O c t o b e r 2 0 1 4 | A p u b l i c at i o n o f I n s t i t u t i o n a l R e a l E s tat e , I n c .
Game
Changer How Ron Carson’s independent RIA is setting the standard for the rapidly evolving investment advisory profession
The REIT Choice Weighing your options across the traded vs. nontraded spectrum
Power Shift
A case for MLPs as a core allocation in investors’ portfolios
Golden Age?
Why the precious metal presents compelling benefits over the long term
Bridging the divide between retail investors and institutional quality real estate investment programs
AR Capital sponsors sector-specific public real estate programs focused on core investment strategies and durable income. Each company is led by an experienced management team targeting the following investment objectives:
Target investment sectors include:
■ Durable Income
■ Healthcare ■ Grocery Anchored Shopping Centers ■ Hospitality ■ Oil and Gas
■ Prudent growth
■ Mezzanine Debt
■ Private / public arbitrage
■ New York City Office and Retail
■ Principal Protection
■ Power Centers
■ Diversification by tenant,industry, property
■ Sale Leaseback
FOR MORE INFORMATION, PLEASE CONTACT:
AR Capital
405 Park Avenue, New York, New York 10022 Web Site: www.americanrealtycap.com – or – Sameer Jain: Phone: (646) 861-7726 | email: SJain@arlcap.com
THIS IS NOT AN OFFER TO SELL NOR THE SOLICITATION OF AN OFFER TO PURCHASE A SECURITY OR AN INTEREST IN REAL ESTATE.
Contents 30
October VOLUME 1
2014
| NUMBER 1
features
30 | Game Changer
Ron Carson’s independent RIA is setting the standard for the rapidly evolving investment advisory profession. By Ben Johnson
36 | The REIT Choice
Investment pros reveal the merits of both publicly traded and nontraded real estate investment trusts. By Joel Groover
42 | Power Shift
A case for MLPs as a core allocation in investors’ portfolios. By Michael Underhill
48 | Gold Standard
36
42
Gold bugs have been touting the precious metal’s bear-market advantages forever, but here is why investors might want to consider it as a long-term hold. By Juan Carlos Artigas
54 | Where Did the Year Go?
It’s time for year-end planning already, and here are a few solid tips for taking control of the process.
48
54
By Paul West
On The Cover Ron Carson talks about his upcoming SEC audit, the state of the profession and the role of real assets. Photo Credit: Michael Kleveter, Michael K Photography
realAssets Adviser | october 2014
1
Contents
October
2014
re a l a s s e t s a d v i s er . com
News & views
22
24
26
28
Real Estate
Infrastructure
Energy
Commodities
22 | Hot Property San Francisco has become the top choice for investors
24 | Utilities Boost Regulated utilities boosting investments to meet challenges
26 | Texas Strong Lone Star state surpasses Europe in oil production
28 | Silver Fix New London benchmark provides pricing transparency
23 | Pension commits Rhode Island fund commits $380m to real estate
25 | Water Parched New federal program arrives to provide drought relief
27 | Coal Assets Trade Blackhawk Mining buys three coal facilities
29 | Copper Climbs Renewable energy demand driving copper prices higher
23 | Healthcare REITs M&A is all the rage among leading healthcare REITs
25 | Debt Index Infrastructure debt index considered roadmap
27 | Gassing Up Gas-to-liquid market to grow by nearly 8% through 2018
29 | Growing Timber Timberland returns see best Q2 in seven years
22 | Twitter HQ Sells NY REIT pays $335m for Twitter’s Manhattan HQ
24 | Institutional Faves Institutional investors are high on energy infrastructure
26 | Index Outperforms Alerian index outpaces S&P 500 over past five years
Coming Next Month
departments
4 | Notes & Trends
11 | Market View
21 | people
8 | Contributors
15 | The Big Picture
63 | Editorial Board
18 | Up Front
64 | Last Word
10 | on the web
28 | Heavy Metals S&P upgrades pricing for precious metals
hat does the future W hold for real assets? Stay tuned.
The publisher of Real Assets Adviser, Institutional Real Estate, Inc., is not engaged in rendering tax, accounting or other professional advice through this publication. The opinions expressed in articles or columns appearing in Real Assets Adviser are those of the author(s) or person(s) quoted and are not necessarily those of Real Assets Adviser or Institutional Real Estate, Inc. Advertisements appearing in the magazine do not constitute or imply endorsement by Institutional Real Estate, Inc. Although the information and data contained in this publication are from sources the publisher considers reliable, its accuracy cannot be guaranteed, and Institutional Real Estate, Inc. accepts no responsibility for any errors or omissions. No statement in this magazine is to be construed as a recommendation to buy or sell any security or other investment. The contents of this publication are protected by copyright law and may not be reproduced in whole or in part or in any form without written permission. Š 2014. All rights reserved. Printed in the USA.
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realAssets Adviser | october 2014
Ranked Among the
TOP GLOBAL INVESTMENT MANAGERS 1 • SEC Registered Investment Advisor founded in 1992 by Peter Bren and Charles J. Schreiber Jr. • KBS has provided direct real estate investments on behalf of large institutional clients such as public and private pension plans, endowments, foundations, sovereign wealth funds and six public non-traded real estate investment trusts. 2
• Invested or managed over $18.9 billion in 1,575 assets nationwide (138.1 million square feet). KBS has sold 1,050 assets since inception. 3
• Fourteen investment funds totaling over 42.5 million square feet of real estate have gone full-cycle. 1
Institutional Real Estate, Inc. special report on 2014 Global Investment Managers. KBS ranked 65th out of 162 managers surveyed. Survey conducted by Property Funds Research, United Kingdom. www.propertyfundsresearch.com
2
Investing in real estate and real estate investment trusts may not be suitable for all investors and involves significant risks. These risks include, but are not limited to, loss of principal invested, no guarantees regarding future performance, limited liquidity, limited transferability and real estate value fluctuation based on various economic factors that may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover.
3
As of June, 30 2014, for all KBS entities. Full cycle refers to the acquisition and disposition of all assets in the portfolio.
2
www.kbs.com
[
notes & trends
By Ben Johnson Managing Director, Editor-in-Chief Real Assets Adviser
]
Welcome to the World of Education and Elevation
Real Assets Adviser is two years in the making, and serves a critical need for the investment advisory profession.
T
his is it. The culmination of more than two years of planning, poking, prodding and nurturing an idea into something that is oh-so-tangibly real. Whether you are reading this in print format or in a digital flipbook on our website, the premiere issue of Real Assets Adviser has arrived. And, like any new parent, we’re extremely proud of our creation, especially now that it is finally walking, talking and interacting with mainstream society. From the start, there are a few important things you should know. First, I didn’t think I would see another brand launch in my lifetime that had the potential to be such a game changer. Real Assets Adviser has that potential — if we execute properly on our mission.
Without a doubt, real assets is the largest and fastest-growing component within the alternative investment market today, and for good reason. We are certainly starting from an incredibly strong foundation, building on the decades-long track record of Institutional Real Estate, Inc. This “information brand,” as I like to call it, is
4
the brainchild of one Geoffrey Dohrmann, who has been a guiding light for the institutional real estate investment industry. Back in 1987, Dohrmann launched his own unique publication, The Institutional Real Estate Letter – Americas. There was nothing like it back then, so in many ways he was a true pioneer, recognizing and filling an information void. The rest is history, and for the past 25-plus years, Institutional Real Estate, Inc. remains the most reliable, smart, analytical purveyor of information in the institutional space. Second, in building and launching this new brand, we took our time to do it right. I like to say that our mission is to “Educate and Elevate.” We canvassed the advisory profession, and found that we were spot-on in terms of the education department. There really is no independent, third-party, credible information source dedicated to educating the investment community about the role of real assets in a portfolio. We also intend to Elevate the real assets class. By that, I mean to elevate the presence of real assets, not just among its alternative investing brethren, but to elevate it into more mainstream investment practice. To achieve that goal, just like Dustin Hoffman in his seminal role as Babe in the classic 1976 movie thriller Marathon Man, we understand the need to answer you and your clients’ most important question, and get it right or else: “Is it safe?” realAssets Adviser | october 2014
Built on insight. With a 40-year real estate investment heritage, an experienced team located in 22 cities globally, and assets under management of $48.2 billion (as of June 30, 2014), our real estate investment business employs a disciplined investment approach and offers a diverse range of solutions designed to help create value for our investors.
Deutsche Asset & Wealth Management represents the asset management and wealth management activities conducted by Deutsche Bank AG or any of its subsidiaries. Clients will be provided Deutsche Asset & Wealth Management products or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services. Š 2014 Deutsche Bank AG. All rights reserved. ARA145837 (8/14) I-035760-1
[
notes & trends
] A publication of Institutional Real Estate, Inc.
| The
Real Assets Adviser brand is 24/7 thanks to our website and flagship publication.
president & CEO Geoffrey Dohrmann CHIEF Operating OFFICER Erika Cohen
The answer, as it turns out, is: “Yes, and no.” We certainly understand the pros and cons of investing in nontraded REITs, for example. We all know the many horror stories about investors being bilked out of millions by unscrupulous broker-dealers who have only a vague notion of what the term “suitability” really means. Still, investors continue to pour billions into these products, so why? We are all about transparency. We want you to understand both sides of every story, not just the sensational headlines that will grab your attention and potentially cloud your judgment. And importantly, we want you to know what your successful peers are thinking and why. Our true value to you is being your go-to source for all real assets information. With that in mind, we will provide you with true thought leadership. With analysis. With the facts. So you can make your own decisions that are in the best interests of your clients. Because we live in an increasingly digital world that is alive every hour of every day, we will bring you news and views that you can’t find elsewhere. Our 24/7 delivery platform includes our website, which provides you with an around-the-clock information stream, supported by daily news emails. Our foundation is the Real Assets Adviser magazine, and you decide how you want to receive it, via mail for the printed copy or email for access to our digital version. Without a doubt, real assets is the largest and fastest growing component within the alternative investment market today, and for good reason. For more on that, I invite you to look around inside. Whether you are an RIA, wealth manager, financial planner, broker-dealer, registered rep, family office or defined contribution pension plan administrator, we have something for you. Read on…
We understand the need to
answer you and your clients’
Managing Director, PUBLISHER & editor-in-chief Ben Johnson SENIOR VICE PRESIDENT, MANAGING DIRECTOR of business development Jonathan Schein EDITORIAL DIRECTOR Larry Gray ART DIRECTORS Maria Kozlova Susan Sharpe Contributing Editors Drew Campbell Loretta Clodfelter Reg Clodfelter Mike Consol Denise DeChaine Richard Fleming Jennifer Molloy Andrea Waitrovich DATA SERVICES MANAGER
most important question:
Ashlee Lambrix
Is it safe?
Justin Galicia
DATA SERVICES Derek Hellender Karen Palma vice president, marketing Sandy Terranova marketing & client services Suzanne Chaix Elaine Daniels Karen McLean Brigite Thompson Michelle Tiziani Caterina Torres SPONSOR SERVICES Wendy Chen Salika Khizer Administration Andrew Dohrmann Jennifer Guerrero
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realAssets Adviser | october 2014
There’s more than one road to prosperity. Broadstone Real Estate offers real estate investment options for yield-driven advisers and accredited investors seeking an alternative to the public markets. Visit Broadstone.com/RAA to download an investor kit.
[
contributors
] Joel Groover The REIT Choice (page 36) Joel knows his real estate, having covered the commercial sector for more than 15 years. Today, he is an Atlanta-based contributing editor for Shopping Centers Today, the monthly magazine for the International Council of Shopping Centers. Joel has written for The Atlanta Journal-Constitution, Atlanta Magazine and National Real Estate Investor, among many others.
Hugh Kelly Learning to Love the Gateway Markets (page 15) Hugh is a borderline braniac. He is a clinical professor of real estate at NYU’s Schack Institute’s master’s degree programs, the 2014 chair of the Counselors of Real Estate, and principal of Hugh Kelly Real Estate Economics. He is the author of nearly 400 published articles and is wrapping up a book on 24-hour cities.
Vee Kimbrell Fact vs. Fiction on Nontraded REITs (page 64) Vee has over 25 years of experience in the financial services industry, having marketed and analyzed mutual funds, variable annuities, fixed annuities and institutional investment management services. For the past 12 years she has specialized in the nontraded REIT industry, honing her expertise in competitive analysis, market research and product development.
Michael D. Underhill Power Shift (page 42) Michael is founder and chief investment officer at Capital Innovations, LLC, and author of the Handbook of Infrastructure Investing (recommended by the CFA Institute). He is also a guest speaker at the Wharton Aresty Institute teaching infrastructure and real asset investing and is an award-winning real assets portfolio manager.
ISSN 2328-8833 Institutional Real Estate, Inc. Vol. 1 No. 1 October 2014 PURPOSE Real Assets Adviser is dedicated to providing actionable information on the real assets class and facilitating important business connections for investment advisers, wealth managers and family offices. Through print, online, conference and data p ro g r a m s , R e a l A s s e t s A d v i s e r provides thoughtful, cutting-edge analysis, helping advisers make informed decisions to diversify clients’ portfolios, provide long-term income and hedge against inflation. Real Assets Adviser (ISSN 2328-8833) is published 12 times a year for $195 per year, by Institutional Real Estate, Inc., 2274 Camino Ramon, San Ramon, CA 94583; www.irei.com; Tel +1 925-244-0500; Fax +1 925-244-0520.
CHANGE OF ADDRESS: Send address changes to Real Assets Adviser, 2274 Camino Ramon, San Ramon, CA 94583 USA. Copyright © 2014 by Institutional Real Estate, Inc. Material may not be reproduced in whole or in part without the express written p e r m i s s i o n o f t h e p u b l i s h e r.
Copyright Permission: Larry Gray, Tel +1 925-244-0500, x119; l.gray@irei.com Circulation or Subscription Inquiries: Direct all subscription inquiries, payments and changes of address to Client Services, Tel +1 925-244-0500 or Fax +1 925-244-0520; circulation@ irei.com. Subscribers have 30 days to claim issues lost in the mail.
Editorial Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Advertising Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com
Richard C. Wilson Wealth Management Is Thriving (page 11) Richard is founder of the Family Offices Group and CEO of Single Family Office Advisors, Billionaire Family Office and the Family Office Executive Search. He has met with more than 1,200 family offices in 17 countries and has written several books, including the bestselling The Family Office Book: Investing Capital for the Ultra-Affluent.
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Sponsorship Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Requests for Reprints: Susan Sharpe, Tel +1 925-244-0500, x110; s.sharpe@irei.com Visit us online: RealAssetsAdviser.com
realAssets Adviser | october 2014
GLOBAL PERSPECTIVE, ACCESS AND EXPERTISE IN REAL ESTATE INVESTING. For more than two decades, Morgan Stanley Real Estate Investing (MSREI) has been one of the most active global real estate investors, acquiring over $189 billion of assets in 36 countries.1 With 17 offices across 13 countries worldwide, MSREI leverages the perspective, relationships and expertise of Morgan Stanley to provide our clients with access to real estate globally. To find out more, visit morganstanley.com / realestate.
