M a r c h 2 0 1 5 | 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 .
Simple
Matters Eric Flett leveraged an accounting career to serve clients through his Concentric Wealth Management
Bumper Crop
Making a play in America’s farmland is easier than ever
ETFs Get Real
Exchange-traded funds are gaining traction for real assets
Rising Up
Secondary cities across the U.S. offer unique opportunities
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
M a r c h
2 0 1 5
VOLUME 2 | NUMBER 3
features
30 | Simple Matters
Adviser Eric Flett leveraged his accounting career to serve high-net-worth clients through Concentric Wealth Management. By Ben Johnson
36 | Bumper Crop
aking a play in America’s farmland M is easier than ever thanks to a growing presence in the REIT market. By Anna Robaton
42| ETFs Get Real
Exchange-traded funds are gaining traction among investors looking to real assets allocations. By Tyson Freeman
48 | Rising Up
36
42
econdary cities offer unique S investment opportunities removed from gateway markets. By Suzanne Franks
54 | Sovereign Interest
Sovereign wealth funds are becoming a growing presence in global infrastructure investing. By Tyson Freeman
48
54
M A R C H 2 0 1 5 | 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 .
On The Cover Eric Flett, founder of Concentric Wealth Management, simplifies investing for clients with his California-based RIA. Photo Credit: James Fidelibus
realAssets Adviser | March 2015
Simple
Matters Eric Flett leveraged an accounting career to serve clients through his Concentric Wealth Management
Bumper Crop
Making a play in America’s farmland is easier than ever
ETFs Get Real
Exchange-traded funds are gaining traction for real assets
Rising Up
Secondary cities across the U.S. offer unique opportunities
1
Contents
M a r c h
2 0 1 5
reala s s e t s a d vi s er . com
News & views
22
24
26
28
Real Estate
Infrastructure
Energy
Commodities
22 | Blackstone Buys Firm expands sector presence with 36 new properties
24 | Oil Prices Are a Drag Falling energy prices spell trouble for securities market
26 | Oregon to Ban Coal? The state considers a ban on electricity from coal
28 | Mining Struggles Global industry sees gloomy end to dismal 2014
23 | Lone Star Launches Fourth fund targeting debt and distressed properties
25 | New Muni Bond? Proposed infrastructure bond could help P3s
27 | Gas Prices Stem Slide 17-week skid reverses course in recent movement
29 | Copper Drops Blame set squarely on Chinese fund activity
23 | Manhattan Offices Rise Recent sales confirm NYC as leading investment market
25 | AMTRAK Carries Deficit Potential challenges ahead if funding comes under pressure
27 | Mega-Funds Growing Billion-dollar funds continue fundraising efforts
29 | Here’s the Beef Industry sees strong price movements in 2015
22 | REITs Dig Hotels Major deals spawn records totaling $710M
24 | Taxing Matter Obama proposes new tax to help fund infrastructure
26 | Energy Transfer Grows Firm becomes second-largest MLP thanks to merger
Coming Next Month
departments
4 | Notes & Trends
14 | The Big Picture
59 | Ad Index
8 | Contributors
18 | Up Front
61 | Editorial Board
20 | people
62 | Last Word
12 | Market view
28 | Timber Gains Q4 prices see best results in past seven years
hat is the Future W of Family Offices
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 2015. All rights reserved. Printed in the USA.
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realAssets Adviser | March 2015
FOCUSED REAL ESTATE INVESTMENT
For over 40 years, our singular focus has been real estate investment. This focus gives us a deep insight into investment markets and asset management techniques that reduce risks and optimize returns for our clients. CBRE GLOBAL INVESTORS – REAL ESTATE IS OUR NATURE
www.cbreglobalinvestors.com
[
notes & trends
By Ben Johnson Managing Director, Editor-in-Chief Real Assets Adviser
]
Why “Getting Real” Is Our Universal Mantra
Investors continue to gravitate to real assets for portfolio diversification — and for good reasons.
W
e often recite the mantra “Getting Real” here as an apt double entendre. On the one hand, we all live in the real world and seek to understand more about the investing landscape with each passing day. But more important (to us anyway) is the catchy meaning of that phrase, i.e., getting “real” with real assets. In fact, a recent study by BlackRock found that institutional investors are increasingly focusing on real assets, and the same movement is afoot in the private market among investment advisers, wealth managers, family office executives and defined contribution pension plan administrators. Obviously, we are highly in tune with this trend, and every issue of Real Assets Adviser is designed and structured to keep you informed about developments in real assets markets, as well as to discover how your peers in the investment advisory profession are running their practices.
We continue to explore the vast variety of opportunities for today’s advisers to invest in the real assets sector. For our March issue, our cover profile on a $190 million RIA located in serenely beautiful Lafayette, Calif., is an interesting read about its founder, Eric Flett, and how he, along with business partner
4
Stewart McGuire, successfully leveraged his budding accounting career into the investment advisory profession. There are a great many similarities between the two disciplines, and in our discussions, Flett observed something interesting about one of the most divisive current movements — the rise of “robo-advisers.” He equated the trend in investment advisory to Intuit’s launch of its QuickBooks software some 20 years ago. Many would argue that QuickBooks helped change the face of the accounting profession for a certain segment of the general public. And yet, it did not diminish the importance of one-on-one, custom-tailored tax preparation for those individuals who required something a bit more robust and personalized than a simple 1040EZ. For more on Flett’s thoughts, please give the entire cover story a read, starting on page 30. Elsewhere in these pages, you will find a story on the emergence of Farmland REITs, as a more efficient and direct method of investing in the U.S. heartland. Recently, I had the honor of moderating a discussion on the current state of real assets and future trends before a group of leading institutional investors as part of Institutional Real Estate Inc.’s annual Visions, Insights & Perspectives (VIP) conference in Dana Point, Calif. While our hour-long discussion was far ranging, I mention this because one of the main questions came from an audience member regarding farmrealAssets Adviser | March 2015
[
notes & trends
]
land investments. He was keen to recount his own recent experiences and observations on trends in the sector. Though this is certainly by no means a mainstream topic (the rolling eyes of many fellow audience members sent a clear message indeed), it is clear evidence that we here at Real Assets Adviser continue to explore the vast variety of opportunities for today’s advisers to invest in the real assets sector. Another more mainstream investment segment involves ETFs, and we asked Tyson Freeman to explore the state of the real assets ETF market in another feature story. It turns out that they are increasingly finding a place in wealth managers’ strategies for real asset investment. In fact, Freeman notes, in some cases, there are really no better choices to gain exposure to the underlying assets. If you are at all familiar with the sports phrase “second is the first loser,” then you should love our feature on the rising popularity of so-called “secondary cities.” Our story squarely rebuffs the traditional notion that gateway markets are the only winners and finds that many smaller cities are, indeed, hotbeds of activity when it comes to real estate investment opportunities. Personally, my formative roots are still deeply planted in the red clay of Oklahoma, and for decades the state was best known for its “fly over” status, meaning, institutional investors and others only viewed it from their comfy flying chairs high above at around 30,000 feet as they flew over the state for the more popular East and West coasts. But given the increasingly frothy nature of commercial property prices in major cities such as New York, Boston and San Francisco, there are new indications that more yield-driven opportunities are likely to be found in traditionally less favored “middle markets” across the country’s coastal gap. The key is in knowing where (and how) to look, and our feature provides some informative insights. Many of today’s advisers are keenly aware of the growth of sovereign wealth funds, since they represent major institutional investors with trillions of dollars of capital to move markets. In particular, fee-based advisers, since they act in the same fiduciary capacity as their larger brethren, institutional investors, are most interested in gauging their long-term strategies. When it comes to real assets, sovereigns are investing across the entire spectrum of real estate, infrastructure, energy and commodities at an impressive rate. And though many of the funds source their capital from oil-rich regions around the globe, there are few signs that their appetite for real assets is diminishing in tandem with the continuing gyrations in energy pricing trends. We hope you enjoy this issue, and please drop us a note any time with your thoughts and opinions. Thanks for the read.
