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  Burning Up the Track! Alpine U.S. Real Estate isn't for the faint-of-heart. But investors with a more aggressive bent would be hard pressed to find a real estate fund better suited to their taste. by Barry Vinocur |
Last year, Alpine U.S. Real Estate was the best performing real estate fund by a wide margin. This year, like all other real estate funds, it was in the red as of early June. (Though it wasn't down as much as most of its competitors.) More important, however, over the trailing 12-month and three-year periods through June 4, Lieber and Halle have burned up the track. According to Lipper Analytical (again through June 4), their trailing 12-month and three-year track records not only beat every other real estate fund, but also the return on the Standard & Poor's 500-Stock Index.
As good as Lieber and Halle's track record is—and it's truly exceptional—investors shouldn't lose sight of the fact that Alpine U.S. Real Estate isn't your garden variety REIT fund. One reason that Lieber and Halle have compiled such an impressive track record is that they are willing to take on more risk (more on that, in a bit). Nevertheless, investors willing to take on a bit more risk would be hard pressed to find a real estate fund better suited to their taste.
You guys are out on your own now. Congratulations. So, summarize for us your investment philosophy.
Lieber and Halle: To make money.
You can't argue with that. But your fund isn't your run-of-the-mill REIT fund. You own REITs, but you also own quite a few names that aren't REITs.
Lieber: Both of us have real estate backgrounds, so we stick to what we understand, and 90% of the time that means pure real estate companies. Not all real estate companies are REITs, however. Now and then, we'll look, say, at a real estate finance company. But that's pushing the envelope.
What about service companies?
Lieber: We look at them because we believe that you can add value to real estate in the leasing process. But service companies aren't our bread-and-butter. They're at the margin.
Describe your investment style.
Lieber: Basically, we're value investors. Like everyone else in this business, we're looking for companies with the best growth prospects. But we also try to find situations where we think a stock is mispriced. That can happen if there's a misperception about the company or its business. We also find opportunities in stocks where there's been some news and the market has overreacted, pushing the stock down more than is justified. The flip side of that is when we think the market is too euphoric, we try to exit.
Halle: The only thing I'd add is to underscore our focus on growth at a reasonable price (GARP). We're not going to chase high multiple stocks. If we see a stock trading at what's perceived as a high multiple and the fundamentals support that multiple, we'll go after it, but only if we're confident that the value will be there. We're not going to chase a stock just because the company is doing deals that are accretive to earnings.
Lieber: Doing accretive deals may make you money in the short term, but unless transactions create long-term value, over the long run they dilute return on equity.
Your international fund is having a good year. Your U.S. fund, which was the top performer among real estate funds last year by a wide margin, is ahead of nearly all of its peers again this year. But as of early June, like everyone else, you were in the red. What's going on?
Lieber: The stocks are under pressure right now, and they have been under pressure for a while. But eventually, the momentum guys who blew out of these stocks early in the year when the broader market started its rally will look back and realize they exited too soon. In the meantime, some good values have been, and are being, created. But you have to be very selective. It's later in the real estate cycle, so the "easy money" has already been made.
Halle: The marketplace is still figuring out the differences between these companies. It will take a while longer before the market has sorted out the differences, say, between the industrial REITs. Early in the cycle, those differences weren't nearly as important as they are today—from the investor's perspective, that is. You know: A rising tide lifts all boats.
That's clearly the case. But today it's the quote attributed to Warren Buffett that probably fits best: "It's only when the tide goes out that you see who's been swimming naked."
Lieber: Exactly. Companies have been growing their portfolios at an incredible rate. Some companies grew so fast that it was a challenge just to keep up with what they were buying. Now everyone is looking around and asking: "Just how good were those acquisitions?" Clearly, some of them were very good. But there also were some very marginal deals that got done. Another issue is how good have companies been at managing their growth? How good a job have they done integrating those acquisitions? The companies that have done a good job are the ones best positioned for the next phase in the cycle.