1 As of June 30, 2014 Š 2014 Morgan Stanley CRC1007897 exp 09/08 2015
7998871 Oct RE Ad 8x10 m1.indd 1
9/9/14 2:34 PM JOB INFORMATION
SPECIFICATIONS
NOTES
[
on the web
]
realassetsadviser.com Web Exclusive
Ron Carson Opens Up on SEC Audits, Fee Structures
O
ne of the leading investment advisers in the land reveals the challenges of preparing for his firm’s upcoming SEC audit and the continued evolution in how the advisory profession charges fees. He also talks about potential M&A opportunities ahead and why he thinks the millennial generation wants a whole new type of adviser that is capable of delivering an entirely new type of service.
REISA Changes Name to ADISA Reflecting change in the real assets marketplace, the former REISA, a leading trade group, has changed its name, to the Alternative and Direct Investment Securities Association (ADISA). The new name was unveiled at ADISA’s annual conference in Las Vegas in mid-September, which was attended by 1,000 alternative investment professionals.
We can’t change the trees or the economy or the state of our profession, but we can change our processes and approach to year-end planning. — Paul West, Peak Advisor Alliance SPE CIA L
Twitter: IREI_Inc
REP OR T
Special Report: Time to Get Real The Case for Real Assets et real Time to g assets The case fo
r real
Download our special eight-page report on the increasingly important role of real assets in the alternative space and why more advisers are embracing their investment characteristics.
Facebook: Institutional Real Estate Inc.
ed.
focus Insights Investor le, Data, IONAL ecting Peop INSTITUT TE, INC. Conn REAL ESTA
In Focus Video: Why adding Real Assets Makes Sense Watch Ed Schwartz, managing director at ORG Portfolio Management, discuss what is driving the latest real assets trend and why it makes sense. Go to:
10
LinkedIn: Institutional Real Estate Inc.
http://www.irei.com/real-assets-adviser/videos/in-focus-edschwartz-on-the-benefits-of-adding-real-assets-to-a-portfolio
realAssets Adviser | october 2014
[
Family Offices 101: Wealth Management Is Thriving
Market View
]
By Richard C. Wilson
Serving ultra-affluents’ needs has spawned a tight-knit but growing industry.
T
he family office has often been misunderstood, even though the concept has been around (in a variety of forms) for hundreds of years. Still today, as the industry controls billions of dollars in assets under management, there are many intelligent, experienced finance professionals who cannot offer a complete definition of what a family office is exactly. Today, the family office industry is expanding at an impressive pace, with new family offices opening every month and assets continuing to grow every year. The family office wealth management industry is larger and growing faster than ever before. Family offices are thriving, and the ways that ultra-high-net-worth families shape our economy and communities is evidenced all around us by their operation of franchises, apartment buildings, operating businesses and capital infusions. Family offices are an important source of capital for the small and medium-sized businesses and investments that fuel much of the global economy, an especially important factor given the risk of economic slowdowns all around the world. At last estimate, there are more than 3,000 family offices in the United States with another 1,000 in Europe and even more in Asia, Latin America and other areas of the world. Almost every week, we are approached by individuals and firms looking to establish a multi-family office or launch a single-family office. This is especially true in areas of the world where wealthy families and individu-
realAssets Adviser | october 2014
als previously had little-to-no access to family office wealth management firms. In places such as Singapore, Hong Kong and Brazil, investment professionals are seeing the increase in wealth and wondering how to best serve those wealthy families, and they are settling on a logical solution: the family office. Family offices are also much more visible in the public eye as of late. With high-profile celebrities, successful business professionals and other people of note turning to the family office model for their wealth management, the family office is becoming more and more well known to even noninvestment and financial professionals. Celebrities such as Oprah Winfrey, business executives such
Almost everything done within a family office is done with long-term planning in mind. as Donald Trump and entrepreneurs such as Paul Allen have all chosen to launch a family office to manage their wealth. It’s no wonder we have seen such a huge increase in global family office assets under management and a higher demand for family office–like solutions around the world.
11
Market View
Top 10 list
of Richest Family Offices
[
]
Firm name location(s)
Number of families
1. HSBC Private Wealth Solutions (Hong Kong) 2. Northern Trust (Chicago) 3. Bessemer Trust (New York) 4. BNY Mellon Wealth Management (New York) 5. Pictet (Geneva) 6. UBC Global Family Office (Zurick, London, Singapore, Hong Kong, NY) 7. CTC Consulting | Harris MyCFO (BMO Financial) (Chicago) 8. Abbot Downing (Wells Fargo) (Minneapolis) 9. U.S. Trust (Bank of America) (New York) 10. Wilmington Trust (M&T Bank) (Wilmington, Delaware)
Assets under advisement (in billions)
YOY% change
340
$137.3
+11
3,457
112.0
+23
>2,200
77.9
+25
400
76.0
+18
>50
57.3
0
NA
47.5
+27
312
35.0
+6
594
32.2
+5
162
31.1
+5
436
24.6
-23 Source: Bloomberg
It is reasonable to assume that this demand will continue as more and more investors and wealthy families come to expect more from their wealth management advisers and want to have a more allencompassing solution for their day-to-day needs, such as tax and compliance work and portfolio management. Many financial and wealth management professionals have noticed this trend, too, and chosen to step off the beaten path of typical banking solutions and launch multi-family offices and single-family offices in order to better serve their clients and better align their interests with that of their clients. The more we speak with single- and multi-family office executives and ultrahigh-net-worth clients, the more excited we are for the possibilities and opportunities that lie ahead for this burgeoning industry. THE Ultra-affluent have different needs The ultra-affluent demand highly specialized financial services. While there are no set rules on what services a family office can or cannot offer, there are common investment and finance-related services that most of them provide for their clients. Many of these advanced services are not available within a private banking or traditional wealthmanagement setting because they are only affordable and, for the most part, necessary for the most affluent clientele. Family offices also offer superior expertise on constructing or selecting alternative investment portfolios and products, including real assets. Many have invested heavily in systems, reporting and institutional consultants to help select the most appropriate alternative investment managers and products for their high-net-worth clients.
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Almost everything done within a family office is done with long-term planning in mind. While recently speaking in Vaduz, Liechtenstein, I heard someone describe the royal family office there as managing portfolios with a multigenerational time horizon in mind, and I think that is a good way to describe the focus of many family offices. We recently interviewed Tal Speilman of Shekal Group, one of the leading multi-family offices in Israel. In the following quote, Tal summarizes his long-term dedication and approach to the client, even to go so far as to eventually know the needs of the client better than the client does: “I think that if you really want to give your client the best product for him and not for another one, only for him, I think you should know him very intimately. I think you should know your clients from all aspects, and this is the only way to, first of all, have the relationship between you and the client, and secondly, to prove for your client that you know his real needs. “Sometimes you will be the only one that will know his needs, and when I said the only one I could say that it’s the only one including him. Because sometimes they don’t really have the time or the ability to know exactly what they need, and because they need somebody from the outside to look and see what they really need, and I’m talking for the long-run aspect. And if you will ask an adviser, as I mentioned you will have the trust for many, many years with the client.” We also recently had the chance to interview Todd Spearin of Waxwing Advisors, who formerly worked inside a multi-family office with more than 100 clients as a managing director of wealth transfer. Here is what he had to say about the focus of service in the family office that he worked for: “What I really valued about the true family office environment is that you really are stewards for the family. Every employee at the firm I worked at had a deep sense of ethics and service and a real strong sense of putting other people’s needs before their own. I cherish that environment where the fiduciary level of responsibility for the clients’ affairs are placed first, all daily activities are focused clearly on the client first. There was no pressure from an organization, from superiors, from stockholders to put the profit before the client’s needs.” Richard C. Wilson is founder of Family Offices Group and CEO of Single Family Office Advisors, Billionaire Family Office and Family Office Executive Search. realAssets Adviser | october 2014
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[
Learning to Love the Gateway Markets
The Big Picture
]
By Hugh F. Kelly, Ph.D., CRE
Investors are rightly focused on pumping money into commercial real estate in major U.S. metros. Here’s why.
T
he commercial real estate asset class is large, more than $4 trillion in size, and extremely differentiated. Institutional investors have long appreciated the usefulness of commercial property in mixed-asset portfolios. Real estate provides diversification benefits, offers most of its return in the form of current income, is tolerant of leverage ratios significantly higher than corporate equities and, over time, has proven to be a helpful inflation hedge. The very size and complexity of commercial property, however, has challenged investors desiring exposure to this asset class. For those responsible for putting capital to work for personal investors, whether individually or in pools, both stocks and bonds provide index funds through which one can “invest in the market,” as recommended by standard portfolio theory. Such vehicles are not available for the entire universe of commercial property. A convenient index, such as the FTSENAREIT index, for example, mirrors the performance of publicly traded real estate companies only. The holdings of such companies, however, are not representative of the entire property market and, worse, are a subset of the equities market, diluting any diversification benefit in mixed-asset portfolios. Real estate investors have long realized that this asset class requires a balance of alpha-directed selectivity and beta-driven risk management for optimal performance. Over time, this column will
realAssets Adviser | october 2014
examine that balancing act, always in the context of the driving forces in the economy as they work at the national and, more significantly, the city level. Real estate’s tested emphasis on “location, location, location” has frequently been challenged, usually by financial engineers promoting some novel technique of “slicing and dicing” the property sector. But it is as true as ever that real estate’s defining characteristic is that it is tied to a particular place. An otherwise similar building has drastically different investment attributes depending on whether it is located in New York City or Newark, Dallas or Detroit, Las Vegas or Los Angeles. Some market aggregation is useful, though. Indeed, to understand this sector’s performance it
Over a nearly quarter-century of data, the 24-hour cities had cumulative total returns that were 72 percent higher at the metro area level. is critical to find common themes that sort through the welter of data investors now have at their disposal. Let’s take just one of those focusing topics, the so-called “gateway” or “24/7” cities. It is now fully two decades since the publication Emerging Trends in Real Estate asserted that the distinction
15
[
The Big Picture
| New
York City is among the best performing investment markets.
16
]
between “24-hour markets” and “9-to-5 markets” would be more important than the more familiar divide between downtown and suburban markets. Emerging Trends has proposed, over the years, a descriptive definition of 24-hour cities. The attributes have been identified as a concentrated mix of uses (office, retail, residential), with excellent transportation access, above-average safety and security, complemented by attractive recreational and cultural amenities. The publication also surveyed the industry to discover the cities considered to best fit these criteria. Over time, however, the discussion remained anecdotal and qualitative, prompting my colleagues and I to test the hypothesis that such markets would provide the expected superior performance for investors. To do so, we took a grouping of places asserted to have the 24-hour attributes and compared them with a group of supposed 9-to-5 cities. To control for size bias, we used groupings that were about equal in population and employment (in the aggregate); to control for geographic bias, we made sure each grouping had coast-to-coast, border-to-border representation. The 24-hour city grouping included Boston, Chicago, Las Vegas, Miami, New York, San Francisco and Washington, D.C. The 9-to-5 cluster comprised Atlanta, Dallas, Los Angeles, Minneapolis, Philadelphia, Phoenix and Seattle. What did the statistical tests show? The two clusters were verifiably different, to a statistically significant degree, in such attributes as population density, transportation modalities, amenities mix, crime rates and a host of related measures of urban quality — uniformly to the advantage of the 24-hour city group. But did this translate into better commercial real estate performance? It did. Using the office sector — the iconic land use of the post-industrial city — the 24-hour cluster had consistently better occupancy rates, higher rents, better operating/expense ratios and lower cap rates (the ratio of income to
price) when compared with the 9-to-5 group. Over a nearly quarter-century of data, the 24-hour cities had cumulative total returns, as measured by data from the National Council of Real Estate Investment Fiduciaries, that were 72 percent higher at the metro area level, and more than double for the downtown office markets. Such an advantage in returns should predict an intense flow of capital seeking the superior yields. The data clearly show that over time institutional investors allocated increasing shares of their real estate funds to the 24-hour cities. This preference has been confirmed by examining the broader universe of investors tracked by Real Capital Analytics. The 24-hour cities have been strong magnets for capital. Efficient market theory supposes that such advantages should be arbitraged away, and that at minimum yields in the capital-attracting cities should be compromised as their prices rise. There is some reason to doubt those suppositions. It is very difficult, very costly and very time-consuming for a city to assemble the 24-hour city attributes, and this helps explain the persistence of investment performance advantage dating back as far as 1987. Nevertheless, it is quite possible for cities to change, with consequences for their commercial property performance. Remember that in the 1970s a list of cities that included Boston, Miami, New York and Washington, D.C., would be almost a “blacklist” for investors. Reforms in local government, modernization of infrastructure and innovation in their economies made a huge difference in the years leading up to 1987, and these cities built upon those improvements subsequently. Likewise, long-term attention to areas such as downtown Los Angeles and downtown Houston — and even smaller cities such as Nashville and Greenville, S.C. — has gone a long way to assembling the recipe for success that has worked so well for the 24-hour cities. On the other hand, Chicago’s crime problem and the economic ramifications of governmental dysfunction in Washington, D.C., now cause investors to think twice about placing bets on their future commercial property performance. Complicated? Sure! But I suppose if it were easy, we would have a real Lake Wobegon effect — where all investors could enjoy above-average returns. Hugh F. Kelly is a clinical professor of real estate at NYU’s Schack Institute’s master’s degree programs, and the 2014 chair of the Counselors of Real Estate. realAssets Adviser | october 2014
up front
Park Avenue landmark could fetch $1.5 billion
Price Tag for Rebuilding NYC: A cool $50 billion
South Korea’s National Pension Fund Service, Invesco Real Estate and Monday Properties are selling 230 Park Ave.
New York City will need $50 billion to overhaul its outdated infrastructure over the next five years, says a recent study.
for sale
Alternatives Continue Their Inexorable Rise
$47,759.90
$47,989.00
$49,000.00
$53,431.30
$53,700.00
$54,292.90
$54,845.00
$59,000.00
$59,000.00
Ma c Dir quar ec ie Bri t Infra Grou dg ew structp (Au at ur str Dir er As e Funalia) ect soc ds UB H e iat SG lob Dire B dge Fes (U al A ct R lac un S) sse eal E ksto ds Dir t Mg state ne ( ect mt Fun US) R . AX eal E (Swit ds A R sta zer D The ire ea te lan Go ct R l Est Fund d) ldm eal ate s Dir an S Estat (Fran ect ac e Fu ce Re hs G nd ) al E ro s Dir ect T state up ( U J.P Pri PG . M vat Ca Fund S) org e E pit s q a an u l As ity F * (U Ko hlb Direc set M undsS) t e H g Dir rg ect Kra edge mt. ( Pri vis Fu US) vat Ro nd e E be s qu rts ity (U Fun CB ds o Black Fund S) RE f H sto s Dir Glob edge ne ( ect al F U Re Inv undsS) al E est Dir sta ors ect Co B te Fu (US Ap mmolackR nds ) Di oll di oc LaS rect P o Glo ties F k (US all riva bal und ) e In te M E g s Dir vest quity mt. Ca ect R ment Fun US) rly d le S eal Es Mgm s olu tate t.( tio Fun US) Pri ns vat Gro ds e E up qu (U ity S) FoF
0
$60,936.19
20,000
$64,096.40
40,000
$70,405.29
60,000
$60,206.00
Alternative Asset Managers Ranked by Total AuM $87,108.00
80,000
time, also includes the top-ranked managers, by assets under management, in each area. Data from the broader survey show that total global alternative AUM is now $5.7 trillion and is split between the asset classes in broadly similar proportions to the top 100 alternative investment managers — with the exception of real estate, which falls to 24 percent, and hedge funds, which increases to 27 percent of the total. “For almost all of the past 11 years of this research, we have seen increasing allocations to alternative assets by a wide range of investors,” says Brad Morrow, head of manager research, Americas. “Not only has the appeal of alternative assets broadened to include many more insurers and sovereign wealth funds, but the range of alternative assets has also increased beyond the likes of hedge funds and infrastructure to include real assets, illiquid credit and commodities.”