Many of today’s advisers are
keenly aware of the growth of sovereign wealth funds.
On Twitter: @RealAssetsAdv and @Bjohn9
6
A publication of Institutional Real Estate, Inc.
president & CEO Geoffrey Dohrmann CHIEF Operating OFFICER Erika Cohen 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 COPYEDITOR Jennifer Babcock Contributing Editors Drew Campbell Loretta Clodfelter Reg Clodfelter Mike Consol Denise DeChaine Jennifer Molloy Andrea Waitrovich vice president, marketing Sandy Terranova marketing & client services Michelle Raab Brigite Thompson Michelle Tiziani Caterina Torres BUSINESS DEVELOPMENT Elaine Daniels Salika Khizer Karen McLean SPONSOR SERVICES Wendy Chen Linda Ward DATA SERVICES Justin Galicia Derek Hellender Karen Palma Administration Andrew Dohrmann Jennifer Guerrero
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Loving
Life Adviser Harvey Spira eschewed the wirehouse route to form Hyperion Wealth Advisors as an IAR.
Year in Review
2014 proved to be a breakout year for real assets
Grand Gestures
Splashy corporate HQs are making a major comeback
Final Bid: Sold!
Auctions are a viable method of direct real estate investing
Real Assets Adviser is the first and only monthly publication dedicated to providing actionable information on the real assets class. The magazine 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 covers the entire spectrum of real assets, including real estate, infrastructure, energy and commodities/precious metals. If you are a registered investment adviser, wealth manager, family office, independent broker-dealer, or defined contribution plan administrator, then you will want to receive the premiere issue of Real Assets Adviser. Sign up for a free copy at www.irei.com/subscribe-realassetsadviser
REALASSETS
ADVISER
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people data insights
[
contributors
] Brad Case The Case for REITs (page 12) Brad is senior vice president, research & industry information for the National Association of Real Estate Investment Trusts. He has researched residential and commercial real estate markets, domestically and globally, for more than 25 years. Brad earned his Ph.D. in economics at Yale University and also holds the CFA and CAIA designations.
Suzanne Franks Rising Up (page 48) Suzanne is a consultant who has worked in real estate investment management for almost 30 years. She recently retired from Clarion Partners where she was head of corporate communications. Prior to joining Clarion, Suzanne managed the marketing support group for Equitable Real Estate Investment Management.
Tyson Freeman ETFs Get Real (page 42) Tyson is a long-time contributor to the IREI family of publications. He has also held positions at various institutional real estate firms, most recently at high-end vineyard developer Premier Pacific Vineyards. Tyson rounds out his writing schedule making wine for three wineries in Northern California.
Sameer Jain Making the Case for Real Assets (page 62) Sameer is managing director and chief economist of American Realty Capital, and managing director, alternative investments for Realty Capital Securities, ARC’s FINRA member broker-dealer subsidiary. He has 18 years of experience in alternative investment. Jain previously headed investment content & strategy at UBS Alternative Investments and was a director at Citi Capital Advisors.
Anna Robaton Bumper Crop (page 36) Anna is an experienced business journalist, with expertise in real estate, investing, personal finance and healthcare. Anna began her career as a daily newspaper reporter and went on to serve as a staff reporter at Investment News, Crain’s New York Business and other publications.
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ISSN 2328-8833 Institutional Real Estate, Inc. Vol. 2 No. 3 March 2015 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.
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Opening
VIEW
Full Bloom
Spring has sprung, and while the cherry blossoms are in full song, so is the U.S. Capitolยนs real estate investment market. The Big Question: How long will it last?
[
Market View
By Brad Case
]
The Case for REITs: Diversification to the Fore Tax advantages, performance, diversification make REITs an attractive option in 2015.
T
he first quarter of the year means it is time for financial advisers to provide two of their most important services: helping clients through an annual review of their investment strategies, and helping them benefit from tax-advantaged accounts. Here is how listed REITs can help you perform better in both respects. REITs are companies whose main business is owning income-producing real estate assets. Equity REITs lease out physical assets of every type from office buildings and shopping malls to rental apartments and senior-living facilities to data centers and cellular communication towers; mortgage REITs earn income from mortgages and mortgage-backed securities.
The total return on listed equity REITs has averaged 11.75 percent for the last 25 years. Congress developed REITs more than 50 years ago to make the portfolio benefits of commercial real estate investment available to all types of investors. Chief among those benefits is diversification: taking advantage of big differences among asset classes to reduce the “bumps in the retirement road” without sacrificing the final destination.