Halle: You also need to ask: What sort of job has management done managing its balance sheet? This is also a good time to review strategy. As we move into the more mature phase of the real estate cycle—the equilibrium phase—you have to focus on whether management's strategy still makes sense.
What about net asset value? Being value-oriented, I would expect that you look pretty closely at NAVs?
Halle: We definitely look at NAV. And because we both have real estate backgrounds, it's a concept that we feel pretty comfortable with. But it's not the only thing we look at. NAV represents, at best, a snapshot. It tells you where you are today. It doesn't tell you where you'll be six, 12, or 18 months from now. So it's important, but it has its limits.
So you focus on NAV, but in relation to other factors, including your assessment of a company's growth prospects?
Lieber: That's right, but that's only part of the picture. Though the premium at which these stocks are trading over their NAVs has come down over the past several months, in some instances by quite a bit, it's still tough to buy stocks at NAV or at a discount to NAV. When you find a stock trading at a discount to its NAV, there's always a reason. Sometimes, it's because the market has mispriced the assets, but more often it's because it's a messy situation.
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Lieber: It is, and it has been for sometime. But we're getting there. We are already seeing signs of a shakeout.
REITs, as measured by the Morgan Stanley REIT Index in early-June, were in the red, down 5% to 6%. Does that surprise you? And what sorts of returns are you looking for this year from the REIT market?
Halle: Tough questions. I guess we thought that REITs, at this point in the year, would have done a bit better. Though frankly, at this stage in the cycle, we weren't expecting REITs to deliver the sorts of returns they did, say, in 1996. Then again, it's still early in the year. Typically, REITs do better later in the year. At least that's what has happened the past several years. We think REITs could still deliver 10% to 12% total returns this year, which if you think about it, would be pretty good considering where they are today.
Lieber: After some very, very good years, especially 1996, we think REITs will start delivering the sorts of returns investors should expect from them long term, which is 10% to 12% per year, perhaps a bit higher, say, 10% to 14% annually.
How do you get to that range?
Lieber: Most of the growth we have seen over the past few years, actually longer than that—probably back to the early 90s, has resulted from external growth. Early on, REITs were about the only game in town, so they were able to buy properties at very, very attractive going-in yields. As competition increased and real estate fundamentals improved, the deals got thinner. So companies can no longer expect 40% to 70% of their growth to come externally. That means the focus is on internal growth. And stabilized real estate won't deliver double-digit growth year-in and year-out.
Halle: This year and next, the earnings forecasts are still pretty strong. In the low- to mid-teens this year and a bit lower than that next year. But longer term, we think, and we're pretty conservative, internal growth in the range of 5% to 6% is realistic. Say, dividends are in the 5% to 6% range. That gives you a total return in the range of 10% to 12%, perhaps, because we're erring on the conservative side, a bit higher.
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Lieber: No doubt. But there are other factors. For instance, some companies are already redeploying capital—in other words, selling more mature properties and buying ones with more upside. That sort of activity isn't capital intensive unless you're buying a major "fixer-upper". So, there are options. But, basically you're correct, if companies cannot raise equity, it will impact earnings, generally speaking.
Halle: Keep in mind that there are a number of moving parts. For example, we expect companies to start using more leverage, in part because rates are attractive now and in part because of the access to equity capital issue. You could make the point that it may be a bit late in the cycle to be adding leverage, that a few years ago it made more sense. But we expect leverage to start rising.
What's the best way to look at leverage? A lot of companies still talk about debt-to-total market cap? Most analysts, however, focus on coverage ratios.
Lieber: It's easy to calculate total debt as a percentage of a company's total market cap. But it's not a meaningful number. What we look at is coverage ratios. We also look at the debt itself, focusing on its cost and when that debt rolls over, for example.