Top 15
100,000 $96,347.90
Total AUM (US$ million)
Total assets managed by the top 100 alternative investment managers globally reached $3.3 trillion in 2013 (up from $3.1 trillion in 2012), according to the latest research produced by global professional services company Towers Watson, in conjunction with the Financial Times. The Global Alternatives Survey, which covers seven asset classes and seven investor types, shows that of the top 100 alternative investment managers, real estate managers have the largest share of assets (31 percent and more than $1 trillion), followed by private equity fund managers (23 percent and $753 billion), hedge funds (22 percent and $724 billion), private equity funds of funds (10 percent and $322 billion), funds of hedge funds (5 percent and $173 billion), infrastructure (4 percent) and commodities (2 percent). The research, which this year itemizes real assets and illiquid credit for the first
FINRA: 18 Months for Nontraded REITs
* Data derived from the Global Billion Dollar Club, pubished by HedgeFund Intelligence Source: Towers Watson
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The Financial Industry Regulatory Authority asked the Securities and Exchange Commission to give independent brokerdealers 18 months, or three times longer than originally expected, to implement rules that are intended to provide greater transparency on the valuation of shares purchased and property portfolios of nontraded real estate investment trusts. Nontraded REITs are expected to raise some $20 billion or more in 2014. But FINRA’s rule 2340, proposed in December 2013 and approved by the SEC, will force sponsors of these investment programs to disclose all fees upfront on investor reports, as well as provide an independent valuation of portfolios within two years of the initial fund raise. The recent delay gives the IBD community more time to adjust to the rule, compared with the original timeline of only three to six months.
India Approves REIT Rules
India's market regulator has given the green light to the creation of real estate investment trusts in one of the world’s largest untapped markets, which could represent a lifeline to property developers there. Based in New Delhi, the Securities and Exchange Board of India said REITs should operate with an asset pool of at least Rs 5 billion ($82 million) and have an initial issue size of at least Rs 2.5 billion ($41 million) for shareholders. REITs will be allowed to invest in commercial properties only, SEBI said. realAssets Adviser | october 2014
Miscellaneous 1%
Cash & Cash Equivalent 11% Real Estate 22%
NJ WEALTH INDEX: ON THE CLIMB
Private Equity 22%
RegentAtlantic’s New Jersey Wealth Index tallied a score of 44 out of 100 in Q2 2014, up from only 17 in 2012.
Commodities 1% Fixed Income 14% Public Equities 23%
Currencies 0%
Hedge Funds 6%
HNWs ALLOCATE TO REAL ASSETS Tiger21 members allocate nearly 25% of their portfolios to real estate and commodities.
Why Real Assets Make Sense for DC Plans
For years, defined contribution (DC) pension plan sponsors have used stock and bond funds as building blocks for their core menus and target date funds. But, with increasing market volatility and lower forecasted returns, sponsors should consider adding real assets — such as commodities, real estate and listed infrastructure — to their plans to help participants achieve their retirement income objectives.
Why add real assets? Although stocks and bonds have historically performed well over time, uncertainty in global equity markets and the continued low interest rate environment continue to impact DC participants’ portfolios. Also, retirees are particularly vulnerable to the loss of purchasing power from higher inflationary environments. According to our research, DC participants could benefit from exposure to real assets because they: •B roaden portfolio diversification due to their historically modest correlation to stocks and bonds; real assets are typically underrepresented in portfolios • I ncrease the potential that the portfolio achieves a consistent real return above the rate of inflation over time •E nhance potential long-term returns by taking advantage of global trends that favor hard assets Adding listed real assets Most DC plans today have daily valuation and liquidity requirements, which limit
realAssets Adviser | october 2014
the choices for all asset classes (if the daily valuation requirement changes, there may be ways to embed less-liquid real assets in DC plans). Based on current constraints, Russell recommends: • Target-date funds should have allocations to infrastructure, real estate and commodities in the early working years, and should start allocating to TIPS as participants approach their targeted retirement dates. This provides diversification throughout the glide path, while becoming more conservative over time. • When adding real assets to the core menu, keep it simple. Instead of offering participants several options within the category, a bundled real assets option can help participants enhance diversification, potentially achieve enhanced returns and benefit from inflation protection. • Consider active management. Relative to other asset classes, real assets offer significant potential to enhance returns and diversification via active management. Selecting the right managers is an important aspect of implementing a real assets strategy. • Evaluate real asset portfolios in the context of their expected volatility. TIPS are not a real asset but can play a role in moderating volatility while acknowledging the importance of inflation to investors.
Josh Cohen, CFA managing director, defined contribution, Russell Investments Lee Kayser portfolio manager, Russell Investments
Capital Overhang Jumps by 23%
New research shows that the current capital overhang confronting the global private investment industry is 23 percent higher than historical patterns, according to Cambridge Associates, the global institutional investment firm. The overhang represents the amount of money that has been raised but not yet called. From 2008 to 2013, private capital and real assets funds raised $1.9 trillion, of which about 45 percent had been called as of Dec. 31, 2013. That leaves a global overhang of $909 billion — $168 billion more than the predicted amount of $741 billion (based on historical call patterns calculated from more than 3,400 funds spanning vintage years 1990 through 2013). U.S. private equity, European private equity and global real estate combined to account for $655 billion, or 72 percent of the total overhang.
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DeAWM Taps Fiedler for Real Assets Role
people
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Chuck Fiedler has joined Deutsche Asset & Wealth Management as head of strategy and business development, which is a new role for its liquid real assets platform and part of its alternatives and real assets business. He will be based in Chicago and report to John Robertson, global head of liquid real assets. In this role, Fiedler will be responsible for overseeing existing liquid real assets products and strategies as well as
developing new ones on a global basis. DeAWM’s liquid real assets platform comprises listed real estate, listed infrastructure and commodities strategies totaling nearly $30 billion in assets under management, as of June 30, 2014. Fiedler has extensive experience in liquid real asset product management, product development, relationship management and sales, including institutional and retail distribution channels,
which will be equally important drivers of future growth. “Interest in liquid real asset strategies has grown significantly over the past several years, with our business having expanded in both scope and scale,” says Pierre Cherki, head of alternatives and real assets at DeAWM. “We believe Chuck’s background in the space will be a significant factor in positioning our platform for long-term success, growth and innovation.”
Wade Balliet has been named chief investment adviser for Bank of the West, where he will lead its investment advisory and management team. Balliet has also been named a member of two BNP Paribas global investment management teams.
J. Lodge Gillespie is now director of real assets at National Railroad Retirement Investment Trust. Previously he was with the Investment Fund for Foundations.
Bob Keogh has been appointed head of alternative investment solutions for the Asia Pacific region for State Street Corp. Based in Hong Kong, Keogh will assume responsibility for the hedge fund, private equity and real estate businesses in Asia Pacific.
Gavin Brandon was appointed CFO and treasurer at Cole Office & Industrial REIT. Nester Clark has joined Institutional Property Advisors as director. Clark began his career at Goldman Sachs and later became the youngest partner ever to join Soros Real Estate Partners. IPA is the institutional property division of Marcus & Millichap. Christoph Donner was appointed CEO of Allianz Real Estate of America. He was formerly chief credit officer and member of the board of Aareal Capital Corp., based in New York City. Conor Flynn is the new president of Kimco Realty Corp. He was formerly executive vice president, COO and chief investment officer with the company. Flynn will continue to be CIO and COO. He replaces David Henry in the role of president; Henry will continue to be Kimco’s CEO and vice chairman of its board of directors. Bernard Geoghegan has been appointed managing director, EMEA and Asia Pacific, with Digital Realty Trust. He replaces Kris Kumar. realAssets Adviser | october 2014
Andrew Glass has joined CBRE Global Investors as managing director, Australia, as part of the firm’s strategy to grow its Asia Pacific investment management capability. Justine Gordon has joined AlpInvest Partners, the private equity fund of funds arm of The Carlyle Group’s Solutions, as managing director of its lead energy and infrastructure investment practice. Prior to joining AlpInvest, she was a managing director and head of acquisitions for Guggenheim Infrastructure. John Guthery was appointed senior vice president in product management at W. P. Carey Inc., based in New York City. He was formerly a 19-year veteran at LPL Financial. Dirk Hallemeier has been promoted to managing director and president of MacFarlane Partners. He has been with the firm for 13 years and replaces Greg Vilkin. Stuart Harris is now director and Chicago office leader for Towers Watson’s international consulting group. David Kay has been named CEO of American Realty Capital Properties. He is replacing CEO Nicholas Schorsch, who is stepping down this month.
Jeffrey Kleintop has joined Charles Schwab’s international investment team after resigning from his role as chief marketing strategist at LPL Financial in August. Spencer Levy has been appointed Americas head of research at CBRE. Levy is a seven-year veteran of CBRE, and had previously served as executive managing director in the company’s capital markets group. Jim McCulloch has joined Vertical Bridge as vice president of its real estate division. In this role, McCulloch will lead the development and expansion of Vertical Bridge’s real estate portfolio. He was most recently at Global Tower Partners, where he served as the vice president of real estate. Perry Offutt was appointed managing director at Macquarie Infrastructure and Real Assets, with responsibility for acquisitions and deal origination. He is based in New York City. Lisa Ward has joined DCT Industrial Trust as regional vice president, Atlanta. She will be responsible for overseeing leasing, development and capital deployment activities in the Atlanta, Memphis, Nashville and Charlotte, N.C., markets.
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R ea l E stat e news
New York REIT Acquires Twitter HQ for $335m
N
ew York REIT has closed on its acquisition of Twitter’s headquarters in Manhattan located at 245–249 W. 17th St. in the Chelsea neighborhood. The sales price was approximately $335 million or $1,191 per square foot. The sellers were Savanna and Atlas Capital Group, which acquired the twobuilding office property in 2012 for $75.8 million and invested $29 million in improvements. The renovations include
two new lobbies along with new state-ofthe-art building systems, windows, elevators and a rooftop terrace that overlooks the Hudson River. The property includes a 12-story office tower combined with an adjacent six-story mixed-use building and contains approximately 282,000 rentable square feet. In addition to Twitter’s headquarters, Room & Board occupies the retail portion of the building. Flywheel Sports is also a tenant.
Manhattan ranks as the number one market for investors, with a total of $17.2 billion in transactions during the first half of 2014, an 8 percent increase from the previous year, according to data collected by Real Capital Analytics. At presstime, during the third quarter, 38 transactions had been announced in the Manhattan office sector, totaling $6.36 billion in sales price. Transaction activity in the first and second quarters of 2014 was $3.3 billion and $6.1 billion, respectively.
Recovering Real Estate Market Boosts REIT Sector Balanced demand and supply are driving the real estate investment trust market. Stock exchange-listed U.S. equity REIT prices were up 16.25 percent, with a dividend yield of 3.52 percent in the first half of 2014, according to the National Association of Real Estate Investment Trusts. These results compare with the S&P 500 Index first-half 2014 total return of 7.14 percent and a dividend yield of 2 percent. Multifamily REITs have been the best performing sector due to strong rental demand and rising rents. Apartment REITs are up about 25 percent year to date. The supply of new multifamily units is being absorbed by demand, and market fundamentals are expected to remain strong over the next two years, according to a recent report from Freddie Mac. Some larger retail REITs, such as Simon Property Group and General Growth Properties, reported strong quarterly earnings. Student housing REITs are also a strong group, as are industrial warehouse and self-storage.
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Investors Leave Their Capital in San Francisco San Francisco has always been a place of investor interest — and the hot market keeps getting hotter. During the first half of 2014, approximately $6.93 billion in property sales were completed in San Francisco, pushing the market to third place in the top 40 most active U.S. investment markets, according to Real Capital Analytics. This was a 125 percent year-over-year increase. Two San Francisco office property transactions made RCA’s list of the top 25 property sales in the first half of the year. Paramount Group bought One Market Plaza from The Blackstone Group in a transaction valued at approximately $1.2 billion, and the Standard Oil Building sold for $315 million to J.P. Morgan.
Despite the fact that office rents in the San Francisco Bay Area are already stratospheric, they continued to climb 5.3 percent from the first quarter of 2014 to the second, representing the second-highest growth rate in the United States, according to Jones Lang LaSalle. The surge in office rents continues to make the market extremely attractive to office buyers. Larger acquisitions occurring during the second half of 2014 include Columbia Property Trust’s purchase of 650 California St. and the acquisition by Norges Bank Investment, which invests on behalf of Norway’s Government Pension Fund Global, and TIAA-CREF of Foundry Square II. Both assets were rumored to carry price tags of approximately $350 million. realAssets Adviser | october 2014
U.S. Commercial Property Sales Volume Jumps in First Half 2014 Sales of individual commercial properties rose 18 percent in the first half of the year, while portfolio transactions increased by 48 percent, according to Real Capital Analytics’ 2014 Mid-Year Review. For the first half of the year, transaction volume totaled $184.1 billion, up 23 percent year-over-year and just below levels achieved in 2006. Retail property sales volume was up 57 percent, well above all other property types. The only sector to register a decline was the apartment sector, and that was due solely to major portfolio sales inflating the yearago comparison.
Manhattan was the number one market, totaling $17.2 billion in transactions, an 8 percent change from the previous year. Two assets in Manhattan — Five Times Square and Time Warner Center — were the highest priced transactions in the country during the first half of 2014, selling for $1.47 billion and $1.3 billion, respectively. The industrial sector showed the most improvement from a year ago. Industrial properties showed the most cap rate compression of the property types in both quarters this year and recorded a 36 percent increase in volume in the first half of 2014 from the same period of 2013.