12
Many investors do not really understand what makes for good diversification; you can help them. The rest of the stock market generally moves according to the “business cycle,” which in the United States seems to average around four years in duration. REITs, though, move to a very different cycle: The real estate cycle seems to average more like 18 years, as the great researcher Homer Hoyt first pointed out back in 1933. Indeed, the last real estate cycle (1989–2007) was 17½ years, and the one before that (1972–1989) was 17 years — while the current cycle is only eight years old. Different cycles means that big movements in various asset classes, such as REITs and nonREIT stocks, tend to happen at different times. That is what it means for two asset classes to have a low correlation, and the correlation between listed REITs and the rest of the U.S. stock market is low at just 0.62. Low correlation protects an investor from seeing the value of her overall portfolio plummet just before she planned to make a big withdrawal to finance, say, tuition or retirement expenses. But low correlation is not enough: After all, the correlation between stockholdings and cash-stuffed -in-a-mattress is zero, but hiding their cash will not help your clients build their wealth. The other part of diversification is genuinely strong performance — the kind of performance that would have made an initial $10,000 investment in listed equity REITs 25 years ago grow to nearly $144,000 today, while the same investment in the S&P 500 stock realAssets Adviser | March 2015
index would have grown to less than $100,000. That’s right: The total return on listed equity REITs has averaged 11.75 percent for the last 25 years, and 12.22 percent per year since records starting being kept at the beginning of 1972. Meanwhile, the S&P 500 has averaged just 10.04 percent over the past 25 years and 10.54 percent since 1972. (For your more finance-savvy clients, that combination of outperformance and diversification translates to a beta for listed equity REITs of just 0.645 along with an annualized alpha of +5.82 percent.) To see what that combination of performance and correlation can do for a typical client, think of a basic 60/40 portfolio of stocks (30 percent largecap, 20 percent small-cap, 10 percent international) and bonds (30 percent U.S. bonds, 10 percent international). Over the past 25 years that portfolio would have returned 8.45 percent per year on average, with volatility of 9.57 percent. That result is perfectly respectable on both counts — but now consider how adding an allocation of just 10 percent to listed REITs would have improved it. A portfolio with slightly less in nonREIT stocks (25 percent large-cap, 17 percent small-cap and 8 percent international) and the same bond allocation, with the addition of 10 percent listed REITs, would have provided more portfolio growth with returns averaging 8.67 percent per year, but with less volatility at just 9.36 percent. Similarly, a portfolio of 40 percent nonREIT stocks (20 percent large-cap, 15 percent small-cap and 5 percent international) and the same 40 percent in bonds, but with double the REITs, would still have shown less volatility than the nonREIT portfolio at just 9.41 percent, but average total returns would have been much stronger at 8.93 percent per year. The difference in wealth between the 20 percent–REITs portfolio ($82,826) and the no-REITs portfolio ($73,204) would have been almost as much as the initial investment! It is important for clients to understand part of realAssets Adviser | March 2015
the power of REITs: They are required to distribute most of their taxable earnings in the form of dividend payments to shareholders, which means REITs do not have the same opportunities that other companies have to squander earnings on illconsidered expansions. As a result, over the last 25 years REIT dividend returns have averaged 5.46 percent per year, more than twice the income return for the S&P 500 (2.27 percent). That strong, steady current income is like manna for retirees and other income-oriented investors, while those who do not need to spend their dividend income can benefit from reinvesting it. Helping your clients take advantage of it, though, will bring to bear another of your most important resources: your ability to help your clients take advantage of tax-deferred and other tax-advantaged investment opportunities. Your clients may want your help locating REIT investments in tax-deferred accounts and low-paying nonREIT stock investments in taxable accounts. Whatever your client’s situation, he or she will need your guidance more at this time of year than at any other. You will need to help your clients reposition their portfolios to take full advantage of the diversification opportunities in the markets while minimizing the tax bite out of their invest-
REITs move to a very different cycle. ment portfolios. For more than 40 years, listed REITs have offered a rare combination of strong returns, dependable income and low correlations to help investors achieve those goals, and you can use them to help your clients achieve theirs. Brad Case is senior vice president, research and industry information for the National Association of Real Estate Investment Trusts.
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[
the big picture
David Belzer
]
Middle-Market Firms Provide Yield Play
Prospect Capital Corporation finances middlemarket companies to drive investment returns.
B
DCs are publicly registered companies that invest in small- and mid-sized businesses. The BDC structure was created by Congress in 1980 under amendments to the Investment Company Act of 1940. One of the leading managers in the space, New York-–based Prospect Capital Management, was founded in 1988 and has a history of investing in companies and managing high-yielding debt and equity investments using both private partnerships and publicly traded closed-end fund structures. Its flagship fund, the Prospect Capital Corporation, has been publicly traded since it went public in 2004. David Belzer is managing director and has been with Prospect Capital Management since November 2004, just a few months after the firm’s IPO. Real Assets Adviser editor Ben Johnson sat down with Belzer to find out more about the firm. BJ: Tell us a bit about Prospect and what you are doing there. DB: Through our BDC we currently are a yieldfocused lender that provides non-controlled debt financing, as well as control-oriented financing, mostly to private companies. We have been in business for more than a decade now as a public company. As of September 30, 2014, Prospect Capital Corporation has total assets of just under $7 billion with book equity of around $3.5 billion.