Halle: You also want to look at debt vs. lease structure. For instance, as a group, shopping mall companies started life as public companies somewhat more highly leveraged than some of the other REITs. If you have long-term leases, with some rent bumps along the way, you can probably use a bit more leverage. If your leases are shorter term, for example, hotels, and/or you need cash to fix up your properties, that's another story.
Let's shift gears and focus on your fund. Specifically, when you look at your U.S. fund's total returns, they're phenomenal. For the year-to-date period through June 4, you're in the red like every other real estate fund, though the Morgan Stanley index was down roughly twice as much as you were. Looking at the trailing 12-month and three-year periods through June 4, Lipper reports annualized returns of 40.1% and 31.7%. Those numbers beat every other real estate fund by a wide margin. They also are better than the returns for the S&P 500. The flip side, however, is that your fund doesn't appear to be for the faint-of-heart. In other words, whether we look at your Sharpe ratio or your standard deviation (see tables on page 52 and 54), your risk profile looks pretty aggressive.
Lieber: One reason we appear aggressive is because we're being measured against funds, most of which invest exclusively in REITs. As we discussed, we buy more than REITs. Home builders, for instance, are more volatile than REITs. We have chalked up some pretty good returns in them this year, even after you take into account the recent selloff. There are some funds that, like ours, aren't pure REIT funds. But they haven't been around as long as we have.
What about your turnover ratio? There's a lot of talk about tax-efficient funds, these days. A turnover ratio of 205% hardly seems tax efficient.
Lieber: Our turnover ratio is going to be higher than some of the other real estate funds. But the 205% number is an aberration. There were some technical factors last year that caused our turnover to be that high. We recently looked at our turnover ratio this year, and it looks as if we're running at what would be about 120% on an annualized basis.
Where do you see opportunities in today's market? Are there specific sectors or companies you could mention?
Lieber: We're still very high on the hotel sector. Assuming we don't have a recession, which seems like a reasonable assumption for the near- to mid-term, we should continue to see moderate increases in the demand for hotel rooms. At the same time, we don't see a lot of new supply coming on line over that time frame.
Halle: But we don't like hotels across the board. What we like are hotels where we see barriers to entry. When you look at construction, there's a fair amount of construction taking place, but it's not at the higher end of the market. We're also focusing on companies that own hotels in markets where it's tougher to build new hotels, especially urban areas.
Are there other sectors you like?
Lieber: Sure, we like offices. But it's important to go back to something Marc mentioned earlier, growth at a reasonable price. Last September, we had roughly 20% of the U.S. fund in office companies. But when we looked around, we thought that prices were high. Companies were trading at 30% to 40% premiums to their NAVs, so we lightened up on offices. By March of this year, we had cut back to about 14 1/2%.
What triggers a sale?
Halle: We have price targets for every stock. When a company gets within 10% of our price target, we take a hard look at things. Sometimes, we decide not to lighten up on our position. Sometimes, a company gets within 10% of its price target after it announces some new acquisitions. If that's the case, we look at the acquisitions and decide whether or not we need to raise our price target.
What about on the downside?
Lieber: That's tougher. We don't have a stop-loss point, though it's something we're considering. When a stock gets nailed, or drifts down gradually, we reassess our position. Sometimes, we sell. But if we think the market has overreacted to some news, or if we think the price drop has created additional value, we'll hang in. There are no hard-and-fast rules. We take it case-by-case.
What about home builders? They took a hit recently.
Lieber: That's right. But between September 30 of last year and April 20 of this year, they had gone up by roughly 40%. So, though we didn't enjoy seeing them go down by 15% to 16%, we viewed it as a bit of give back.
Halle: We have been in the home building stocks the past few years, and over that time frame, we have done pretty well in them. One reason we like the home builders is the change that's taken place in that business. For example, they're now using options to tie up land rather than land banking. That provides the companies with more balance sheet flexibility. That's definitely been a major plus. There's also been a good deal of consolidation in the industry, and, on balance, we think that's been a very positive trend.