Rhode Island to Invest up to $380m in Real Estate
New Public Lodging REIT Readied by Inland American Inland American Real Estate Trust has plans to spin off its lodging subsidiary into a publicly traded company. The new REIT, to be called Xenia Hotels & Resorts Inc., formerly known as Inland American Lodging Group, will own 46 hotels in 19 states and the District of Columbia and a majority stake in two properties under development. Xenia will invest primarily in premium full-service, lifestyle and urban upscale hotels in the top 25 U.S. lodging markets and key leisure destinations throughout the United States, with a particular focus on urban and densely populated suburban markets with multiple demand generators and high barriers to entry. The company’s portfolio will include premium brands such as Marriott, Hilton, Hyatt, Starwood, Kimpton, Aston, Fairmont and Loews. The Xenia spinoff is part of a trend of firms creating REIT spinoffs. In 2013, Gaming and Leisure Properties, a triplenet-lease REIT, was spun out by Penn National Gaming to solely focus on casino and other gaming assets in Penn’s real estate portfolio. It is considered one of the largest REIT spinoffs since 2013. realAssets Adviser | october 2014
The $8.2 billion Employees’ Retirement System of Rhode Island is looking to invest $100 million into core real estate in each of the next two years and $180 million into noncore real estate during the next two years. The real estate portfolio, which exceeded its benchmark in 2013 with a 13 percent return despite a focus on core funds, represents about 5–6 percent of the total ERSRI portfolio. Including unfunded commitments from the past 18 months, the retirement system is still short of the 8 percent target allocation to the asset class. ERSRI’s real estate portfolio is slightly underweight to retail, industrial and apartments and slightly overweight to hotel and office, noted David Glickman of Pension
Consulting Alliance, the pension fund’s general consultant, in a recent board meeting. The capital invested into real estate during the next two years will mostly be invested with managers that ERSRI already uses, though a few new investment managers may be added. Glickman added that the portfolio should not add any new managers in the next six to nine months. In separate news, LaSalle Investment Management received a $1 billion mandate to invest in U.S. real estate from a large European institutional investor. The new mandate will seek direct real estate investment opportunities across all property types in U.S. primary and top secondary markets.
Healthcare REITs Capitalize on Rising Medical Services Demand NorthStar Realty Finance Corp. purchased Griffin-American Healthcare REIT II for $4 billion. The boards of directors of both companies have unanimously approved a definitive merger agreement under which NorthStar Realty will acquire all of the outstanding shares of Griffin-American in a stock and cash deal. The acquisition was announced in August and is expected to close in the fourth quarter of 2014. The acquisition followed Ventas’ bid to acquire American Realty Capital Healthcare Trust in June. While the ARC Healthcare merger is pending approval, Ventas acquired 29 Canadian senior living communities from Hol-
iday Retirement in an all-cash deal shortly after the merger announcement. The private-pay properties are located in seven Canadian provinces, with the majority in Ontario and Alberta. At the close, Atria Senior Living assumed management of the communities. And in other healthcare real estate news, the recently formed new Carter Validus Mission Critical REIT II, managed by Carter & Associates, purchased its first property, Cy-Fair Surgery Center, a 13,645-square-foot ambulatory surgery center in Houston. The nontraded REIT acquires assets in the data center and healthcare sectors.
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Infrastructure news
Institutions Favor Energy Infrastructure Markets, Worry Demand Is Inflating Prices
W
hat are the most attractive sectors for infrastructure investment today? Not surprisingly — according to attendees surveyed at IREI’s 2014 Institutional Investing in Infrastructure conference — they are energy transmission (31.2 percent) and energy generation (28.6 percent). And what geographic strategy is the most attractive for infrastructure investment? Conference participants say they prefer a combi-
nation of global and regional funds (38.4 percent) over only regional funds (30.1 percent) or only global funds (20.5 percent). A considerable number of I3 conference attendees indicated they do not think geographic diversification matters as much as who is managing their commitments — 11 percent said they are agnostic about geography and put more emphasis on finding the best infrastructure manager, regardless of the fund’s geographic allocation of capital.
The members of the Editorial Advisory Board for the Institutional Investing in Infrastructure publication, meanwhile, gave their opinions on conditions in deal markets at the annual I3 Editorial Advisory Board meeting, held prior to the I3 conference. Advisory board members expressed some concern over the competition for infrastructure assets, including the rising amount of capital targeting investments as well as increasing amounts of leverage used in transactions.
Dynegy in $6.25b Power Deal Dynegy is buying 10 power plants and a retail sales company owned by Duke Energy Corp. for $2.8 billion, and another nine power plants through a $2.45 billion purchase of Duke shares owned by private equity firm Energy Capital Partners. Dynegy will issue $5 billion in debt and sell $1.2 billion in stock. Once the acquisition closes in Q1 2015, Dynegy will generate 26,000 megawatts of power, enough to supply nearly 21 million U.S. homes, making it the United States’ secondlargest independent power producer along with Calpine Corp. The largest independent power producer is NRG Energy at 52,466 megawatts. Independent power producers do not own regulated utilities, and they operate independently from the regulatory price schedules that apply to regulated utilities. IPPs sell their power to regulated utilities and other end users, but the power generated by IPPs is subject to market pricing, which just three years ago forced Dynegy to file for bankruptcy when unregulated power prices collapsed.
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U.S. Regulated Utilities Boost Investments to Meet Challenges Regulated utilities in the United States are facing a myriad of challenges that require intensive capital investments, from updating and replacing aging infrastructure to adopting smart-grid technologies to investing to meet new environmental standards. According to U.S. Regulated Electric Utilities’ Annual Capital Spending Is Poised to Eclipse $100 Billion, a report by Standard & Poor’s, “this ever-growing need to fund improvement projects and comply with upcoming regulations could pressure utilities’
financial measures, resulting in almost consistent negative discretionary cash flow throughout this higher construction period.” Despite the pressures, Standard & Poor’s believes most U.S. regulated utilities will be able to maintain their investment-grade credit quality through effective management of regulatory risks as well as securing financing by new creative methods. Capital spending should reach $95 billion in 2014 and decline slightly in 2015–2016, Standard & Poor’s notes. realAssets Adviser | october 2014
Infrastructure Debt Index Considered Roadmap
Parched U.S. Water Systems Poised for More Federal, Private Support The Water Resources Reform and Development Act was signed into law by President Obama in June. The WRRDA authorizes funding for the construction and repair of waterway and port projects across the United States and includes a Water Infrastructure Finance and Innovation Act program that is similar to the U.S. Department of Transportation’s popular TIFIA program for public-private partnerships, or P3s, focused on the transportation sector. Writing in a research note about the passage of the bill, members of Mayer Brown’s infrastructure practice John Schmidt, David Narefksy, Joseph Seliga and George Miller note: “The U.S. Department of Transportation’s TIFIA credit support program is by far the most successful federal program providing financial support for surface transportation public-private partnerships. Few major P3 transportation projects in recent years would have been possible, and few P3s in the pipeline will go forward, without TIFIA assistance. Now, Congress has set out to try to repeat the success of TIFIA with a similar program — just substituting a ‘W’ for the ‘T’ in the acronym — to support major water infrastructure projects.” With many U.S. states experiencing varying degrees of drought — including the entire state of California — the new federal-level program has arrived just in time, and it should open the door to more P3 opportunities for private investors. realAssets Adviser | october 2014
The EDHEC-Risk Institute has published a new report — Unlisted Infrastructure Debt Valuation and Performance Measurement — a valuation and risk measurement framework for illiquid infrastructure debt. The report was produced from the Natixis research chair at EDHEC-Risk Institute on the Investment and Governance Characteristics of Infrastructure Debt Instruments. It is one of the “stepping stones” of a roadmap established by EDHEC-Risk Institute toward the creation of adequate performance measurement tools for long-term investors in infrastructure. According to the authors, investors considering infrastructure investment must consider the trade-off between credit risk and duration risk, which is unique to infrastructure debt.
“Long-term infrastructure debt poses a significant pricing challenge with no market prices, private cash flow data scattered amongst originators, and covenant structures creating ‘embedded options’ that are not taken into account in standard valuation models,” notes an EDHEC statement. “Taking these characteristics into account is instrumental to capturing the expected performance of infrastructure debt.”
Photo from Coolcaesar, en.wikipedia
CalPERS Taps New Infrastructure Consultant, Hires Managers The largest U.S. public pension fund, the California Public Employees’ Retirement System (CalPERS), has announced commitments totaling more than $1 billion to global infrastructure managers Morgan Stanley and UBS. Also, after listening to finalist presentations from three infrastructure consultants — Courtland Partners, Meketa Investment Group and StepStone Group — it selected StepStone Group following its investment board meeting in mid-September. Meketa is the current consultant and its contract expires in March 2015. StepStone was awarded the highest ranking among the three consultant finalists. StepStone hired David Altshuler from Meketa in January 2014. Altshuler was the lead infra-
structure consultant and worked closely with CalPERS. In investment news, CalPERS announced a $735 million commitment to UBS in August, including $485 million to Golden State Matterhorn, a $500 million joint venture between the pension and investment manager, and $250 million to UBS International Infrastructure Fund II. UBS has made a $15 million co-investment to the joint venture partnership, which expects to make between two and four investments between now and 2018. Morgan Stanley was awarded a $300 million commitment to its Morgan Stanley Infrastructure Partners II fund, which received a commitment from the Teachers Retirement System of Texas in June.
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ene r g y n e ws
MLP Index Outclasses Stocks, Bonds, REITs Over Long Haul
T
hough it slightly trails the S&P 500 Index over the past year, the Alerian MLP Index (AMZ) has thoroughly outpaced it over the past five years, with annualized returns of 26.2 percent compared with the S&P 500’s 18.8 percent annualized returns over that period. The MLP index, which tracks the performance of large- and mid-cap energy master limited partnerships, has performed even better when compared with the performance of utilities (14.4 percent for the S&P 500 Utilities Index) and
bonds (4.9 percent for the Barclays US Aggregate Total Return Bond Index) over the past five years, and has still outpaced REITs (22.5 percent for the Real Estate 50 Index). It performed even better compared with these indices over the past 10 years, signifying greater resilience during the global financial crisis. AMZ 10-year annualized returns are at 17.3 percent, well ahead of utilities (10.7 percent), REITs (9.5 percent), the S&P 500 (7.8 percent) and bonds (4.9 percent). What’s more, the
AMZ is also producing a higher current dividend yield (5.2 percent) than the other indices, with utilities yielding 3.5 percent, REITs yielding 3.8 percent, the S&P 500 yielding 2.0 percent and bonds yielding 2.2 percent (all data as of June 30). The AMZ equal weighted index (AMZE) has outperformed the AMZ in each of these measures except for the 10-year annualized returns, which were within 10 basis points of each other, suggesting that smaller companies in the index have performed better.
Texas Surpasses European Continent in Oil Production Oil production in Texas has surged through 2014, and at 2.9 million barrels a day, the state now produces more oil than the entire continent of Europe, according to the Energy Information Administration and JLL Research. That number could reach 3.5 million barrels a day by the end of 2014, putting the state’s production above all OPEC countries outside of Saudi Arabia, and representing an increase of more than 1 million barrels a day from the end of 2013, also according to the Energy Information Administration and JLL Research. The United States itself surpassed 8.5 million barrels per day of crude oil production for the first time in 27 years in the month of July. Currently, the United States is the world’s third largest oil producer after increasing production by an average of 1 million barrels a day for three consecutive years and is now projected to reach 9.3 million barrels a day in 2015, according to the EIA.
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Atlantic Wind & Solar Doubles Sales in Q2 Second quarter sales at Atlantic Wind & Solar, a Toronto-based renewable energy producer, jumped 231 percent year-overyear, marking the 18th straight quarter of sales growth, according to a statement from the company. Year-end sales for 2014 are on pace to double the 2013 results after reaching $3.4 million through the first half. The publicly traded company has a portfolio that primarily comprises solar photovoltaic assets across 22 municipalities in the province Ontario and five regions
in Central and South America, including Ecuador and Peru. Though solar energy accounted for only 0.39 percent of U.S. electricity generation in 2014 through May, the sector continues to grow rapidly, with U.S. solar photovoltaic generation increasing from 1,012 megawatt hours in 2011 to 8,327 in 2013, and U.S. consumption of solar energy is projected to nearly double from 2013 to 2015, according to the U.S. Energy Information Administration. realAssets Adviser | october 2014
Global Gas-to-Liquid Market Expected to Grow 7.8% Annually Through 2018 The global gas-to-liquid (GTL) market is expected to grow at a compound annual rate of 7.8 percent from 2013 through 2018, according to the latest report from Infiniti Research Ltd. GTL is the refinery process by which long-chain hydrocarbon products such as GTL diesel and GTL gasoline are created from natural gas. As it stands, there are only five operational GTL plants on the globe: Shell runs two plants in Malaysia and one in Qatar, a joint venture between Sasol and Chevron operates another in Qatar, and Sasol runs the last in South Africa. Only one plant, located in Nigeria,
is currently under construction. Capacities at the facilities range from 2,700 barrels per day to 140,000 barrels per day, according to the U.S. Energy Information Administration. According to the report, the high cost of capital related to the need for strong technical expertise and use of advanced technology is one of the largest barriers to new facilities. Three plants have been proposed in the United States, though only one is large-scale and none are under way. Shell canceled plans to build a large-scale GTL facility in Louisiana in December 2013 due to the high cost of capital.
Blackhawk Mining Buying Three More Coal Facilities for $52m James River Coal Co. has accepted a $52 million bid from JR Acquisition, a wholly owned subsidiary of Blackhawk Mining, for the Hampden Mining Complex, the Hazard Mining Complex (other than the assets of Laurel Mountain Resources) and the Triad Mining Complex, plus the assumption of certain environmental and other liabilities. The three plants are all located in either central Appalachia or the Illinois basin. James River filed for Chapter 11 bankruptcy protection in April after struggling with falling coal prices. The bid was approved by the court in late August. Blackhawk Mining purchased Arch Coal’s ICG Hazard complex, located in Eastern Kentucky, for $26.3 million in March 2014, and in 2012 the firm purchased Pine Branch Coal Sales and the accompanying complex, also found in Eastern Kentucky, in a move that more than doubled the company’s production, according to a statement from Blackhawk Mining president Nick Glancy. realAssets Adviser | october 2014
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Commodities news
Metals Price Assumptions Receive S&P Updates
S
tandard & Poor’s recently updated its pricing assumptions for key metals. According to the credit rating firm, the biggest change is a decrease of $10 per metric ton in the forecast price of iron ore. The approximately 10 percent decline is due to an increase of supply from Australia and Brazil, along with a decrease in demand, particularly from China. Regarding the price of gold, S&P suggests uncertainty regarding quantitative easing has continued to weigh on the precious metal. The firm notes: “Incorporating our expectation of benign U.S. inflation of 1.5 percent to 1.9 percent through 2016, we believe that gold prices will remain particularly susceptible to shifts toward higher U.S. interest rate expectations and a stronger U.S. dollar.” Additionally, S&P’s assumptions include a 15 percent increase in the price of nickel, driven by an Indonesian export ban. Though, the firm notes, “We also expect nickel prices to remain very volatile. For example, a potential cancelation of the Indonesian ore export ban could once again lower prices.”