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Prospect Capital Management has more than 100 people, so we are one of the largest dedicated teams focused on middle-market credit. BJ: When you first went public, you were focused mostly on investing in the energy sector. Why did you decide to diversify? DB: It was really a desire to grow and further diversify our asset base while maximizing our ability to obtain leverage. Lenders were less willing at the time to provide leverage against a single industry–focused fund, so by diversifying we were able to maximize that side of the balance sheet a little bit better. BJ: Why the focus on investing in middle-market companies? DB: We believe this strategy offers better risk/ reward relative to investing ineither larger cap or small, micro-cap type companies. There is a lot more capital, more investors, more competition focused on large cap companies. In the middle market, investments are less efficiently priced, resulting in higher yields, better returns, lower leverage and more attractive valuation multiples. Middle-market businesses account for more than $4 trillion of U.S. GDP, and it is actually the fifth-largest economy in the world, accounting for more than 40 million jobs. It is estimated that there are more than 200,000 middle-market businesses. We have a very diverse realAssets Adviser | March 2015
origination platform, one that we think is unique compared to most institutions. We have eight or nine different channels that we tap into, including our own management relationships, co-lending relationships and sponsor relationships. BJ: you created a joint venture with Behringer. Describe how the venture is working. DB: We launched our first fund, Priority Senior Secured Fund, in 2012, and it is currently raising capital, focused more on structured credit. On the heels of that success, we have now launched Pathway Energy Infrastructure Fund, which is primarily focused on generating current income for investors and secondarily providing capital appreciation. We employ a diversified investment strategy by not only investing across the capital stack, leveraging our prior track record by focusing on senior secured debt, unsecured debt and dividend paying equities, but also investing across the energy value chain. This fund is going to invest across the upstream, midstream and downstream sectors within that energy value chain. While it is an energy-focused fund, it is highly diversified across both the cap structure and subsectors within energy. BJ: How is the venture structured? DB: Behringer is the wholesaler and is raising capital for the fund through relationships with financial advisers. They have added new management and are repositioning the company with a focus on new alternative products. Prospect is focused on the investment management, making actual investment recommendations. BJ: What are some of the challenges in today’s energy/infrastructure sector in general? DB: At the end of the day, the energy sector is large. Energy spending represents approximately 8 percent of GDP. This is a huge swimming pool for investors, presenting a multitude of opportunities. That being said, the energy sector can be a difficult sector for people to understand. We have identified 1,000 public companies that we think will be taking advantage of opportunities within this sector. The long-term market forces and supply and demand will continue to drive the sector. This includes relatively inelastic demand driven by population and economic growth, increasing supplies due to new technologies and a huge appetite for capital for the ongoing development needed in the sector. realAssets Adviser | March 2015
BJ: So how does $2 gasoline at the pump impact the future of energy investments? DB: There are always periods of price fluctuations. Gas is priced low right now because oil prices have fallen, and this is proving to be basically a tax break for the consumer. This will not only spur demand from the consumer, but also from the industry, serving as an overall benefit for everyone. For us, we have a diversified strategy across the entire value chain. Yes, oil has dropped 50 percent since mid-2014, but the energy sector is a lot more than just oil prices. When you look at natural gas, it went through a similar adjustment with its supply configuration, where now we have really what feels like permanent low natural gas prices that have benefited everyone, but this has not eliminated the opportunities for long-term investment in the sector. Over the last five years our oil supply as a result of oil shale development here in the United States has spiked to more than 9 million barrels a day, on par or soon to be greater than that of Saudi Arabia. Accordingly, we have a period of adjustment here where we need to work through that oversupply. We envision a one- or two-year period of low oil prices, but our strategy is to invest in those companies that have low leverage, are well-hedged, are well-positioned, well-diversified to withstand that period of the down cycle and then come out even stronger on the other end. We are seeing a tremendous amount of investment opportunities today in the debt markets, as there has been indiscriminant selling across anything to do with energy as a result of the decline in oil. Our investors are going to benefit from what we call the pullto-par benefit. When we combine securities in the secondary market at a discount, and as those securities are paid off, those debt securities benefit from some capital appreciation in addition to the income that we realize over time. BJ: So your strategy is to mitigate risk by diversification in the types of investments that you make? DB: Exactly. Again, our orientation is towards protecting our capital in the form of debt, which is senior to equity, so we are avoiding some of the volatility associated with equities in this market. Sure, there is still some selling pressure out there, but we are long-term investors and we think our investment strategy will be a good mitigant to protecting our downside.
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[
the big picture
Tom Voekler
]
New Rules Designed for Investor Protection
Regulations promising greater transparency will change the direct investment fundraising landscape.
R
eal Assets Adviser editor Ben Johnson recently sat down with Tom Voekler, president of the Alternative and Direct Investment Securities Association, for an update on new rules surrounding direct investments.
BJ: Nontraded REITs and DPPs have to make substantial reporting changes due to a new FINRA Rule. Tell us what this means for the industry. TV: The Customer Accounting Rule has been a major concern for all players in the nontraded real estate investment trust (REIT) space. In October 2014, the U.S. Securities and Exchange Commission approved amendments proposed by FINRA, known as 14-006, to modify NASD Rule 2340 and FINRA Rule 2310. These rules were amended to provide greater transparency on customer account statements provided to investors of publicly registered nontraded REITs and other direct participation programs (DPPs), such as nontraded business development companies (BDCs). The amendments, which go into effect beginning April 2016, 18 months after the SEC’s approval, will change how these customer account statements are handled by each sponsor and adviser. The amendment changes how nontraded DPPs’ or REITs’ estimated price per share value is reported on customer statements, and it establishes an estimated net value of the investment by
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deducting sales commissions and related charges. These charges include, but are not limited to, organizational and offering costs from the initial public offering price on a per-share basis. The price-pershare estimated value must come from one of two methods. The net investment method establishes the net value by deducting sales commissions and related charges, and then reports that account value based on the estimated net value per share multiplied by the number of shares. Additional disclosures are also required with this method. The appraised value method, which can only be used within 150 days after the second anniversary of escrow break, requires independent third parties to determine or provide material assistance in the process of determining the estimated net asset value of a portfolio. BJ: How do you think it will impact alternative investments? TV: First and foremost, it will increase the transparency for investors in nontraded REITs and other DPPs with regard to upfront fees and costs associated with these products. The amendments will also improve the investor’s ability to rely on valuations listed on customer account statements. Whereas they could previously be 18 months old, the frequency is now annual for these valuations. With the change in the way valuations are presented and an estimated net value is established, disclosures will also now be timelier. realAssets Adviser | March 2015
The amendments can lead to greater market acceptance from financial advisers previously leery of recommending investment options if a valuation has not been publicly set or having comfort with regard to the fees they can charge on customer accounts. In addition, it may lead to more positive acceptance from investors overall. Education is of the utmost importance. It is the responsibility of industry organizations, sponsors and other key players to further the education of financial advisers and investors about the proper interpretation of these amendments and how they can greatly benefit existing and future investors. While there are many upsides to this amendment, these changes in customer accounting are cumbersome to existing REIT sponsors, and they may very well result in some sponsors shutting down or having reductions in their fundraising. There has been talk of it possibly having a serious effect on the fundraising for REITs and, therefore, a significant impact on the nontraded REIT sector as a whole. BJ: In addition to the new amendment, the North American Securities Administrators Association began circulating proposed changes to its REIT policy in August 2014 to industry regulators and representatives, with the same goal in mind. What sort of impact will these have on the industry and, specifically, nontraded REITs? TV: NASAA’s proposed changes to its REIT guidelines include 33 revisions that are currently being discussed and argued either for or against, by many players in the industry. ADISA, and other leading industry organizations, submitted various letters to and have had conversations with the NASAA REIT Guidelines Task Force, outlining suggestions of revisions and why some changes may be problematic. As with the recent 14-006 amendments, the desired end result from all parties is to continue to further the protection of investors taking part in realAssets Adviser | March 2015
nontraded REITs, while minimizing the impact to the industry. Included in the proposed changes by NASAA is a change to the minimum contribution amount allowed from the existing $200,000 to 1 percent of the maximum offering amount. ADISA believes this could have a large impact and create an additional barrier to entry. Instead, the organization proposes a cap of up to $1 million as a more appropriate contribution. Additionally, NASAA proposes to change the minimum offering amount to the lesser of 5 percent of the maximum offering amount, or $25 million. In its response letter to NASAA, ADISA points out that a significantly high minimum offering amount disadvantages newer sponsors who are just establishing their broker-dealer networks and competing with older, more established sponsors as well as those sponsors bringing new and innovative products to the market. It’s uncertain when these guidelines will be determined, but given the 33 proposed changes, there could be a significant impact on the REIT industry. Still, it’s important to note that these are proposed changes to existing REIT guidelines from NASAA, and they will likely have less of an impact than a
It is the responsibility of industry organizations, sponsors and other key players to further the education of financial advisers and investors. brand new set of 33 guidelines that REITs must follow. In addition, NASAA is discussing creating BDC guidelines, which will likely be delivered after the REIT guidelines are finalized. Tom Voekler is co-founder and co-managing partner of law firm Kaplan Voekler Cunningham & Frank PLC.
