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Real Estate, Raw and UncookedBy Paul Sutherland, CFP ®Posted Oct 6, 2011
Current ObservationsOctober Edition by Jeff Lokken, CFP®, ChFC® Designating A Trust As Beneficiary Of Your IRA Depends On Your Objectives by Alice McDermott, CFP® I think that the world economy could be very slow for a very long time. And I feel that as former Federal Chairman Paul Volcker has said repeatedly … you can't inflate yourself to prosperity and out of slow economic growth, giant deficits and structural impediments to wealth and job creation. Recently, Volcker has been quite critical of the banks that have been run like leveraged hedge funds, with proprietary trading rooms and private equity investing. In fact, he has been quoted as saying that the "… only useful banking innovation has been the invention of the ATM." I was a young man managing portfolios when I was able to watch Volcker's leadership and unwavering determination to do his job without outside influence. I admired his courage, and though it may sound silly, I was proud that we shared the same first name. He did the right thing. And what I find interesting is that many are feeling that the path we took in the 1970s – e.g., a little inflation is good, maybe a little more is better – might also be a good path for today. Well, it is not – inflation does not cause jobs because the economy and society just "reset" themselves based on "expectations" of constant inflation. While we may possibly be on a path toward inflation, it seems that our path will most likely be akin to Japan's in the last 20 years, with many years lost as politicians squabble and disagree on where to make cutbacks, and as citizens say "no" to paying for all they expect government to do for them. So gridlock we will get, which translates into terra inferma for businesses, investors and taxpayers. Right now, the U.S. appears to be one of the healthiest horses in the glue factory – but that will change, and capital will flow where citizens and governments are fair, kind and consistent with their policies regarding investors, labor, job creators and entrepreneurs. These environments make it simple and easy for their business community to create real, sustainable jobs. It is against this backdrop that I would like to discuss real estate. Real EstateOkay, we all have heard the phrase LOCATION, LOCATON, LOCATION, and that is true. But to that I would add type of property, ownership structure of the real estate (e.g., bought with debt or owned free and clear) and who is managing the real estate. Nothing is simple. Raw land looks great until you get your first tax bill, the freeway bypasses your land or you realize it doesn't bring in any income. Farmland looks great until you have a drought, commodity prices collapse or trade barriers are erected. Office buildings are great until the tenant moves to a different site. And residential real estate … well, everyone reading this knows the risks of residential real estate. We believe that assessing real estate investing must be premised with the following nine "guiding premises" in mind:
Everything Is CyclicalMoney is "scared" right now, and investors are risk averse. Try to get a new real estate project off the ground and you're going to find that convincing people to invest is a very hard sell. If it is going to be slow-going for new projects, that eliminates a significant competitive force, allowing select existing real estate operators the advantages of scarcity. Now strip mall owners are not feeling real lucky right now, nor are second- and thirdtier landlords. With home ownership no longer available to many people, rental housing is booming in some areas. As workers move closer to where they work, that benefits owners of some city center properties. Not to belabor the point, but people live in New York, Hong Kong, Singapore, Beijing, Sydney, London, Frankfort and other great cities for a reason. I have been to those cities, and there is a quality of life that is quite attractive – even for a guy like me who grew up in a very small town (Glen Arbor, Michigan). I was in Sydney on business a while back, and every meeting I had, save one, was a short walk from my hotel. After the financial collapse in Asia back in 1997, my colleague, Barry Hyman, and I clocked 17 appointments with companies and analysts in one day. So quality city center locations will tend to always be expensive and in demand. So besides analysis of the real estate securities what else do we look for? We want to buy at the right price. Sustainable Cash Flows and DividendsFIM Group client portfolios may contain up to five income- and growthoriented real estate investment trusts (see sidebar at right). Also, many clients own shares of Brookfield Real Estate (Canada realtors), Market Leader (a company that helps real estate agents be more effective through innovative software and marketing products) and three companies that have significant real estate holdings: Cheung Kong (Hong Kong), Brickworks (Australia) and Lippo Karawaci (Indonesia). continued from page 1 Of course we consider the nine premises for real estate listed earlier in this essay, but we also look for sustainable dividends and dividends that can grow over time. Real estate income can increase by rent increases, lower inventory, ramp up of properties, rent participations, lower cost of debt and increased asset deployment as new projects become income-generating. At FIM Group, when analyzing real estate companies, we look for several things:
The lowest current cash dividend-yielding securities in client real estate-oriented securities is Lippo Karawaci Indonesia at 1% (very growth-oriented) and Cheung Kong, which reinvests most of its income but still gives a cash dividend yield of 3% (as of September 18, 2011). The highest yielders are the five REITS and Brookfield Real Estate, which all have cash yields of between 6% and 8.75%. Clients who need significant current income from their portfolios typically will not have Lippo Karawaci and more modest dividend payer, Cheung Kong holdings in their portfolios. The Raw and UncookedGlobal financial markets are in disarray right now, Europe is testing its power over the Euro, the U.S. is looking ungoverned and leaderless, and Asia is transitioning to relying on the resilience of its own domestic economies as export-driven growth slows. It’s all good – if you’re on the right side of the changes. We believe that as Asia looks inward, real estate will benefit. Today, the brokers are getting sell orders from their average investors/customers and buy orders from the management of the companies that people are selling. There is a real disconnect right now between how companies are seeing the value of their own equities and how the public is behaving. It is a very good sign that you’re “buying at the right price” when insiders are buying. We are seeing significant insider buying on many of the securities mentioned here and in our client portfolios – and that’s a very good thing. There is no better show of confidence than management buying shares of the company it knows best. As we wait patiently for people to realize that there are great yields on great investments selling at pennies on the dollar, we will collect our cash dividends and pay them out for the clients needing current income, and reinvest them for clients who will need income later in their lives. I am amazed at the bargain prices we are getting today – it’s like the early 1980s, 1987 and 2008 all over again. Going forward, there are great opportunities to invest for sustainable, resilient, consistent income and profits. |