Metals price assumptions
2014 2015 2016
Aluminum (US$ per pound)
$0.80 $0.85 $0.95
Copper (US$ per pound)
$3.10 $3.10 $3.10
Nickel (US$ per pound)
$8.50 $8.25 $8.25
Zinc (US$ per pound)
$0.90 $0.95 $0.95
Gold (US$ per ounce)
$1,250 $1,200 $1,200
Iron ore (US$ per metric ton)
$95
$95
$95
Source: Standard & Poor’s, as of June 16, 2014
Gold Demand, Price Fall in Second Quarter Gold demand fell 16 percent in the second quarter of 2014 from the same period the year before, according to the World Gold Council. In addition, gold prices dropped 9 percent, reports the WGC, with the London PM fix at $1,288 per ounce in the second quarter, down from $1,415 per ounce in the second quarter of 2013. The culprit was a drop in demand attributed to lowered interest from the jewelry industry (generally the largest segment of demand, and representing 53 percent of gold demand). Additionally, gold supply increased by 10 percent, and mining production was up 4 percent year-over-year in the second quarter. Central banks continued to be a strong source of demand in the second quarter, representing 12 percent of the market, with a 28 percent increase in demand year-over-year.
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The Fix Is in — Silver Pricing Gets an Overhaul The silver market entered the 21st century on Aug. 15, with the introduction of the London Bullion Market Association Silver Price, an electronic auction that is expected to bring new transparency to the industry. The new pricing scheme replaces the London Silver Fix, a daily conference call between just three banks that set the price for the metal — and that some believed to be an archaic relic of the Victorian era in which it began.
CME Group and Thomson Reuters run the new electronic auction mechanism, which will continue to operate out of London, with prices mid-day London time. In the first day of the new LBMA Silver Price, the price settled at $19.86 per ounce — exactly the same as it was on the last day of the silver fix. The silver market may be the first of the precious metal fixes to get an electronic update, so: Can the gold fix be far behind? realAssets Adviser | october 2014
Farmland Returns Track Lower in Second Quarter Farmland returns in the second quarter of 2014, at 1.73 percent, were the lowest since 2011, according to the NCREIF Farmland Index, released by the National Council of Real Estate Investment Fiduciaries. NCREIF’s index tracked the performance of 539 investment-grade farm properties, comprised of 395 annual crop properties and 144 permanent farm properties. The total return comprised appreciation of 0.78 percent and income of 0.95 percent. “Both the income and appreciation returns for the Farmland Index in second quarter were lower than the second quarter returns from a year ago,” comments Christopher Jay, chairman of the NCREIF Farmland Committee and director of financial analysis with Prudential Agricultural Investments, in a statement. In the second quarter of 2013, the index had a total return of 1.97 percent.
Returns over the past year also declined, with the four-quarter rolling return falling to 17.17 percent. However, notes Jay, “There continues to be strong interest from institutional investors as well as local farmers on property that comes up for sale.” At –1.18 percent, the worst-performing region was the Lake States; the region had depreciation of 1.81 percent. The Pacific West was the best-performing region, at 2.41 percent.
Solar Energy Growth Is Powering Demand for Copper Renewable energy sources, such as solar power, are big users of copper in the power cables and grounding wires. Now according to a presentation at the National Solar Conference this past summer, “Estimated Copper Demand from Projected Solar Electric Generating Capacity,” an increase in solar power generation will have a positive effect on copper demand. “Solar panels over large-scale areas require installing miles of copper grounding and copper-centric power cables,” notes Zolaikha Strong, director of sustainable energy for the Copper Development Association, who presented the findings at the conference. “By 2020, we estimate that 150 [million] to 410 million pounds of copper will be used in these systems.” The CDA study notes that investment in solar power is expected to grow from $91 billion in 2013 to $158 billion by 2023. That’s a lot of copper wiring. realAssets Adviser | october 2014
Timber Performance in Q2: Best Since 2007 Timberland experienced the best second quarter since 2007, returning 1.08 percent, according to the NCREIF Timberland Index. However, the second quarter 2014 return was down from the first quarter’s stellar 1.60 percent return. The second quarter return was split between 0.41 percent from appreciation and 0.66 percent from income, and the index tracked 461 timber properties valued at more than $23 billion. Looking at the index’s performance for the past 12 months, the rolling four-quarter return was 9.93 percent, split 2.58 percent from income and 7.20 percent from appreciation. This represents the largest rolling four-quarter return since the third quarter of 2008.
Regionally, the Lake States led the way in the second quarter of 2014, posting a 2.56 percent total return that was nearly double the return from the Northeast, which had the second highest returns. Despite a fairly lackluster second quarter, the Northwest still leads all regions on a rolling four-quarter basis by a wide margin with a 17.64 percent total return. Value per acre in the Northwest dropped from more than $3,000 during 2012 to less than $2,500 in 2014, but the Northwest still leads all regions in this category as well. NCREIF notes this decline was due to the index’s addition of new properties in the region rather than an actual depreciation of property value.
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| Ron
Carson looks forward to his SEC audit and the future of the profession.
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realAssets Adviser | october 2014
e m a G ger
n a h C
By Ben Johnson
How Ron Carson’s independent RIA is setting the standard for the rapidly evolving investment advisory profession.
R
on Carson is in a hurry. He has exactly one hour to catch a flight to a conference in Denver, so he is simultaneously packing, thinking and talking at 90 miles per hour. He also is calmly dealing with a pending SEC audit of the firm he has spent the past 20 years building. His frenetic nature is exactly what led him to an extraordinary business decision only three years ago — to break away from the largest independent broker-dealer in the world, LPL Financial, to form his own registered investment adviser. Today, his Carson Wealth Management consistently ranks among the top 10 investment firms in the United States, with more than $4 billion in assets under management. In late 2012, Carson launched another division, Carson Institutional Alliance, serving advisers with clients who have $75 million to $700 million in assets. Carson says the division is performing well and “has exceeded our wildest expectations.” Of more immediate attention is focusing on the SEC audit, for which Carson says he
realAssets Adviser | october 2014
is well-prepared, having spent substantial time reviewing his compliance procedures and conducting mock investigations and interviews with staff. This comes at a time when these audits are a white-hot touchpoint within the advisory profession. A recent study by compliance consultant RIA in a Box estimates that RIA firms could pay $310 million annually, or more than $27,000 per firm in user fees to fund SEC exams. “I had done a mock audit about a year and a half ago and we came through it with a good grade,” says Carson. “There were some things that we said we could improve, and so I was just literally in the process of signing the engagement letter to do another mock audit, and we got notified by the SEC that we were getting audited. I figure it doesn't get any better than that to know how you are doing, so I will know soon on the compliance side.”
Real assets are key. I think there is always a place to have real assets in the portfolio.
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It did not take Carson long to figure out that launching his own independent RIA would be one of the toughest challenges of his career. Running his own RIA has been the best of times, and the worst of times, full of both pluses and minuses. “I tried to go into it with my eyes wide open about what was involved, the complexity of running your own RIA, and I was
not under the illusion that I think a lot of advisers are,” he says. “Prior to that, I was under LPL corporate — I was an IAR for their RIA and I think that most advisers think they are giving them all their money. The reality is my economics are at best break even and possibly a little worse by having my own,” he says. In fact, Carson pointedly says that if he only considered it from a cash flow or earnings standpoint, “I wouldn’t have done it, not to mention all the additional responsibility that you have. But from a business flexibility standpoint, it has been a game changer. We are able to do things that have improved communications, and we are able to have a much more vibrant offering by being our own RIA.” Building a Better Rep The move is one that Carson hopes will help set a standard for investment advisory
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in the years to come. He also acknowledges that financial advisers often lurk near the bottom of many consumer rankings of services professions when it comes to trust, and more needs to be done to change that general perception. “Our profession has really taken advantage of people, and we have not been very transparent,” he says. “I ask all of us in our
profession to take the lead on being more transparent, disclosing every potential conflict, not just in your ADV, but verbally disclosing if you have a conflict and what it is. Really trying to put yourself in true alignment of interests.” Carson’s philosophy is pretty simple, and yet, easier said than done: Advisers should focus on putting their client’s interests ahead of their own. “Sitting on the same side of the table as the client, I would want to know where I stand. We do that. I want to know you are being proactive behind the scenes. We do that. I want to understand the rationale when you make changes in strategy. We do that with trade notes. We’d love to hear your rationale behind your investment committee's thinking. We do that in a live quarterly stream. In general, the client wants to know more about the process that goes into how you manage their wealth.”
When it comes to another white-hot button, compensation, not surprisingly, Carson hates the word “fee.” “I think advisers and clients alike need to think of it as an investment they are making. The client is making an investment, but are they getting a return in excess of what they could get on their own? That is where advisers have to really think about the investments they are making in technology. Can they clearly articulate, beyond a doubt, what clients really get out of working with them.” Carson relates the situation to a chapter titled “Beyond Any Doubt” from his next book, The Growth Edge, to be published in January 2015. “It is all about the client asking, ‘Can I see what you are charging and is my investment creating more value? And I am letting you, Mr. Adviser, take a portion of that.’ I think gone are the days when you can just do a mutual fund wrap account, charge an advisory fee and not really create real value. There is always going to be some out there, but it is a shrinking percentage.” Making Way for Millennials One of the largest emerging groups of clients, the millennials, present advisers with a whole new set of challenges. “The next generation of clients are smart and they are savvy. They have all of the information, so you are going to have to really up your game to be able to demonstrate that you are adding value,” Carson says. He has seen the millennial effect firsthand. “Last fall I had two panels, one made of millennials that were expecting to inherit two or more million dollars in the next 10 years and the other made of traditional clients. While they had some similarities, it was amazing to see what the millennials thought about advisers versus the traditional client segment and how they measure the value. It is changing rapidly.” Carson relates a particular crescendo in the dialogue. “A traditional client said, ‘With my adviser, sometimes I am scheduled for 90 minutes, and I still don’t have all of my questions answered and I feel like he is rushing me out of his office.’ The millennial says ‘Oh, my gosh, are you kidding me? Ninety minutes! What are you doing, watching a baseball game?’ EveryrealAssets Adviser | october 2014
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body laughed, but the point was the millennial wants the information when they want it. If they want to know how they are doing at 2:30 a.m. on Christmas Eve, they want to be able to do it, and they don’t need an adviser to sit down and tell them how they did.” In other words, the up-and-coming generation is running on a demanding 24/7 schedule, and their real demand of advisers is to provide advice when it comes to effective information that they cannot find on their own. “The traditional client wants you to provide more services. In a lot of cases they need more handholding and they definitely want you to be proactive. Both young and old, the millennial and the traditional, want you to do more. They are not necessarily asking you to reduce your fee, but they are asking you to do more for the same fee or investment that they are willing to make.” Librarian vs. Library Carson recalls how significantly the advisory profession has already changed to meet this new client dynamic. “Back in the day, I was a one-man band, and I didn’t really have a lot of people to help me. I had to do everything. I didn’t have the Internet, and sitting in client meetings it was hard to always know more than they did on a variety of topics. But today the pressure is off. I love telling people, ‘I don’t know, but I can find it.’ That is the advice I give to advisers. Trying to stay educated on everything is impossible, but knowing where to find it is really the leverage point that can help you add true value for your clients.”
before you are either a) going to have tremendous margin compression or b) you are going to lose a client because your value proposition didn’t keep up.” Using Real Assets One of the key ingredients in future planning involves the real assets class. “Real assets are key,” Carson says. “We definitely are embracing the idea of real assets, and I love the idea that I can get paid while I wait for appreciation that might come from a higher inflationary environment. My own personal belief is that, at some point, we are going to have hyper-inflation, and I talk to clients about it all the time. Even if I am wrong, I think there is always a place to have real assets in the portfolio.” Again, Carson relates to a home-grown experience. Having grown up on a farm, he continues to invest heavily in his family farm operation, but also for client’s portfolios. “We have a single family housing fund called the Neighborhood Stabilization Fund, and we are buying bank-owned properties in selected markets. We are rehabbing the properties and we are actually renting them out, and we believe we can get internal rates of return in the high teens or the low 20s. We don’t need the market necessarily to go up. If we just have OK economic growth, we are going to do well.” Carson’s strategy is simple. His renovation costs are only about $68 per square foot, which is some 40 percent below replacement cost (the cost of building a new property). “We are buying a margin of safety and we are getting tremendous cash flow from the rents, but it is labor intensive. There is no commission, no charges to the client other than our advisory fee.” Because the strategy is labor intensive, he hired Charlotte, N.C.-based firm Gorelick Bros. to run the fund. In totality, Carson’s real assets strategy is multifaceted. “As a firm, we run 14 different strategies, and energy is a big part of it. We think that if you just look at the world, even though we have really an energy renaissance going on here in the U.S., l
I love telling people, ‘I don’t
know, but I can find it.’ That is the advice I give to advisers. In an increasingly complex world, striking the balance of fees to services is an ongoing challenge. “I find that clients are asking us to do more for the same investment that they are willing to make, which means that we have to invest heavily in technology to compete. If you are not investing back in your business, it is only a matter of time
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like investing in the potashes of the world, all the way down to the trans-ocean, the deep-sea drillers. We definitely think there is a place for energy commodities and real assets, and we will own gold stocks and gold mining stocks as well.” Sizzle with Substance Looking to the future of the profession, Carson has an interesting perspective on being prepared for the next major economic downturn. “What will happen over the next five years is equivalent to what would have happened in the past 20 years.” Essentially, Carson sees massive changes over the next five years, particularly if a bear market takes hold. “If we have another 50 percent draw down like we have had the last 14 years, I think we will see massive consolidation in the profession. You are going to see the world of the robo. The traditional adviser is going to embrace the best of the robo world and combine it with the reality of being able to talk to a human and to do comprehensive planning. That is why I think the two worlds will merge, and those advisers who figured out how to do that will get very big.” “One of the things we say is that you have to have equal parts substance and sizzle in your practice,” Carson notes. “There was a point where I had more sizzle than substance, and my belief is that if you have all sizzle and no substance, you will attract lots of clients but you won’t keep them. If you have all substance and no sizzle, you will go broke because you will have a great value proposition, but nobody will know about you. So you have to really think about both parts of it.” The bottom line: Do not rest on your laurels, Carson says. “I think a lot of advisers have patted themselves on the back about their performance because of this great reflation that we have had in values from the lows of March 2009. I don’t think they have really put in place mechanisms and risk-measuring algorithms to understand if the client is ready for the next downturn.” realAssets Adviser | october 2014
advocacy / collaboration / education / resources / awareness
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Since 2003, IPA member firms have purchased 443 million square feet (US & international) of commercial Real Estate Assets and corporate debt with a value of approximately $87 billion.
To learn more about Direct Investments, visit IPA.com.
Making the
c h oice Investment pros tout the merits of both publicly traded and nontraded real estate.
R
eal estate has become the most popular form of alternative investing. And real estate investment trusts, or REITs, have been getting their fair share of the capital pie lately.
