a retail department chain with substantial real estate assets or a real estate company on which retail stores, some of which are struggling, sit.

“Analysts are saying that we are not giving credit to a lot of the real estate now because the retail operations are not good enough to justify it. But some of the smartest real estate investors in the world have put their own capital into the real estate joint venture (with HBC). They are saying this is the real value of the real estate,” said Varghese, noting that HBC’s share price is below the estimated value of the real estate.

Of the $ 2 billion of publicly listed real estate assets t hat Varghese oversees, about 30 per cent is invested in Canada, 60 per cent in the U. S and the balance in Europe and Singapore. Over time, the Canadian portion has been scaled back.

Varghese’s view is similar to that adopted by Vision Capital Corp., a specialist real estate manager which serves accredited investors. “We are looking to buy real estate cheaper in the stock market than we can in the real estate markets. And if we see the opposite then we can go short,” said Andrew Moffs, a senior vice- president and portfolio manager.

“We are NAV f ocused, we think long term, take a private equity approach, but can have liquidity in 10 minutes.” He said Vision’s approach contrasts with the yield- driven objective used by some investors, including retail. “The last thing we worry about is interest rates. We worry about supply and demand,” he said, adding that HBC was recently added to the portfolio.