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up front
95-STORY TOWER SET FOR JERSEY CITY
RECORD WEALTH TRANSFER OVER NEXT 30 YEARS
A Chinese developer is planning a 95-story condominium tower for the Jersey City waterfront, making it the tallest building in the state.
Rich families are expected to transfer a record $16 trillion to the next generation over the next 30 years, according to Wealth-X and NFP.
DC Contribution Rates Are Climbing Rapidly
A new study finds that 401(k) participants are increasing their contribution rates at a faster clip than ever before. In fact, 32 percent of participants increased their deferral rate over the past year, far surpassing the 21 percent who expressed the intention to do so in 2013. Moreover, one-quarter (26 percent) of those who did not make a change to their contribution levels within the last year indicate the intention to do so in the next 12 months. Not only does this tee up years of future growth in account value, but it represents an opportunity for providers, as participants become more engaged in saving for retirement. These and other findings are included in DC Participant Planscape, an annual Cogent Reports study by Market Strategies International. Cogent Reports conducted an online survey with 4,636 defined contribution plan participants from September to October 2014. The younger generations are driving this increase in contribution rates, and Cogent found that Gen X and Y participants have a stronger appetite for automatic plan features such as auto-increase and auto-rebalance, making them prime candidates for the combination of plan features that maximize savings potential. “This spike in contribution rates is likely due to the improved eco-
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nomic climate in the U.S. and growing account balances. The reason this increase is coming primarily from the younger generation may be because these cohorts are starting to understand the value of investing in their defined-contribution (DC) plans and the importance that their savings in these plans will have on their financial well-being in retirement,” explains Linda York, vice president of syndicated research at Market Strategies. “In an era where many providers are choosing to get out of the DC plan record-keeping business, those that maintain their presence may be sitting on a potential gold mine with their Gen X and Gen Y participants.” The full report, first conducted in 2012, evaluates the competitive position of 20 leading plan providers on a variety of metrics, including overall satisfaction and likely consideration for additional products and services outside of the retirement plan. At an industry level, participant satisfaction with DC plans has improved dramatically over the past 12 months, presenting the strongest opportunity providers have had since the financial crash to capitalize on goodwill with their current customers. “Among the top 20 providers, seven saw a significant lift in participant satisfaction, which, if maintained, could lead to lucrative cross-sell business in the future,” says York.
SEC Seeks to Bulk Up Examiner Staff in 2016
RIAs, take note: The U.S. Securities & Exchange Commission is hoping to add at least 225 new examiners to its roster as part of the U.S. federal budget that takes effect in October 2016. The regulatory agency freely admits, however, that even that level of new staffing will not give it the resources it needs to examine even a simple majority of U.S.-based RIAs. The commission notes that it reviewed just 10 percent of advisers in 2014, and about 40 percent of all advisers have never been reviewed.
Canada Steps Up as Leading RE Buyer
A new study by CBRE finds that Canada is the unrivaled global investor in U.S. real estate with nearly $10 billion of direct investments in 2014, ahead of Norway, China, Japan and Germany. Global direct investment in U.S. real estate totaled $41 billion in 2014 — about 11 percent of all investment in U.S. property assets. This represents a 6 percent increase in global investment when compared to 2013. Canada was the lead global buyer of U.S. real estate last year with 26 percent of direct foreign investment — $9.7 billion. Canadian investors had already transacted a significant $2.75 billion in U.S. real estate as of mid-January 2015. Canadian real estate investment in the United States was one of the largest cross-border capital flows in the world in 2014 after U.S.-to-U.K. and Hong Kong–to-China capital flows. realAssets Adviser | March 2015
GLOBAL INVESTORS INCREASING REAL ESTATE ALLOCATIONS
LONDON, MANCHESTER FORM $750M REAL ASSETS FUND
Institutional investors are increasing their allocations to real estate and intend to spend $50 billion in 2015, according to research by INREV, ANREV and PREA.
Local council pension funds from London and Manchester have created a $750 million investment vehicle for infrastructure and alternative assets.
More Cranes = Construction in 2015, Says New Index
For the first time in the United States, Rider Levett Bucknall predicts construction growth in major cities by counting construction cranes, and the inaugural edition of the RLB Crane Index forecasts that the growth rate in the construction industry is expected to increase, especially in the residential sector. Rider Levett Bucknall’s RLB Crane Index is published biannually and tracks the number of cranes in major cities across North America. According to the first issue of the index, the residential market — specifically condominium and apartment development — continues to lead the U.S. construction recovery. The commercial, healthcare, hospitality and education sectors also have started to see increases in crane activity. “Unlike other forms of data, cranes are observable and recognizable icons of major construction activity. Therefore, they are an extremely useful measure of the changing pace of the construction industry,” says Julian Anderson, president of Rider Levett Bucknall North America. In addition to the new North America edition, versions of the index are also currently published in Australia, New Zealand, the Middle East and Southern Africa.
realAssets Adviser | March 2015
The North American RLB Crane Index also indicates that residential projects in Boston, Chicago, Denver, Honolulu, Los Angeles, New York and Seattle are responsible for the majority of cranes populating the city skylines, with the majority of the projects being condominium and apartment developments. The index further indicates that: • Denver’s market shows approximately 92 percent of cranes are active on residential and mixed-use residential projects. • Honolulu’s residential cranes are leading the count at nearly 53 percent. • New York’s construction market is gaining strength and is being driven by increased demand for higher quality multifamily residential developments. • Seattle is experiencing a large increase of construction activity, with 50 percent of cranes on residential projects. • In Phoenix and San Francisco, commercial and mixed-use projects have the most cranes active. • Other property sectors across the United States exhibiting growth in crane counts include hospitality and healthcare.
