Brian Jones and Steve Shigekawa grew up on opposite coasts, but they share the same view of the country’s commercial real-estate market: It’s headed higher. After a traumatic collapse that pushed prices dramatically lower, values have hit bottom and a multiyear recovery is under way, fueled by still low interest rates, improving cash flows, rising demand and a scarcity of new development projects, according to the portfolio managers.
Jones is a 39-year-old native New Yorker and Harvard grad, while Shigekawa is a 40-year-old from Los Angeles with a degree from UCLA. They first met at Neuberger Berman, the well-regarded money-management outfit founded by investor and modern art-lover Roy Neuberger, who passed away at the age of 107 on Dec. 24.
Most recently, the twosome, both based in New York, have run the top-performing $211 million Neuberger Berman Real Estate Fund (ticker: NBRIX), a no-load institutional vehicle that’s just been opened up to retail investors (NREAX). Individual investors must pay a hefty 5.75% load and cope with a 1.23% expense ratio. But the fund pays a quarterly dividend and has a 1.89% yield.
Jones and Shigekawa’s goal is to beat the market by at least one or two percentage points a year by maintaining a fully invested, well-diversified portfolio of publicly traded real-estate securities, primarily real-estate investment trusts. Target investments, they say, must have access both to cheap financing and equity c
So far, so good. Through Dec. 29, Neuberger Berman Real Estate had outpaced at least 97% of its peers over three- and five-year trailing periods, which include the financial crisis. It climbed an average of 5.21% per annum for the trailing three years, outpacing the Standard & Poor’s 500 index, which was down 3.02%. For the five-year period, Neuberger Berman Real Estate was up an average of 6.26% a year, versus a 2.22% gain for the S&P. In the last trailing year, the fund ranked in the top decile. It’s up 29.04%, versus a gain of 14.13% for the S&P.
Obviously, sustaining REITs’ big gains of 2010 won’t be easy. The FTSE NAREIT All REIT Total Return index was up nearly 25.4% this year. But Jones and Shigekawa argue that commercial real-estate values are increasing due to improving cash flows and greater availability of debt and equity capital. REITs trade at about 15 times the managers’ estimates of 2011 funds from operations, which isn’t that much higher than REITs’ long-term average of about 13 times. REITs’ funds from operations, or FFOs, refer to their cash flow from operations and are used in lieu of earnings. Jones and Shigekawa expect rising dividends to continue to attract retail investors, foreign capital and pension money.
Plus, they will have ample opportunity to increase cash flow. Jones says billions of dollars of real-estate debt will mature in 2011. Even more will mature in 2012. So far, banks generally have been extending the maturity of loans rather than writing them off. But that could change as bank-balance sheets improve and the value of real estate rises; then REITs may have an opportunity to buy discounted, high-yielding commercial properties from the banks.
Jones and Shigekawa use top-down analysis of national and regional economic trends to decide which property sectors and geographic regions they favor. They want to own companies that can both expand their existing holdings and make new acquisitions as properties are recapitalized over the next few years. They pay particular attention to a REIT’s debt level compared with its earnings before interest, taxes, depreciation and amortization, or Ebitda.
|NB Real Estate/ NBRIX||29.04%||5.21%||6.26%|
|Top 10 Holdings||Ticker||Portfolio**|
|Simon Property Group||SPG||9.7%|
|Host Hotels & Resorts||HST||3.5|
|Vornado Realty Trust||VNO||3.5|
|*All returns are as of 12/29; three-and five-year returns are annualized.
** As of 12/8. Sources: Morningstar; Neuberger Berman
“On average, the REIT industry has a little over eight times debt to Ebitda, and typically we are looking to invest in companies at that level or below that ratio,” says Jones. Sectors like apartments, which have short leases, got hit the worst in the downturn, but now hold the most promise in the recovery.
They like apartment owner Equity Residential (EQR), though it climbed more than 50% in 2010; it’s more than doubled to $52 since they bought it below $22 in July 2009. They think it has more room to rise because the company has upgraded its portfolio.
“Today they are in much better markets and properties are concentrated on the coasts where they are able to get higher rents,” says Shigekawa. They anticipate Equity Residential’s FFO to come in at $2.45 in 2011, up from $2.20 in 2010, and $2.70 in 2012.
Another big winner has been Public Storage (PSA), a large self-storage operator. The fund bought it at $64 and it was recently trading at $102. “It’s not clear whether the housing crisis helped or hurt self-storage fundamentals, but generally speaking occupancies have improved and they are beginning to increase rental rates on existing and new customers because the more popular unit sizes are full,” says Jones. He and Shigekawa think the 2011 FFO will rise to $5.50 from $4.85 in 2010, and then to $5.90 in 2012.
Hotels have also attracted the managers because the business traveler, who usually pays full fare, has returned to the road. To play this trend the fund bought Host Hotels & Resorts (HST) under $7 and it’s jumped to nearly $18. Host has a seasoned management and is a major owner of hotel buildings, which it leases to various chains. They see Host’s FFO rising from 65 cents a share in 2010 to 95 cents in 2011 and $1.20 in 2012.
One other Neuberger Berman pick is Boston Properties (BXP), which owns trophy properties like the GM Building in New York. They purchased shares for about $50, which have subsequently run above $80. But they still like the REIT’s long-term leases and durable cash flow from well-heeled tenants. They expect FFO to reach $4.40 in 2011, up from $4.25 in 2010, before rising to $4.80 in 2012.
Jones and Shigekawa don’t see any major shocks lurking within the commercial real-estate market for 2011. But they caution that the damage from the leveraged-buying binge of the 2005-2007 hasn’t been healed. Some private owners of commercial real estate may need substantial equity infusions or to sell assets. That could lead to some juicy deals for well-capitalized public REITs and, by extension, Jones and Shigekawa (credit j.r. brandstrader, barrons)