Evidence of this is the $8.1 billion in real estate equity raised in 2013 by American Realty Capital. The sum is remarkable when you consider the average individual investment is between $30,000 and $40,000. “We have so many investors — thousands of them coming in — and they are mostly retail,” says Sameer Jain, chief economist and managing director of the New York City–based advisory firm. “This is what allows us to raise that $8.1 billion a year. And when we lever up, we can buy lots of properties.” While growing ranks of investors have accessed real estate through publicly traded REITs over the past quarter-century or so, the more recent growth of the nontraded
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REIT sector has further broadened the investment landscape. “The less affluent are now gaining the kind of access to real estate that institutions have had for many years,” Jain notes. Congressional tweaking The keys to recent industry growth were minor tweaks made by Congress in the late 1980s and early 1990s, says Brad Case, economist and senior vice president of the National Association of Real Estate Investment Trusts (NAREIT), a Washington, D.C.-based nonprofit. “REITs originally had to be externally advised, which wasn’t as favorable for investors,” Case says. “When that was corrected, the REIT industry took off. Since the end of 1990, returns for REITs traded on stock exchanges have averaged more than 11.7 percent per year — pretty extraordinary for such a long time.”
By Joel Groover
How keen is the interest? Traded REITs are now worth more than $800 billion — nearly 100 times as much as in 1990 — and hold more than $1 trillion worth of property, according to Case. Since 1990, REITs traded on stock exchanges have provided income averaging 6.6 percent plus capital gains averaging 5.2 percent, according to NAREIT data. Meanwhile, their nontraded counterparts grew by nearly 100 percent in 2013 to become a $20 billion industry, says Kevin Hogan, president and CEO of the Washington, D.C.–based Investment Program Association (IPA), which serves the direct investment industry. “This year, that figure is expected to grow again,” Hogan says. “We would not be seeing those kinds of numbers if these products were not delivering investor value.” Nontraded REITs, in particular, have come under intense scrutiny by regulators realAssets Adviser | october 2014
| KBS purchased 171 17th St. in Atlanta for $132.5m.
realAssets Adviser | october 2014
including FINRA in recent years, relating to transparency issues such as share valuations and fee structures. Despite the pressures, investors continue to pour billions into the programs. The heterogeneous nature of real estate is part of its appeal, as it provides the flexibility required to create diverse risk/reward profiles precisely because it can be accessed through so many channels — whether public or private, debt or equity. “There is no one-size-fits-all,” Jain says. “It depends on the type of exposure people might want to take. The major investment avenues all have their own strengths and weaknesses, and they can all play a valuable role in portfolios.” Indeed, Hogan adds, the diversity of available products today is an outgrowth of this flexibility. “With investment products covering such a wide spectrum — whether it’s resorts, retail, multifamily, office, you name it — investors can work with their advisers to pick and choose based on their interests,” he says. And often the end result is gratifying for investors, particularly when weighed against the ups and downs of Wall Street. “Study after study has shown that commercial real estate, notwithstanding certain macroeconomic forces like a deep recession, has exhibited minimal correlation to the behavior of the overall stock market,” says Charles Schreiber, CEO of KBS Realty Advisors and its affiliate KBS Capital Advisors, two real estate investment advisory firms with transactional volume in excess of $30 billion. But, of course, considerations vary based on client goals. Traded REITs are liquid investments and subject to the same market volatility of stocks on the exchanges on which they are traded. Nontraded REITs, by contrast, are essentially illiquid investments notwithstanding the limited share repurchase plans REITs may offer, Schreiber notes. “Investors who are looking for immediate liquidity, or even liquidity after one year, should not invest in nontraded REITs, as that is not how they are designed,” Schreiber says. “Nontraded REITs are somewhat like an investment
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|
.Y. REIT SL Green N paid $783m for Citigroup’s Manhattan HQ in August 2014.
then nontraded REITs may be worthy of consideration,” Schreiber says. But just as relatively conservative investors can find outlets for their money in real estate, the diversity of this asset class also means that more opportunistic approaches are available as well. In its adviser presentations, Lightstone Group highlights the benefits of squeezing more value out of real estate from a value-add standpoint. “We buy properties where we think we can increase the net operating income — and hence the ultimate value — of the asset itself,” says Mitchell Hochberg, president of the New York City–based real estate firm. “It starts with the acquisition. We always feel that if you can’t make money on the
the robust appetites of private equity firms and sovereign wealth funds have been driving down cap rates for larger portfolios. By doing lots of all-cash, quick-close deals to beat out its competitors, Lightstone has been able to amass single properties at a capitalization rate of 9 percent or 10 percent, then flip them as a portfolio and sell them with a cap rate of 7 percent, Hochberg says. Pension funds typically allocate about 10-15 percent of their total assets to real estate, with about 50 percent dedicated to a core strategy. But among institutional and private investors alike, asset allocations vary widely based on clients’ needs: An insurance company might seek stable, fully tenanted AAA properties, while a wealthy individual
The major investment avenues all have their own strengths and weaknesses, and they can all play a valuable role in portfolios. — Sameer Jain, American Realty Capital club concept where you are leveraging the pooled financial resources of many investors and the operational and management expertise of the REIT’s advisory company.” The advisory company provides skilled expertise with the intent to generate the strongest cash flows and also maximize the value of each asset in the portfolio. “The adviser is also able to recommend when each individual asset is ready to be sold in order to attempt to realize the best possible gain for the investor,” Schreiber says. In the end, questions related to traded versus nontraded REITs boil down to the client’s goals. “If immediate liquidity is not necessary and the desire is to have an investment that is correlated to the actual property itself — and not a volatile stock market —
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buy, then it can’t be a good deal.” Toward that end, Lightstone talks with banks and scours real estate markets to find distressed or undermanaged assets. After acquiring a well-located but undermanaged hotel, for example, the firm ramps up the property’s operations, including upgrading the appearance of the asset or hiring salespeople to fan out into the community. Adopting smarter revenue- and cost-management strategies — everything from hourly price adjustment via online tools such as Expedia to buying sheets, toilet paper and other supplies in bulk — can also bolster asset value over time, Hochberg says. Last comes the exit strategy. Of late, single properties in U.S. secondary markets have been trading at nine or 10 caps. By contrast,
might accept exposure to higher-risk distressed assets or ground-up developments. Nonetheless, it is always important to take an active role in the allocation process, says Steve Gruber, managing member of Real Asset Portfolio Management, a registered investment adviser based in Portland, Ore. He cites the common mistake of passively weighting property types based solely on the profile of the $354 billion, 7,000-property national property index from the National Council of Real Estate Investment Fiduciaries (NCREIF). Office property investments represent 36 percent of the NCREIF total, more than any other property type. “Office is historically one of the most volatile property types with the lowest returns,” Gruber says. “With realAssets Adviser | october 2014
|
hesapeake Lodging Trust C purchased the JW Marriott San Francisco Union Square for $147m.
office, timing and being with an expert manager are critical. At our firm, we are more likely to underweight office and focus on those property types that historically have provided higher returns and less volatility — apartment, retail and industrial.” Real estate is also creating opportunities for investors to leverage broader market and demographic shifts. An example is the rising demand for healthcare services among the aging U.S. population. In April, ARC listed its healthcare REIT — ARC Healthcare Trust — on the NASDAQ. Healthcare giant Ventas subsequently acquired the REIT in a stock-and-cash deal worth $2.6 billion. According to Jain, the opportunities to further deploy capital within healthcare are vast. Public REITs, he says, own only about 7 percent or 8 percent of U.S. healthcare assets worth a total of $1 trillion. With 80 million baby boomers reaching retirement age — and the 85-and-over population segment growing faster than the national average — ARC has been snapping up hospitals, medical office buildings, senior housing and post-acute care facilities around the country. Likewise, the timing is right for strategic investments in the hotel sector, says Kevin Hart, president of Lightstone’s capital markets division. “Hospitality is the slowest sector to recover in a recession, but about three or four years into stability and an improved outlook, people start going on vacation with their kids, and businesses put a few more salesmen on the road,” he
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says. “What we’re seeing today is an uptick in net operating income, which is an extension of increased occupancy and increased room rates. That has historically been the case going all the way back to 1933.” None of this is to suggest that real estate is a shoo-in, and advisers should pay particular attention to the strategies employed by program sponsors. Lightstone, for example, has grown wary of certain real estate sectors. “A lot of real estate investing is about timing and being able to watch the markets and ascertain what is the right time to invest,” Hochberg says. For its part, KBS focuses on acquisitions in the top job growth markets nationwide, as economic momentum lifts demand by tenants for office space and new construction remains limited. But what about the collapse of so many real estate companies following the 2008 Wall Street meltdown? At the height of the liquidity crisis, for example, Chicagobased mall REIT General Growth Properties was saddled with more than $25 billion in debt; it went into bankruptcy in April 2009 before emerging in 2010. The current era is far more cautious, says T.C. Rolfstad, investment associate at Real Asset Portfolio Management. “Some of the managers that survived that down cycle have reassessed their strategies and how they implement debt,” Rolfstad says. “Today, some are going in with 100 percent equity, executing their value-add strategy and then, only after the property has sustainable cash flows, leveraging it to see out the final endgame.”
Today, real estate trends are generally favorable overall, Gruber says. “Improving rents, declining vacancy, new development, rising transaction volume, recovering debt markets — all of this bodes well for commercial real estate,” he says. From a strategic standpoint, however, real estate investors should pay heed to certain time-honored principles, says Trevor Bond, president and CEO of W. P. Carey Inc. One is the wisdom of diversification. “A real estate allocation that provides exposure to diverse property types, diverse geographic locations and markets, diverse industries, and diverse tenants is most likely to provide the non-correlated, stabilizing performance advisers should look for to provide an inflation hedge over time,” Bond says. Likewise, real estate can most likely add to portfolio stability when deftly managed as a long-term investment. “No matter the vehicle — traded REIT, nontraded REIT or other type of real estate investment fund — the manager should have an established, long-term track record,” Bond says. “The manager should have the capabilities to not only make attractive, risk-adjusted investment acquisitions, but also manage assets and portfolios over the long term. A manager with this approach and capabilities will maximize the inflation-hedging potential and offset the shorter-term volatility of market-driven equity investments.” And with an estimated 10,000 baby boomers retiring every day, the demand for income will likely continue to translate into a larger appetite for real estate investments moving forward, says Hogan of IPA. “Investors are tactically retreating from the financial markets and broadening their portfolios by looking to these kinds of not-correlated, hard-asset investments,” he says. Indeed, in a survey of 500 high-networth investors, IPA found that 45 percent of respondents planned to include real estate in future portfolios. “And 83 percent of them felt that real estate was going to outperform the equity markets over the next five years,” Hogan says. Joel Groover is a freelance writer based in Atlanta. realAssets Adviser | october 2014
shi
Power By Michael Underhill
| MLPs
were spawned from the oil and gas industry.
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realAssets Adviser | october 2014
ift realAssets Adviser | october 2014
A case for MLPs as a core allocation in investors’ portfolios.
I
nvestors continue to adjust asset allocation models to reflect a significant overweight to positions in global equities and alternative investments that may include private credit, special situations and, increasingly, real assets. We expect a paradigm shift in asset allocation to occur, which may surpass the period of enlightenment that occurred in institutional investment from fixed income to equity securities in years past. Master limited partnership investing was once considered to be in the alternative investing realm, but now has become mainstream as there is increasing demand for assets offering stable income and growth potential. “[Three decades] ago alternatives were in fact ‘alternatives’ and they have now become allocations that range from 25 percent–50 percent,” notes Commonfund’s January 2014 report, Alternatives Reality: What to expect from future allocations. Allocations to MLPs by financial advisers and institutional investors have been growing as investors are seeking the benefits that MLPs afford.
MLPs — past, present and future
For the uninitiated, an MLP is a publicly traded partnership — a term used in the U.S. tax code. It is a partnership, or a limited liability company that has chosen partnership taxation, that trades on a public exchange (NYSE, NASDAQ, etc.) or over-the-counter market. An MLP does not have shareholders per se, but they are referred to as “unitholders.” The phrase MLP is used to refer to publicly traded partnerships and LLCs taxed as partnerships that operate active businesses, primarily energy related. There are a significant number of publicly traded partnerships that do not operate businesses but are simply investment funds, usually commodity funds. These are not viewed as MLPs by experienced industry executives or professional investors. The first MLP was launched in 1981 by Apache Oil Co., and other oil and gas MLPs soon followed. Their goal was to raise capital from smaller investors by offering them a partnership investment in an affordable and liquid security that was typically reserved for larger institutional investors
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|
oday there are nearly 130 MLPs T trading on major exchanges.
including multibillion-dollar public pension funds such as the California Public Employees’ Retirement System (CalPERS) or large endowments such as Harvard and Yale universities. The attraction of MLPs was that smaller investors could participate in natural resource investing that generated multiple “streams of returns” in their investment: interest, dividends and capital gains. Currently, there are close to 130 MLPs trading on major exchanges or, in a few cases, over the counter. Today’s MLPs primarily focus on energy-related industries and natural resources. The majority engage in oil and gas midstream and downstream activities — gathering, processing, natural gas compression, transportation, storage, refining, distribution and marketing. Others are in other oil and gas activities and the coal and fertilizers space. (Other MLPs are listing that have involvement with nonpetroleum natural resources — fertilizer, fracking sand or trona ore for production of soda ash.) The total market capitalization of MLPs as of Dec. 31, 2013, was close to $490 billion, with about 86 percent of the total
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— roughly $422 billion — attributable to energy and natural resource MLPs, primarily the midstream group.
How investors use MLPs
Many investors believe real assets can generate compelling risk-adjusted returns, provide attractive capital appreciation and deliver important diversification benefits. The specter of rising interest rates is leading to a corresponding increase in concern over inflation. While current U.S. government estimates of inflation by the Congressional Budget Office remain modest and do not appear to represent a near-term threat, the potential for rising costs over the medium term is expected to lead investors to seek alternatives that offer a greater degree of inflation protection. MLPs provide high current income and benefit client portfolios uniquely in both inflationary and deflationary scenarios. In a deflationary environment: • Relatively higher yield in a potential prolonged low-yield environment • Yield compression could provide an additional source of return (capital gain)
• Lower overall cost of financing, both debt and equity, could lead to higher M&A In an inflationary environment: • Hard assets with increasing replacement value •L ong-term contracts tied to PPI and CPI •D istribution growth historically higher than the inflation rate An MLP portfolio invests in essential companies with inelastic demand, which shields earnings from most economic volatility. Hard assets with high barriers to entry provide the business backdrop for highly predictable cash flow. Established and, in many cases, nearmonopoly business franchises support consistent future growth. Throughput increases are leveraged into even higher income and cash flow gains because most costs remain fixed.
Tax benefits
MLPs are the exchange-traded securities of real businesses with real assets that generate real cash flow. As partnerships, publicly traded MLPs are not subject to corporatelevel taxation. realAssets Adviser | october 2014
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In addition, the majority of the annual cash flow paid to investors is not taxed as ordinary income, but instead reduces the unitholder’s cost basis and is subject to recapture upon sale. Most MLPs are in the energy infrastructure business and generate cash flow from gathering, processing, transmitting and storing natural resources such as oil and natural gas, and their many byproducts. While some MLPs are exposed to commodity price fluctuations and have volatile operational results, the businesses that are best suited to the MLP structure are typically referred to as “toll road businesses”. These businesses collect fees for their services without taking ownership of the physical commodity. Many of the newly constructed publicly traded MLP investment options share two common characteristics: 1. Ease of use 2. Fees, expenses and tax drags that have resulted in significant underperformance However, other approaches to MLP investing do not share those characteristics. The traditional forms of MLP investments are separately managed accounts
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and investment partnerships. These MLP investment options offer active management, lower expenses and do not have a corporate-level tax drag. The common characteristics of these options include the opportunity to outperform the index and tax efficiency, albeit with a greater administrative burden than their public counterparts, which would be the responsibility of the separate account asset manager.