Study: DC Plans Favored by Savers
A recent study by the Investment Company Institute, American Views on Defined Contribution Plan Saving, found that U.S. households value the discipline and investment opportunity that 401(k) plans represent and are largely opposed to changing the tax preferences or investment control in those accounts. A majority of households also affirmed a preference for control over the disposition of their retirement accounts and opposed proposals to require retirement accounts to be converted into a fair contract promising them income for life from either the government or an insurance company.
Ultra Wealthy Hold $3T in Real Estate
Nearly $3 trillion of the world’s private wealth is held in owner-occupied residential properties, a value greater than the GDP of India, according to a new report by Wealth-X and Sotheby’s International Realty. There are 211,275 ultra-high-net-worth (UHNW) individuals in the world, and 79 percent of them own two or more residences. The main hubs for luxury residential real estate are New York City, London and Hong Kong, but niche locations — such as Lugano, Switzerland, the Hamptons outside New York City, and rural areas around the world — are gaining in popularity. The report notes that the shift in wealth creation from West to East and intergenerational wealth transfers, will put an emphasis on new developments and a change in investment-grade cities.
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Scott Brown Assumes Global CEO Role at Cornerstone Cornerstone Real Estate Advisers, one of the largest global real estate investment managers, announced that president Scott D. Brown has assumed the additional title of global chief executive officer. He replaces CEO David J. Reilly, who has transitioned to vice chairman of the board. While Reilly will formally retire from the firm on April 30, 2015, he will continue in his new role as vice chairman to provide counsel on strategic issues and special assignments to Brown and his leadership team. Reilly was appointed CEO in 2006 and has been with the firm for 20 years. Brown, 51, joined Cornerstone in February 2014, succeeding Reilly as president of the firm. His career in the real estate industry spans 28 years, during which he has served as
an investor, consultant and adviser. Prior to joining Cornerstone, Brown served as head of the Americas at CBRE Global Investment Partners. There, he was also a member of the global investment committee, the CBRE GIP board of directors, and the CBRE Global Investors Americas operating board. He also served as an advisory board member for a large number of investment vehicles, structures and property sectors in the United States, Mexico and Brazil. Over Reilly’s 40-plus year career in real estate, he has gained extensive experience in asset and portfolio management, acquisitions and dispositions, and operations across all institutional property types. As president and CEO of Cornerstone, he played an integral role in defining and driving the vision for the company,
supporting its growth from $7 billion in real estate assets under management in 2006 Scott D. Brown to over $45 billion today. Cornerstone expanded its European presence through the acquisition of German real estate money manager, Pamera Asset Management, and plans to continue its growth on the continent in 2015 by opening offices in Paris, Milan and Madrid. Under Brown’s leadership, Cornerstone will also look to establish an investment management platform in the fast-growing Asia-Pacific region in the next year.
Catherine Arnold joined U.S. Bank as a wealth management adviser for the Private Client Reserve high-net-worth unit in Seattle. She was previously a vice president and senior director with BNY Mellon Wealth Management.
industry specialist for the bank’s Private Client Reserve high-net-worth unit in Nashville. He is responsible for developing relationships with musicians, actors, producers and other clients in the entertainment industry. Prior to joining the Reserve, Briggs was a vice president for the American Society of Composers, Authors and Publishers.
sor serving the greater Washington, D.C., region. Her primary responsibilities will be leading an investment team to work closely with clients to develop and actively manage unique portfolios designed specifically to address each client’s goals and needs.
Jean-Philippe Aubertel is now director at InfraMed Management. Aubertel, formerly director of the French Agency for Development’s Group Risk Management, will focus on InfraMed’s 350 clients, including 100 infrastructure-focused clients such as utilities and transportation companies. Shannon Baustian joined U.S. Bank’s Private Client Reserve high-net-worth unit as a senior wealth planner in Minneapolis. She was previously director of client service for Market Street Trust Company.
Kenneth Caplan was promoted to global chief investment officer for real estate at Blackstone Group. Caplan reports to Jonathan Gray, global head of real estate. Caplan was a senior managing director and head of real estate for Europe. Anthony Myers, a senior managing director, is replacing Caplan.
Gregory Block has joined U.S. Bank’s Private Client Reserve high-net-worth wealth management unit as a private banker in Milwaukee. He was previously with Park Bank, where he served as vice president of the commercial banking division and as a credit analyst.
Vivian Chan joined BNY Mellon Wealth Management’s Hong Kong office as wealth director of business development. She provides discretionary investment and wealth management services to high-net-worth individuals and families in Hong Kong. Chan was formerly with Oppenheimer & Co. in Newport Beach, Calif., where she was a director of investments.