Lieber: One reason consolidation is positive is that it's turned some regional players, for example, into national firms. So, instead of saying "we're in California, we have to build in California," a company can shift its focus to where it sees opportunities. There are, of course, still some regional players. And the market has, in effect, penalized them in terms of their multiples. Some of them, in fact, look pretty cheap.
Is there a regional home builder that you like?
Lieber: Crossmann Communities, which is based in Indianapolis, focuses on the Midwest. The company's return on equity had been up around 29%. The company recently raised some equity to expand its business down to Kentucky and a little bit into Memphis and Nashville. That diluted the company's return on equity a bit, down to about 23%. The stock still looks reasonably cheap to us.
There's a lot of talk today about investing overseas. A number of U.S. REITs have already invested overseas, and others are talking about following their lead. Then, there are a number of mutual funds, already up and running or on the launching pad, that invest abroad. No one, however, has been at it longer than Alpine Management & Research's Sam Lieber. We spoke with Lieber recently to get his take on the outlook for real estate stocks abroad and on U.S. REITs buying overseas. Is it time to focus on the rest of the world? Before we started our fund in 1989, we spent a lot of time researching overseas property markets. What we found was that the returns in the early- to mid-1980s were unbelievable. A lot of that was Japan and Southeast Asia, which put up incredible numbers during that period. The numbers were pretty good in Europe, though when you dissected the data what you found was that there were a few countries that did pretty well, but overall it wasn't anything spectacular. We launched our fund in 1989, and for a while we were humming right along. Then there was Tiannamen Square, and we got cut off at the knees. Since then, there's been a good deal of volatility abroad. We saw sustained rallies in Asia and Europe in 1993. There were a couple of other markets that popped in 1995 and 1996. But that was it. So for the past eight or nine years, except for the occasional rally, overseas markets haven't been a very good place to be.
It can be. But the way we look at it is that there's been a really great run in the United States. As economies overseas begin to recover, property stocks abroad should benefit. How many countries are you in today? We're in 19, not including the U.S. Out of that group, I suppose there are two or three that don't look all that great right now. But, as you know, we're value investors. So we look for situations that might not look great today, but where we see opportunities for substantial growth in the future. Sounds like a lot of countries. We have positions in that many countries, but we're concentrating our bets in only a handful (see table below). What about the diversification story—in other words, what you were talking about earlier, that overseas markets are out of the sync with the real estate recovery in the U.S., and that creates an opportunity? You can make that case. To some extent it's valid. But all too often the "out of sync" argument ends up being an excuse for mediocre performance, or worse. Our investment thesis overseas is a mix of value, growth, and takeover plays. Then, there's our view that there are quite a few countries where the process of securitizing equity real estate will follow what has happened in the U.S. Historically, there are opportunities when industries consolidate. What sort of returns do you expect abroad? We recently reviewed the data on the GPR index, which is the Global Property Research Index). It's an index put together by a couple of university professors in Maastricht, The Netherlands, who also act as consultants. What their index shows is that from the end of 1983 through May of this year, returns in North America, which is predominantly the U.S. but also includes a bit of Canada, have been 9.9% per year. In Europe, the number has been 10.5%. And for the Far East, with obviously a heavy weighting in Hong Kong and Japan, the number is 13.0%. What about U.S. REITs that are talking about investing overseas? How risky do you think that strategy is? It depends. Some countries are going to be easier for U.S. REITs to enter. For now, that's primarily the European countries. But there are a number of issues to take into account. The people in those countries aren't wild about U.S. companies buying up their real estate. Remember what happened when the Japanese started buying a lot of property in the U.S. in the late-1980s? If anything, the reaction will be stronger overseas. For that reason, as well as others, it's going to be important for U.S. companies to form partnerships with local players in foreign countries. If they do that, there will be some decent opportunities. | ||||||||||||||||||||||||||||||||||||||||||||||||||||