janus's dublin-based fund of real estate investment trusts will invest broadly but not in interest rate-sensitive mortgage reits
Janus has launched a fund of US real estate investment trusts (Reits), called the US Reit Fund. Although the fund is new, the strategy is not, having followed for five years in another fund run by the same manager, William Schaff.
The new structure is domiciled in Dublin and has a minimum initial investment of $2,500 or e2,500, with subsequent minimums of $1,000 or e1,000. The benchmark is the Morgan Stanley Reit Index.
The portfolio invests primarily in publicly traded Reits, with the majority of these being listed on the New York Stock Exchange. The portfolio does not include real estate operating companies or companies with large real estate holding where the majority of earnings are non-real estate related. The fund also does not invest in mortgage Reits as these are highly interest rate sensitive and are more financing vehicles than real estate operations.
Schaff says: "Our objective is to provide investors with direct exposure to the changes in value of predominantly US-based commercial real estate and the companies that own, manage, acquire and develop it. By excluding all non-Reit securities, the portfolio ensures that it does not inadvertently create portfolio risks for clients that correlate with the core parts of their portfolios.
"Commercial property has a low correlation with the US housing market. It has taken a while for Reits to get recognised as an asset class. But, Reits now have become proxies for direct commercial real estate as it does not have the liquidity problems of selling a building. A Reits portfolio can be re-balanced quickly."
Reits have had a long history in the US and date back to the 1960s when US congress passed the Reit Act that created a structure that allowed small investors to invest in commercial property.
The major commercial property sectors that can be included in the Reit Fund are retail, office, industrial and hotels. Retail can be shopping malls and centres as well as outlet centres. Offices include high-rise central business districts and suburbia. Industrial properties can be warehouses and distribution centres, residential apartments and manufacturing.
Hotels include full service and limited storage properties as well as nursing homes and assisted living centres. There is also a special category for car lots, storage properties, golf courses and restaurants.
retail vs commercial
The portfolio is invested across the board. According to Schaff, in recent times retail has done well because of consumer spending following the strength of the housing market and low interest rate environment.
But Schaff does not feel the retail sector will continue to perform well. Instead the economic recovery should see the industrial sector perform well as growth begins.
Schaff says: "As interest rates rise the affordability of buying a house will become less apparent and more people will be looking for apartments to rent."
For the next 12 months, Schaff believes the US real estate markets will see two out of the three major Reit sectors, apartments and office/industrial, remain weak, reflecting a continuing lack of demand for space by US business.
However, Schaff expects that over the next several quarters, the demand for space will begin to improve and that real estate owners' cash flows will stabilise. Real estate cash flows and Reit owners' dividends will provide most of the investors' returns for the remainder of 2003 and into the early part of 2004, but Schaff expects to see better prospects for equity appreciation later in 2004, reflecting the recovery of the US commercial real estate market.
Over the next 36 months Schaff expects there to be a continuing recovery of demand for space in apartments and offices, as capital expenditures rise and job growth increases. Meanwhile, Schaff believes the retail sector will continue to enjoy stable and healthy returns, driven by increasing consumer incomes and confidence levels.
In choosing stocks, Schaff does not use macroeconomic forecasts in his investment strategy but rather looks at each Reit from a bottom up perspective. Once an idea is generated, it will be followed up by an analyst on the team. Schaff's research is long term in nature, focusing on a company's ability to generate acceptable free cash flow on a long-term basis. The analyst is expected to review both quantitative and qualitative aspects of any company's operations.
Schaff says: "In Reit investing it is crucial to focus on management. The top managements are able to make the best long-term real estate investments via acquisition or development, while maintaining a strong balance sheet. These management teams, over time, create the most incremental value and stock returns for equity investors. The team focuses closely on management quality, the amount of debt leverage used and the quality of the real estate held."
Qualitative factors are also looked at such as Reit management, location, properties, the supply/demand situation, and growth opportunities (both internal and external).
Schaff's valuation models allow for the blending of three separate methodologies into one valuation: firstly, discounted cash flow; secondly, net asset value adjusted for qualitative measures; thirdly, comparisons of Reits multiples and those of its peer group. This model determines a fair stock price and is a crucial part of deciding whether to add to the buy/sell list.
The portfolio generally consists of 30-40 securities with an optimal amount in the middle of the range. Exposure to riskier sectors such as hotels, are kept to a minimum. As a rule, sectors that Schaff believes will face difficult real estate markets over the next 18-24 months will be underweighted relative to the benchmark. Sectors are over- weighted if Schaff feels confident of their long-term outlook.
Risk is minimised in the portfolio by limiting investments to liquid securities, allowing rapid exit if necessary; by avoiding over-exposure to any single real estate sector; by focusing on high quality management teams and solid balance sheets; and by favouring Reits that own higher quality assets.
The primary interest in the product is from Asia as it has a high yield structure. Over the past 20 years, equity Reits have delivered average annual returns of 11.95% according to the National Association of Real Estate Investment Trusts. It is also a way of gaining access to the US commercial real estate market without the problems associated with direct investing.
In addition, Reits must pay out nearly all of their taxable income to shareholders, investors can look to Reits for reliable and significant dividends. Therefore, the fund will be a good fit for investors who seek high levels of current income and the opportunity for moderate long-term growth. Additionally, since Reits demonstrate low correlation to other investments, investors can use this fund to diversify their investment portfolio beyond stocks and bonds.
About the manager: William Schaff
William FK Schaff, CFA, portfolio manager and manager of the Undiscovered Managers REIT Fund (formerly co-managed with Ralph Block since 1998). Schaff is a team Portfolio Manager for the Janus Adviser Small Cap Value Fund and manages Large Cap Value Institutional Portfolios within the Janus Capital Group. Schaff started his career as a business analyst for Chevron Corporation in 1980 and was one of the principal analysts responsible for divestiture valuations during the Chevron/Gulf Oil merger. In 1985, he joined the San Francisco based asset management firm of J Stewart Investments as a senior investment analyst and portfolio manager. In 1986, Schaff co-founded Bay Isle with Dr Gary Pollock.
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