John Briggs joined U.S. Bank as a wealth management consultant and entertainment
Maria R. Clarke has joined U.S. Trust as senior vice president and private client advi-
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Jim Costello, CRE, has joined Real Capital Analytics, a global data and analytics firm focused on the commercial real estate sector, as senior vice president. “Jim brings a tremendous wealth of experience and knowledge to the firm,” says Bob White, president and founder of RCA. “I’m excited about the new analysis and insight Jim will pioneer using our data.” Costello joins RCA from CBRE where he was managing director of investment research for the Americas, providing economic and market insight to industry professionals in development of their investment strategies. During his 20 years at CBRE, Costello also served as director of investment strategy at CBRE Econometric Advisors and as an economist at CBRE Torto Wheaton Research. Costello is a noted authority on the real estate capital markets and has authored many opinion pieces and articles for industry journals and publications. realAssets Adviser | March 2015
Andrew Crofton joined BNY Mellon Wealth Management as a senior wealth director in Manhattan and Garden City, N.Y. He was formerly a private client adviser at U.S. Trust. Rachel Ferguson was named managing director of private banking for U.S. Bank’s Private Client Reserve high-net-worth wealth management unit in Cincinnati. In her new role, Ferguson oversees a team of private banking professionals. She was previously a managing director of private banking for the Reserve’s Twin Cities offices. Bernard (Ben) Figlock has been appointed to serve as a director of general partners, Plains All American GP LLC and Plains GP Holdings LLC. Figlock has been appointed by an affiliate of Occidental Petroleum Corporation to serve as its designated representative on each board, replacing Vicky Sutil. Sutil recently accepted a position with California Resources Corporation, a former subsidiary of Occidental. Figlock currently serves as vice president and treasurer at Occidental, where he directs and oversees management of Occidental’s treasury and risk management functions including finance, investments, insurance and operational risk, commodities trading credit and market risk, and currencies. Peter Finley has joined Lowe Enterprises Investors as senior vice president to lead the firm’s marketing and business development efforts. Previously, Finley was head of capital markets for Paramount Group, co-founder and managing director of JT Partners, and executive director for the real estate investment banking group of UBS Investment Bank. Heather Gross joined U.S. Bank as a trust relationship manager for the Private Client Reserve high-net-worth wealth management unit in Sacramento. She was formerly an estate planning and trust administration attorney for Legacy Law Group. Michael Hamilton has joined AMP Capital as investment director for the Americas region. Hamilton, formerly a managing member of Blue Wave Capital, is based in New York City and will focus on energy and power infrastructure. The firm also has brought on Andrew Kirby, who joined AMP as a senior associate in the New York City office. Kirby, previously an associate with Rothschild in the mergers and acquisitions division, will focus on transaction support and execution activities. realAssets Adviser | March 2015
Carol Hopper has joined international law firm Ropes & Gray LLP as a partner in the London office. Her arrival marks the second high-powered partner to recently join the firm’s global real estate investments and transactions practice, after Ed Sheremeta joined the firm on Jan. 5 in Hong Kong to lead a pan-Asia real estate initiative. In addition, Matt Posthuma, a private investment funds partner who focuses on real estate investments, joined the firm’s Chicago office. Their arrivals enhance the firm’s robust global real estate practice at a time of increased activity in real estate investments in Europe, Asia and the United States. Hopper previously was a partner in Allen & Overy, and her clients have included Avestus Capital Partners, Balfour Beatty, David S. Smith, Depfa, Deka, Goldman Sachs, Lloyds Bank, Tyco International, Welcome Break and Wells Fargo. Ena Licina joined U.S. Bank’s Private Client Reserve high-net-worth wealth management unit in Las Vegas as a trust relationship manager. She was previously a trust officer with Wells Fargo Wealth Management. Amanda McMillan, currently a managing director of Glasgow Airport, will become the CEO of the new AGS Airports Ltd., a partnership between Ferrovial and Macquarie Infrastructure and Real Assets that was established to invest in the Aberdeen, Glasgow and Southampton airports. AGS invested in the three airports through a transaction with Heathrow Airport Holdings on Dec. 18, 2014. McMillan has been with Heathrow Airport Holdings since 2005 and the Glasgow Airport since September 2006. Terrence Mullen, a former Sun Life Financial Inc. senior vice president, joined American Realty Capital Properties Inc.’s nontraded REIT sponsor, Cole Capital, as a senior adviser. Mullen will work with the leadership of Cole and ARC Properties’ board of directors to strengthen Cole’s sales and marketing and broker/dealer relationships. Marcelino Pendas joined BNY Mellon Wealth Management as a senior director and team leader in Miami. He is responsible for growing the firm’s international private client business with a focus on Latin American opportunities. Prior to BNY Mellon, Pendas was director of trust sales for Amicorp Services’ Private Client Group. Dorian Reece has joined Deloitte Corp. Finance as director of airport and infrastructure finance. Reece, formerly director with Deloitte Real Estate, is based in London.
Lindsey S. Rheaume has been appointed executive vice president, C&I chief lending officer at EagleBank. He will be responsible for the expansion of the bank’s commercial and industrial portfolio and will oversee EagleBank’s experienced C&I lending teams. Rheaume reports to senior executive vice president and chief operating officer Susan G. Riel. Rheaume has more than 25 years of commercial lending, credit risk and managerial experience in the financial industry. Most recently, he served as relationship executive for JPMorgan Chase, responsible for business development in the Washington, D.C., suburban Maryland and Northern Virginia market with clients ranging in revenue from $20 million to $500 million. Edward Ruijis and Mark Saxe have been promoted to managing directors with First Reserve. Ruijis, who joined the firm in 2011, has focused on contracted midstream, power and energy sectors. Saxe, who also joined the firm in 2011, has focused primarily on the contracted midstream sector. As managing directors, both will continue to focus on energy infrastructure, with Ruijis focusing globally on energy infrastructure and Saxe focusing more narrowly on contracted midstream energy infrastructure globally. Indu Sambandam has joined the Teacher Retirement System of Texas as an investment manager with the pension fund’s real assets team. Sambandam, formerly a senior portfolio manager of infrastructure and real estate investments with the State of Michigan Retirement System, is based in Austin and will focus on the retirement system’s infrastructure investments. Magnus Spence has been appointed head of asset management at Dexion Capital, responsible for expanding the range of real asset and alternative credit fund offerings. Spence has held a number of leading roles at Mercury Asset Management/Merrill Lynch Investment Managers, and in 2002 he co-founded Dalton Strategic Partnership. Paul A. Weissgarber has been named chief commercial officer of Enable Midstream Partners LP. Prior to joining Enable Midstream, Weissgarber was a senior vice president at Dallas-based Enlink Midstream. There, he played a key role in the company’s 2012 acquisition of its Ohio River Valley assets and subsequently led the growth strategy of the company’s crude oil business in that area.
