In early 2008, Michael Winer felt like a kid with empty pockets in a candy shop. After a downturn in real estate stocks in 2007 and early 2008, Winer, who manages the $2.3 billion Third Avenue Real Estate Value fund, was itching to buy shares of what he considered great real estate companies at discounts he had not seen for nearly a decade. But in the midst of daily headlines about declining home prices and suffering real estate markets, the fund, like other real estate offerings, had seen net redemptions by the end of 2007. The frustrated manager recalls "pounding the table, saying this is the time to buy" at a time when there was little cash to go shopping.
Eventually, investors saw the sector as over-punished and, like Winer, found the compelling valuations hard to ignore. Since March, real estate investment trusts, or REITs, have performed better than the broader markets. After suffering a 27% decline between January 2007 and February 2008, the FTSE NAREIT All REIT Index began climbing and was up 6.46% during the first five months of the year, a period when the broad market averages sank into negative territory.
Winer says that while large discounts to net asset value are not as across-the-board as they were at the beginning of the year, he still sees plenty of value, particularly in certain overseas real estate companies with strong portfolios and pummeled stock prices. If the real estate market has been punished, he says, the stocks of solid publicly traded real estate companies have been punished even more.
Pessimism may continue in the housing market; however, Winer's fund is focused not on housing but on commercial real estate companies with long-term leases, strong management, solid cash flow and properties located in attractive markets with high barriers to entry. "There will be pockets of weakness in commercial real estate, but some companies will need to go through two or three real estate cycles before they have to start worrying about vacancies," Winer says. "Notwithstanding the evidence that commercial property values have declined, and may decline even farther, the public market for stocks of high-quality real estate companies has overreacted to the global credit crisis."
The fund's global exposure is one reason that its performance often diverges from that of its competitors. Its foreign holdings, which make up nearly half of the portfolio, worked in its favor during the sector's downturn in 2007, when surging stocks from Japan and Hong Kong balanced out lagging returns from U.S. holdings. Last year, the fund's Hong Kong holdings leaped 60% to 80% as U.S. REITs suffered double-digit declines. But with the recent upturn in large, popular U.S. REIT stocks, the fund has lagged many of its more traditional peers so far this year. "We often zig when the rest of the REIT market zags, and we tend to outperform in bear markets," observes Winer, who has shifted some of the profits from the Hong Kong holdings into U.K. and Japanese stocks with more compelling valuations.
A certified public accountant and former real estate developer, Winer was investing in overseas real estate stocks long before the practice became popular. With a small asset base and plenty of stock bargains to choose from in the U.S., Third Avenue Real Estate Value fund stayed domestic for a few years after it opened its doors in September 1998. It expanded its reach about five years ago as U.S. real estate stocks became pricey and its asset base swelled.
To access the kind of valuations he wanted, the manager called on the international equities team at New York-based Third Avenue Investors to help him mine less discovered real estate companies based abroad. Today, the fund has ample exposure to real estate companies based in the U.K., Hong Kong, Japan, Canada and Singapore.
Winer says that foreign real estate companies tend to be well financed and more conservative in their business practices than their U.S. counterparts. And despite their far-flung properties, there is plenty of information available about them to determine whether their stocks represent a good value. In the U.K. and Hong Kong, for example, real estate companies must get properties appraised twice a year, a mandate that helps Winer arrive at an estimate of their real estate portfolios. Japanese reporting is somewhat less transparent, although the firms in Japan own some of the highest-quality office properties in the world and enjoy favorable financing rates of less than 2%.
Regardless of location, one of the key questions Winer asks when he makes a purchase is whether the public value of a company's stock is less than the private market value of its real estate, and if so, by how much. Even though many of the companies in his portfolio have attractive real estate collections and strong fundamentals, their stocks often sell at a substantial discount to the value of their holdings.
He cites British Land Common as an example of a stock that has been oversold because of fear and uncertainty, despite very strong underlying property and corporate fundamentals. The firm has a high-quality portfolio of office buildings outside of London, with average lease terms of 14 years; properties that are 99% leased; low-cost, fixed-rate financing; and cash flow that covers interest charges by 180%. Even though property valuations have declined, the company's stock has dropped at an even greater rate and, according to Winer's estimate, was recently selling at a 45% discount to net asset value. Other stocks of U.K. real estate companies are selling at discounts ranging from 35% to 50%, he says.