How MLPs work
Whether structured as a limited partnership or a limited liability corporation, it is lower-level entities, not the MLP, that own the assets and conduct operations. Taxation is on a pass-through basis. There is no corporate or other entity-level tax. All tax items flow through to the unitholders, who pay tax at their own rates. The benefits of operating as an MLP are significant. The pass-through tax structure (no double taxation) means lower cost of capital. This is important in capital intensive energy industries. This allows companies to build and operate low-return assets (e.g., rate-regulated pipelines) and still provide a sufficient rate of return to attract investors. An MLP is a pass-though entity that
pays no tax itself, and the unitholders are treated for tax purposes as if they are directly earning the MLP’s income. Each unitholder is allocated on paper a share of the MLP’s income, gain, deductions, losses and credits. This is reported annually on the K-1. The unitholders enter these items on their tax return and pay tax on the net income at their own tax rate. Technically, MLPs have “membership interests” rather than partnership interests and do not have a general partner. Both management and investors have the same “membership interest.” MLP LLCs have no incentive distribution rights, although there may be other management incentives. All members, including public unitholders, have voting rights.
Conclusion
Investor interest in alternative assets is growing, and MLPs are increasingly one of the recipients of these allocations. MLP investments can offer investors many benefits including income, diversification and tax advantages. Michael Underhill is CIO of Capital Innovations, based in Pewaukee, Wis. realAssets Adviser | october 2014
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By Juan Carlos Artigas
Gold standard Gold bugs have been touting the precious metal’s bear-market advantages forever, but here is a new case for why investors might want to consider it as a long-term hold.
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realAssets Adviser | october 2014
W
hile geopolitical uncertainty looms large, the economic outlook, at least in the United States, has improved over the past year and the economy is in much better shape than it was a few years ago. As such, investors have shifted from a focus primarily on risk mitigation to one that more decidedly balances risk and reward.
Yet, limited upside on bonds — given the current low level of rates — and a stock market that many investors view as overbought suggest that a traditional cash/ bonds/stocks portfolio mix may not be enough to produce adequate returns while effectively diversifying risk. In our view, a missing component is gold. Throughout history, gold has helped investors preserve wealth and has provided liquidity when it is needed most. Today, it is an asset with unique properties and an important role to play in any well-balanced portfolio. While gold can help investors withstand the potentially debilitating market effects of global disruption, it also benefits from economic growth — and the resulting higher incomes — especially present in emerging economies. Research by the World Gold Council has found that including gold as a strategic component of a portfolio can offer sustainable investment qualities and financial advantages — not to mention a level of protection and security — that effectively complements other assets.
Unique properties, global reach As an asset, gold has unique properties and can play a key role in providing both preservation of purchasing power and portfolio diversification. Many investors even consider gold as an asset class in its own right. Gold offers genuine portfolio diversification through lower correlation to other assets such as equities or fixed income; on average, gold’s correlation relative to equities and bonds has been historically low. Gold also tends to have a lower correlation to broader markets compared to other commodities. Further, gold generally lowrealAssets Adviser | october 2014
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ers its correlations to other assets during recessionary periods — a feat that few assets can claim. Gold tends to benefit investors and helps manage tail risk events more effectively than other risk hedges. Portfolios containing an allocation of gold are, on average, far more likely to provide loss protection when compared to similar portfolios without gold. Additionally, gold is a high-quality liquid asset. It lacks credit risk, enabling investors to balance the risk of fixed-income and equity allocations. In fact, gold’s properties are the result of more nuanced supply and demand dynamics than other asset classes. Gold consumption (such as jewelry and technology) makes up the majority of physical demand; this type of demand typically increases alongside better economic growth. Thus, a good portion of gold demand remains in place even when interest rates head north. Further, the majority of demand, both as an investment and as a consumer good, comes from outside the United States, and monetary tightening/easing cycles differ across regions. Gold is also less sensitive to U.S. interest rates because approximately 70 percent of demand comes from emerging markets,
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Gold spot price (US$/oz)
Sources: Bloomberg, World Gold Council
and 60 percent of its uses are linked to jewelry and technology. Specifically, consumers in China and India, where the precious metal is culturally valued as both a luxury good and a hedge against domestic inflation, drive demand. Today, gold has a global reach and appeal, and worldwide demand outstrips mine production. While investment demand, especially in the form of ETFs, dramatically fell in 2013, it has been more than compensated by consumer and retail investment demand in physical form. In our view, given that mine production is constrained
and recycled gold has been declining since 2009, the positive trend of global demand will continue to support the gold market in years to come. Asian Demand grows Despite market uncertainty in the United States and globally, gold continues to be a valued asset. Its demand remains steady and healthy. Demand in China and India is especially high; Indian and Chinese purchases accounted for roughly half of the market during the first two quarters of 2014. The popularity of gold in China and India is due to not only its enduring value as an investment asset but also its value as a cultural asset. More than in other cultures, gold is seen as a treasured asset that should be passed down from generation to generation, bringing a stronger familial and traditional connection to the purchase of and investment in gold. If you consider the limited offering of financial services and assets open to many Indian and Chinese investors, then gold becomes doubly important. Its appeal is also shaped by the expanding wealth and demographic changes in these countries. Estimates say that by 2020 the number of urban consumers in China and India will reach 1 billion. That trend is additionally fueled by the projected rise in disposable income, which tends to heighten demand. Globally, gold has provided a store of value in times of extreme financial distress. That is as true for government entities as realAssets Adviser | october 2014
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it is for individual investors. Look no further than the activity of central banks in the wake of the global economic slowdown of late 2008 into early 2009. After two decades of being a net seller, central banks became net purchasers during the second quarter of 2009 and have remained net purchasers to date. In the past two years alone, the central banks in a number of key national economies, including China,
nations could have a profound impact on the gold market. Accessibility and rising demand The evidence shows that individual customers, money managers and the major central banks agree that gold is a prime investment option, especially in financially distressed times.
The trend is moving toward a more active pool of sophisticated investors and money managers building portfolios that hold 2 percent-10 percent of assets in gold. India and Russia, have purchased substantial amounts of gold. Their counterparts in smaller economies, such as Sri Lanka, Venezuela, Mauritius and Tajikistan, have also been active in gold purchases. Today, the central banks of the world’s advanced countries keep about a third of their reserves in gold, a legacy of the gold standard days. Smaller economies, however, hold less than 5 percent in gold reserves, and less in developing Asian countries. Even a small increase in the percentage of gold reserves in these still developing
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The advantages are many. Gold is unique in that it is both a luxury good and a monetary asset. It has properties that can bolster and better diversify investment portfolios. It behaves differently when compared with other valuation models. The consumption of most commodities is directly tied to industry and commerce; they perform well when things are going well, and less so when the financial markets ebb. That is not necessarily the case with gold. For investors, the market offers a myriad of ways for investors to access gold.
They range from direct purchases of bars and coins to gold accounts held at bullion banks and depositories, gold accumulation plans, gold trading platforms, gold funds, derivative contracts, and mining equities. These all have relative advantages and disadvantages, and the most suitable vehicle may depend on an investor’s objective and risk tolerance. In addition, many investors choose to buy gold through physically backed exchange-traded funds, such as SPDR Gold Shares. ETFs can offer investors a simple and cost-effective means of accruing the benefits of gold and maintaining access to market liquidity. Whatever the access vehicle an investor uses, the trend is moving toward a more active pool of sophisticated investors and money managers building portfolios that hold between 2 percent and 10 percent of assets in gold. While it is easy to view gold as an asset to help navigate a bear market, it is also not the full picture. Gold has unique properties that can play a key role in providing both preservation of purchasing power and portfolio diversification. Though gold’s short-term benefits are considerable, more importantly, investors should consider gold for the long term. Juan Carlos Artigas is director of investment research at the World Gold Council. realAssets Adviser | october 2014
Where did the
Year go? By Paul West
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Yes, it’s time for year-end planning already, and here are a few solid tips for taking control of the process to grow your business and client relationships.
realAssets Adviser | october 2014
C
hange. Oh how that familiar word seems to mean so much during this time of year. Changes in the color of leaves and landscape. Changes in the economy. And changes in our profession as financial advisers. 2014 has been full of change, and it’s had a sizable effect on both the lives of our clients and us as business owners. We can’t change the trees or the economy or the state of our profession, but we can change our processes and approach to end-of-year planning. As the managing director of one of the most successful coaching programs in the country I can tell you, ironically, that the simple act of planning is one ignored by many financial planners today. Yes, those that plan every single day for others forget to plan for themselves. A simple phrase governs many of our approaches: “Wait broke the bridge.” Let’s not “wait,” and instead start preparing your year-end planning today. To do this, I will focus on two key concepts: year-end planning for your business and year-end planning for your clients. Both are needed, and that is why it’s even more important to understand how you can use both to better position your business and your clients in 2015.
Year-end Planning for Your Business As with many other areas of your business, you must first train your team so they can effectively manage your clients in terms of information, education and service. Yearend planning for your clients directly correlates to the preparedness and organization of your team, so it only makes sense to begin with your business in mind. Here are three things you can do now: 1. Systematize Your Year-End Planning Process with Clients — To properly prepare your business for year-end planning with clients, you must systematize the process to make it as seamless as possible for you, as an adviser, and for your clients. Does your team have updated information on the CRMD (cost basis, etc.) issues that will be affecting your clients in 2015? Do you have detailed systems in place to keep everyone organized as they collect client information, schedule and meet with clients, and deliver realAssets Adviser | october 2014
this information? Are you communicating with your clients? Even if their strategy is to do nothing, you are providing value by reviewing their situation. 2. Schedule a Team Retreat — The best thing you can do for your team in the final quarter of the year is to help them develop a plan for success in 2015. The purpose of a team retreat is to reflect on how you are performing as a firm and establish your vision and corresponding goals for the year ahead. Start by scheduling a day on the calendar in December or early January for your entire office to gather. Next, develop an agenda. To help you get started, download our Annual Retreat System at www.peakadvisoralliance. com and enter the code “Retreat” on the Free Tools page. This system will walk you through the particulars of planning the day, setting the agenda and executing everything successfully.
The simple act of planning is one ignored by many financial planners today. 3. New Business Development — Make sure your year-end planning process includes a goal for new business! Value and reciprocity are two key ingredients to generate new assets from existing clients and referrals for new clients. Ensure you are educating/reminding your clients of all the value you offer — like year-end planning. During planning meetings, your clients often share how much they value the session, so take the opportunity while reciprocity is on the table! Now is the best time is ask for referrals! It’s also a great time to find and move more client assets to you. All three of these actions sound simple, and the truth is, they really are. Advisers tend to forget the accumulation of all these “little” things that, done right, add up to making huge changes and dramatic shifts in the growth of your firm.
Year-end planning for your clients Year-end is the perfect time for you to remind your clients about important details and changes that may affect their financial situation and plan. Many of our Peak Advisor Alliance members are focused on the following needs, but you will want to tailor your processes and planning checklist to the needs of your clients. So, use the following checklist as a starting point for your own office: Retirement Savings & Cash Flow Many types of retirement plans have deadlines at or prior to year-end to establish the plan and/or fund contributions to the plan to realize a current year tax deduction. On the flip-side, taking money out of a qualified plan or annuity has implications on taxable income. However, cash flow may be a higher priority consideration than the tax liability of structuring a payment stream. Managing one’s tax liability does not necessarily mean minimizing one’s tax liability, so use these points regarding retirement savings and cash flow: •P roject current year and subsequent year tax liabilities to time taxable income and when to use deductions to manage tax liability. • Remind your clients of milestone ages: 50 - making catch-up contributions to IRAs and some qualified retirement plans 55 - taking distributions from 401(k) plans without penalty if retired 59 ½ - taking distributions from IRAs without penalty 62 to 70: - applying for Social Security benefits when it makes sense 65 - applying for Medicare 70 ½ - taking RMDs from IRAs (and some other retirement plans if retired) If you have clients who are non-working spouses or their income is above the IRA earnings limit of $181,000 for a deductible IRA contribution, consider making a nondeductible IRA contribution and convert to a Roth IRA to affect a Roth IRA contribution for high-income earners.
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Hot Topic: Social Security One of the hottest topics in financial planning is maximization of Social Security payments. This is especially true for married couples with substantial choices in not only when to file for payments but when to receive payments or suspension of benefits. There may be increased payment amounts for delaying the receipt of Social Security or penalties for accelerating payments to an age earlier than Normal Retirement Age (NRA); 65 for those born before 1954, 66 years for those born between 1954 and 1959, and age 67 for those born in 1960 or later. Address this area of your year-end planning by using these points with clients: Review Social Security maximization strategies annually for any person turning 62 to 70 years of age in the following year. File for Medicare at age 65 even if Normal Retirement Age for Social Security is 66 or 67. Consider a “file and suspend” Social Security strategy to maximize monthly Social Security payments and to qualify a spouse to file for a spousal Social Security benefit payment earlier than the primary wage earner may begin to receive payments. If income will exceed $117,000 in 2014, potentially accelerate income into 2014 to avoid Medicare tax of 6.2 percent on compensation over $117,000. To stay under the Net Investment Income limit for the additional 3.8 percent Medicare tax, the income rules are
Certain retirement plans (defined benefit plans) and 401(k)s (defined contribution, elective deferral) must be established and funded prior to year-end to qualify for a current-year tax deduction. A SIMPLE-IRA plan must be established prior to Oct. 1. A Simplified Employee Pension plan, or SEP, may be established and funded up to the due date (including extensions) of the business establishing the SEP. Review upcoming pension or annuity qualification rules to maximize cash flow in retirement and possibly continue payments for surviving spouses through joint and survivor payment alternatives.
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joint income of $250,000 and single income of $200,000. Fund HSA contributions with employer payroll deductions to avoid Medicare and Medicaid payroll taxes on contributions. Gifting & Charitable Contributions Many gifting and charitable provisions are “use it or lose it.” If they are not utilized by year-end, the opportunity is permanently lost. Consider annual gifting to individuals before Dec. 31 (2014 amount of $14,000 to each individual or $28,000 from a husband and wife). Consider a gift, funded to a Roth IRA, in a matching amount to what a child earns for the year. The tax deferred or potentially tax-free earnings may compound over decades to create a significant retirement savings balance. The rules for IRA-RMD distributions that are gifted to 501(c)(3) organizations have not been extended for the 2014 tax year. However, gifting appreciated securities directly to the charity is still a good idea in the event Congress extends the IRA charitable gifting rules at the last minute in 2014 or in 2015 to be applied retroactively to the 2014 tax year. Consider potential lump-sum “buyout” offers from annuity companies for certain contracts with living benefits. Review the tax consequences on nonqualified annuity contract buy-out offers which are ordinary income for value above the contract’s tax basis.
Investment/Tax Tax, more than any other discipline of financial planning, is ruled by the calendar. Actions must be taken in strict compliance with deadlines and dates in mind. To be deductible in the current year, most payments must be made on or before Dec. 31, or paperwork must be authorized and filed. From a planning standpoint, lead time is necessary to implement recommendations, which makes it paramount to plan well in advance of the “ball-drop” in Times Square on Dec. 31. Understand the following points as you approach year-end, and alert clients if any of these items affect their situation: • 2014 is the first year taxpayers must file financial information related to the
Affordable Care Act in their income tax returns. The IRS has no funding provisions for enforcement or collection, so a refund may be confiscated for payment of the penalty. Therefore, if your clients will owe the penalty, you should target a payment due for April 15 as opposed to overpaying and anticipating a refund (which may never come). • Capital gains on appreciated property for gifts with carryover basis to qualifying students, age 25 to 27, are not subject to the Kiddie tax (children taxed at the parent’s marginal tax rate). Therefore, students may pay capital gains tax at a lower rate than the giftor. • Year-end tax-loss selling can minimize income tax liability. Ideally target a short-term loss and/or long-term gain. Wash-sale rules apply if a substantially identical security is purchased within 30 days of tax-loss sale. Life Circumstances If your clients experienced a major change in life, help them understand options and considerations based on the change. For instance, did your clients experience any of the following •B irth or adoption of a child or grandchild •D eath or significant illness of a family member •A gift or inheritance •S elling a major asset like a home or business •A marriage or dissolution of marriage •A n event requiring a beneficiary change As you can see, the amount of information in each of these areas of year-end planning is substantial, making our role as wealth advisers even more crucial to the lives of those we serve. I tell hundreds of advisers every year to get in the habit of becoming a librarian, not a library. As complex as our responsibilities in this profession become, it is important to keep this notion in mind. Cheers to you and yours as we approach 2015! Paul West is the managing director of Peak Advisor Alliance, a premier advisory coaching and practice management program. realAssets Adviser | october 2014
[Sponsor Section] Recently, Ben Johnson of Real Assets Adviser spoke with Jason Mattox of Behringer. The following is an excerpt of that conversation.
What market changes have you seen recently in the commercial real estate industry, and what are the implications for institutional real estate investors? Commercial real estate investors seem determined to invest despite the fact that interest rates are continuing to cause uncertainty. Investors wanting to complete their allocations have been increasingly active in the market and are not demonstrating sensitivity to asset pricing or longer-term jitters about interest rates. It is generally expected that interest rates will rise, but how far and how fast is difficult to forecast. As the economy continues its paced recovery, space market fundamentals are improving in many markets. Capital is plentiful, investor appetite is strong, and there is a general urgency to lock-in financing at today’s low interest rates, before they rise. Foreign capital in many forms is flooding into the U.S. commercial real estate markets. The U.S. multifamily sector, which was consistently the bright spot in the industry during the recent recession, has attracted significant interest from foreign investors as well. In addition to sovereign wealth funds and other more typical foreign institutional interest, commercial real estate has been targeted by foreign investors seeking to take advantage of the Immigrant Investor Program, also known as EB-5, which sets aside certain visas for investors in new commercial enterprises in designated regions where the U.S. government desires to promote economic growth. These trends have implications for institutional investors based in the United States who must compete with foreign or private buyers. Foreign investors may have the capacity to pay more for sought-after properties because they do not have the operating expenses associated with a public company or have underlying rationales for investing that go beyond traditional economics such as pure currency plays or overall concerns about geopolitical risk. One result is that some experts are wondering if institutional investors are already overpaying for core multifamily assets in top markets. Where do you see the most compelling opportunities in commercial real estate? Compared to the depths of our previous recession, demand and pricing for industrial and multifamily properties have essentially normalized. Both leisure and business travel have rebounded, and stronger demand has benefited hospitality properties as evidenced by growth in average daily room rates and similar metrics. But we believe, like others active in the hospitality marketplace, that pricing still leave attractive opportunities for
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Jason Mattox is an executive vice president and chief operating officer at Behringer. He has served as an executive officer and principal of the company since its inception. Mattox also serves as codirector on the TIER REIT board of directors. Mattox was vice president of Harvard Property Trust from 1997 to 2002. In this capacity, he served as a member of the investment committee, asset manager of commercial office assets, and acted as industry association liaison. He was also a marketing project manager and an acquisitions officer during this tenure. From 1999 to 2001, Mattox also served as vice president of Sun Resorts International, a recreational property investment company affiliated with Harvard Property Trust.
investing in hospitality assets. Recovery in the office sector has been slower, and attractive opportunistic investments can still be found in certain markets such as the suburbs of major metropolitan areas. Office properties in some central business districts may be available at attractive prices, if selected skillfully. The market disruptions associated with the recent recession, as well as suggested regulatory changes in the securities industry that affect non-listed REITs and other investment vehicles, have prompted institutional real estate investors to become increasingly creative. Many are testing the waters with new product structures that offer promise in addressing the perceived disadvantages of previously established product structures. The pace at which conditions have changed in both the capital markets and commercial real estate markets has quickened over the past few years. In such an environment, those who can rapidly adapt their commercial real estate investment strategies will be better positioned to respond to market changes in beneficial ways. Agile product structures are likely to become a key component in achieving the flexibility that could contribute to a competitive advantage. How can institutions that have invested primarily in commercial real estate expand their investments into other asset classes, and why might they want to do so? I can speak to this question most effectively by describing our experience at Behringer. We initially sponsored nonlisted commercial real estate investment opportunities realAssets Adviser | october 2014
and raised capital primarily by distributing securities through the retail channel. The historic recession that began in 2008 had a dramatic effect on commercial real estate as demand contracted and values plummeted in most property sectors. We sought to respond creatively to the significant change in investor appetites prompted by this severe cyclical downturn and its far-reaching impact, and this ultimately contributed to a pivotal shift in our strategic direction. We viewed this challenging environment as an opportunity to sharpen our investment discipline to take advantage of the disruption in the commercial real estate and capital markets. We also sought new strategies that would help us establish a presence in a wider range of markets, asset classes and distribution channels. Our goals were to grow our customer base and expand our relevance in an increasingly complicated investment landscape. Public and private debt and equity investments in commercial real estate will continue to be an important part of our strategies. At the same time, we are adapting our core competencies and expanding our distribution platform to offer a wider range of investment opportunities that address evolving market demand. We also are diversifying our strategies to encompass broader asset types, distribution channels and product structures such as closed-end funds and Delaware Statutory Trust (DST) 1031 exchange funds. New additions to our team and top-tier partners have energized our strategic evolution. We believe we have attracted some of the best talent in the industry — innovative thinkers who share in our entrepreneurial spirit, have a real passion for what we do and make their presence felt in productive ways. They also have experience with many asset classes, distribution channels, and business cycles, as well as expertise in developing and distributing multi-manager investment opportunities. We have partnered with large institutional investors, such as pension fund managers outside the United States, to co-invest in U.S. commercial real estate, primarily in the multifamily sector. Where specialized services and expertise have been needed to complement and extend our core competencies, we have established relationships with best-in-class asset managers that extend our ability to bring specialized investment opportunities to the market. This approach enabled us to innovate by marketing, with a co-sponsor, the first structured credit product for individual investors in a public, non-listed, closed-end package. For us, it is all about expanding investors’ options for allocating capital, managing risk and diversifying assets. We are working to help both institutional and individual investors access different streams of income and return. Although investments in hard assets such as real estate are attractive opportunities for many investors, there is a limit to how much can be prudently allocated to any single asset in a well-diversified portfolio. By broadening our investment strategies, we can be better positioned to advocate for enhanced
portfolio diversification, especially in light of the impact of downturns like the recent recession. We also can play new and different roles in the investment portfolios of our customer base and complement the business strategies of our co-investing and co-sponsoring partners. What core competencies could help institutional investors reposition their investment strategies to include new asset classes in addition to commercial real estate? Smart and successful institutional investors in commercial real estate often have developed core competencies and related disciplines that translate well into managing investments in other asset classes. Those who have an intimate knowledge of the investment challenges faced by established customers are in a better position to develop new investment opportunities that will have strong appeal for loyal customers who are likely to be a particularly receptive audience for new and innovative approaches. For Behringer and other institutional real estate investors, relationship-building skills have been important in developing partnerships and joint ventures that can extend buying power, enable entry into new markets, and expand product offerings and distribution channels. Extensive due diligence and deal-making experience is valuable in many investment scenarios, and the ability to craft, negotiate and close complex agreements can be especially beneficial. Experience in launching and growing new enterprises is widely applicable to many types of business and investment opportunities. Moreover, an established understanding of and comfort level with primarily illiquid, non-correlated assets such as real estate can position institutional investors to successfully participate in a wider range of public and private debt and equity investments. CORPORATE OVERVIEW Over two decades, Behringer has owned and operated commercial real estate in virtually every asset class. The entrepreneurial company is now diversifying its investment strategies across varied asset types and product structures. Large, multinational institutional investors have teamed with Behringer to pursue new investment strategies and enter new markets. The company seeks to provide total risk-adjusted returns, enhanced portfolio diversification, and reduced portfolio volatility. Member FINRA and SIPC. CORPORATE CONTACT Barbara Marler Director of Strategic Communications +1 469-341-2312 bmarler@behringermail.com http://www.behringerinvestments.com
Behringer creates, manages and distributes specialized investments through a multi-manager approach that presents unique options for allocating capital, managing risk and diversifying assets. Investments sponsored and managed by the Behringer group of companies have invested into more than $11 billion in assets. For more information, call toll-free 866.655.3600 or visit behringerinvestments.com.
realAssets Adviser | october 2014
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Advertiser index American Realty Capital....................... C2 KBS Realty Advisors................................3 Deutsche Asset & Wealth Management..... 5 Broadstone Real Estate, LLC...................7 Morgan Stanley.......................................9 CBRE Global Investors.........................13 Colony Capital, LLC.............................14 Inland Real Estate Investment Corporation, Inc................................17
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Real Assets Adviser..................................20 IREI NewsCloud...................................33 Investment Program Association...........35 National Association of Personal Financial Advisors..............................39 Global Real Estate Institute...................41 The Institutional Real Estate Letter..........45 Family Office Super Summit.................47 Opal Financial Group...........................51
Information Management Network.......53 Opal Financial Group...........................57 Behringer........................................ 58-59 Real Capital Analytics...........................61 Summit Publishing................................62 REISA/ADISA..................................... C3 National Association of Real Estate Investment Trusts.............................. C4 realAssets Adviser | october 2014
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[ Mary Adams
Melissa Joy
Executive Director Defined Contribution Real Estate Council
Partner, Director of Wealth Management Center for Financial Planning, Inc.
Norm Boone
Hugh Kelly
Founder & President Mosaic Financial Partners
Brad Briner Director of Real Assets Willett Advisors LLC
Ron Carson Founder Carson Wealth Management
editorial board
]
Clinical Professor of Real Estate NYU Schack Institute
Jonathan Kempner President TIGER 21
Vee Kimbrell Managing Partner Blue Vault Partners
Martha Peyton Sam Chandan President and Chief Economist Chandan Economics
Head of Research and Strategy TIAA-CREF
Stacy Schaus Merrie Frankel Vice President, Sr. Credit Officer Moody’s Investors Service
Steve Gruber Managing Director Real Asset Portfolio Management
John P. Harrison Executive Director and CEO Alternative & Direct Investment Securities Association (ADISA)
Kevin Hogan President Investment Program Association
Julianna Ingersoll Director and CFO, RREEF Property Trust Deutsche Asset & Wealth Management
Sameer Jain Chief Economist & Managing Director American Realty Capital
realAssets Adviser | october 2014
Executive Vice President PIMCO Defined Contribution Practice
Charles Schreiber Chairman & CEO KBS Realty Advisors
Amy Tait Chairman, CEO & President Broadstone Real Estate LLC
Michael Underhill Chief Investment Officer Capital Innovations LLC
Steven Wechsler CEO National Association of Real Estate Investment Trusts (NAREIT)
Robert White President Real Capital Analytics
Richard C. Wilson CEO & Founder Family Offices Group
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[
Last Word
]
Fact vs. Fiction on Nontraded REITs Real data dispels popular myths about this often controversial asset class.
W
hile most financial intermediaries already know that nontraded REITs offer above-average distribution yields, their real performance has historically remained a mystery. With the goal of measuring the true performance of nontraded REITs, Blue Vault Partners, in collaboration with the Real Estate Finance and Investment Center at The University of Texas at Austin McCombs School of Business, has conducted studies during the past two years to compare the full-cycle returns of each individual nontraded REIT to its own unique custom benchmark.
The [study] results indicate no meaningful advantages exist for timing investments in nontraded REITs. Full-cycle events occur when a REIT liquidates its portfolio, completes a listing of its common stock on a public exchange, or is acquired by or merges with another entity. Utilizing the NCREIF Property Index for returns of institutionally owned real estate and the FTSE NAREIT index for the returns of publicly traded REITs, these studies shed light on the real perfor-
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mance of nontraded REITs and dispel myths that have been circulating within the industry for more than two decades. Myth #1: Invest Late, Never Early One of the most common myths about nontraded REITs is the perception that investors who are among the last to buy shares before it closes to new investments will see higher gains over the long term. In some respects there may be some truth to this, but only in the sense that compared with early investors, late investors may have higher average returns simply because the same capital gain is earned over a shorter holding period. As it relates to the data, when the results of 27 full-cycle nontraded REITs were analyzed side by side, there appeared to be no tendency for investors who purchased shares in the middle or late stages of the offering period to outperform those who purchased during the initial quarter of fundraising. In fact, early-stage investors outperformed late-stage investors for 14 out of 27 REITs, while mid-offering period investors outperformed early investors for only 13 out of 27 REITs. Overall, the results indicate no meaningful advantages exist for timing investments in nontraded REITs.
By Vee Kimbrell
Myth #2: Nontraded REITs Never Perform as Well as Stocks or Bonds As it relates to stocks, when comparing the full-cycle internal rates of returns of the 27 nontraded REITs to the average compounded quarterly returns on the S&P 500 Index, 67 percent outperformed the index during their holding periods. Also, the average total return on the S&P 500 Index during the lifecycles of the 27 full-cycle REITs was 6.08 percent compared with an average IRR for the REITs of 8.27 percent. As it relates to bonds, the intermediate-term Treasury bond was considered to be a reasonable benchmark, given the typical lifecycle of nontraded REITs is six to 10 years. Results of this analysis showed that 74 percent of the nontraded REITs in the study outperformed the intermediate-term U.S. Treasuries returns. While not appropriate for all investors, the higher average rates of return and the low correlations in quarterly returns between nontraded REITs and the S&P 500 Index and the intermediate-term U.S. Treasury Bond Index suggest the potential for diversification benefits within the context of well-diversified portfolios. Vee Kimbrell is co-founder and managing partner of Blue Vault Partners, a research firm focused on the nontraded investment industry. realAssets Adviser | october 2014
ReISA is now AdISA Alternative & direct Investment Securities Association REITs / BDCs / 1031s / Private Placements / Oil & Gas / Equipment Leasing
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