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R ea l E stat e news
REITs Buy West Coast Hotels for $710M
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n separate deals, two hotel REITs have increased their California presence by paying record prices for luxury properties. Strategic Hotels & Resorts acquired the 250-room Montage Laguna Beach in Laguna Beach (pictured above) from an affiliate of Ohana Real Estate Investors for $360 million, or $1.4 million per room. Real Capital Analytics reports this transaction is the highest priced hotel asset to be sold in the greater Los Angeles metropolitan area in the past 24 months, making Strategic Hotels & Resorts the number one buyer in the Los Angeles hotel sector. Montage Laguna Beach is one of the Southern California resort market leaders, with a trailing 12-month revenue per available room (RevPAR) penetration index of 185 times, a 2015 budgeted average daily
room rate of nearly $600 and total RevPAR of more than $1,000. Montage Hotels & Resorts will continue to manage the fivestar destination resort. The Los Angeles metro hotel sector has shown consistent growth since the first quarter 2014, which had transactions totaling $213 million in sales price, a drop compared with the fourth quarter 2013, which closed $668 million in sales price. During the final three quarters of 2014, hotel transaction volume averaged $710 million per quarter. Thus far this quarter there have been 11 hotel transactions, totaling $581.5 million. The fourth quarter closed with 28 property exchanges, totaling $785.4 million. The other hotel sold was the 681-room Westin San Francisco to LaSalle Hotel
Duke Realty Sells $1B Office Portfolio
Blackstone Buys 36 Apartments in $1.7B Deal
Duke Realty Corp. plans to sell a $1.12 billion suburban office portfolio, comprising all of the REIT’s wholly owned suburban office properties in Nashville, Raleigh, N.C., South Florida and St. Louis. The seller is a venture of Starwood Capital Group, Vanderbilt Partners and Trinity Capital Advisors. The portfolio consists of 61 in-service properties, one property that is under development and 57 acres of undeveloped land. The sale is part of the firm’s effort to increase its focus on bulk industrial and medical office properties and to reduce its investment in suburban office assets. The proceeds from the transaction will be used to repay debt and to fund ongoing development activities.
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The Blackstone Group has agreed to buy 36 apartment properties across the country for about $1.7 billion as it expands its residential rental business. The lowrise, garden-style properties located in California, Boston and Washington, D.C., are being sold by Praedium Group. Blackstone’s LivCor multifamily real estate unit will manage the apartments. The national apartment vacancy rate was 4.2 percent in the fourth quarter, hovering near the lowest level in 13 years, according to property-research firm Reis.
Properties for $350 million, or $513,950 per room. The seller was Westbrook Partners, which acquired the property in 2011 for $170 million. RCA ranked the transaction as one of the highest priced deals in the San Francisco hotel sector in the last 24 months, as well. LaSalle is ranked as the number one hotel buyer, and with the addition of Westin, the REIT now owns five hotels in the city with price tags totaling $599.2 million. The San Francisco hotel sector is attracting investors’ capital. According to the latest first quarter stats, six hotel deals have been consummated totaling $1.04 billion. In fourth quarter 2014 there were 11 deals totaling $435.7 million. During 2014, the San Francisco hotel sector saw 83 property sales, totaling $2.76 billion.
According to Reis, three of the four cities with the highest annual rent growth last quarter are in California, with San Jose in first place, followed by Oakland in third and San Francisco in fourth. realAssets Adviser | March 2015
Westbrook Holds First Close
Two Manhattan Offices Sell for More than $1B
Westbrook Partners has raised $693 million for its Westbrook Real Estate Fund X from eight existing limited partners, according to an SEC filing. The value-added fund launched in June 2014. According to IREI’s FundTracker database, the fund held a first close on Jan. 15. The firm will be hosting monthly closes before its final close in September 2015. Westbrook declined to comment on its fundraising efforts. The fund targets office, hotel, residential land, industrial and retail assets in select coastal markets in the United States, as well as global gateway cities such as Berlin, Frankfurt, London, Munich, Paris and Tokyo. It follows the same strategy as its previous funds. A recent investor is the $12.6 billion Maine Public Employees Retirement System. Westbrook Real Estate Fund IX closed in 2012 with $1.61 billion in equity commitments, and Westbrook Real Estate Fund VIII raised $2.5 billion in 2008.
Two Manhattan office properties are under contract in separate deals with a total sales price of approximately $1.2 billion. The 1.2 million-square-foot Helmsley Building is being purchased by RXR Realty. An official announcement has not been released, but Real Capital Analytics projects the asset to be priced at $1 billion, or $825 per square foot. The sellers are Invesco Real Estate, South Korea’s National Pension Service and Monday Properties. The previous owners, Monday Properties and Whitehall Real Estate Funds, managed by Goldman Sachs Group, acquired the 34-story office building in 2007 for $1.15 billion. Invesco Real Estate and NPS acquired a 95 percent interest in 2011 for $769.8 million when Whitehall Real Estate
Lone Star Launches $5B Real Estate Fund Lone Star Funds is marketing a fourth real estate fund and aiming to raise $5 billion, according to an SEC filing. Lone Star Real Estate Fund IV will invest in debt and distressed properties. The fund has an investment period of 36 months. It is one of the largest funds to launch so far this year. And Lone Star is one of the mega-fund elites in the market. Lone Star Real Estate Fund III closed in 2013 with $7 billion in equity commitments and is in its investment period. Lone Star Real Estate Fund II closed in 2011 with $5.5 billion in equity commitments. Fund II invested the majority of its equity capital in the Americas and Europe (more than 50 percent and 40 percent, respectively) and the remainder in Japan. Investments primarily consisted of commercial real estate loan portfolios, direct real estate, CMBS and a commercial real estate company. During its 46-month investment period, Lone Star Real Estate Fund II invested substantially all of its equity capital in 31 investments comprising 3,587 assets with an aggregate purchase price of approximately $14.1 billion. realAssets Adviser | March 2015
Funds exited the building. Monday Properties, which owns office buildings in the New York City and Washington, D.C., areas, has managed the building since 1998. The second deal is located in the Meatpacking District: the newly constructed 63,131-square-foot boutique office and retail building at 837 Washington St. TIAACREF is paying $200 million, or $3,158 per square foot, to Taconic Investment Partners and Thor Equities.
Harrison Street Fund Exceeds $750M Goal Harrison Street Real Estate Capital has announced a final close for its fifth opportunistic fund, Harrison Street Real Estate Partners V, exceeding its $750 million original equity target and reaching its $850 million hard cap. Fund V will invest in student housing, senior housing, medical office/healthcare properties and self-storage properties on a single-asset acquisition or development basis.
In addition, the firm simultaneously raised a $160 million Fund V Co-Investment vehicle, bringing the total capital raised for the opportunistic strategy to more than $1.0 billion. Harrison Street has $3.5 billion in purchasing power for real estate in the education, healthcare and self-storage sectors. From first close to final close, the firm raised this amount in only three months.
SDCERA Commits $500M to Real Estate, $400M to Real Assets
The $10.5 billion San Diego County Employees Retirement Association is looking to invest $500 million into real estate by 2017, as well as potentially invest $275 million to $400 million into real assets in 2015. The $500 million into real estate will be necessary for the retirement association to raise its real estate allocation from its current level of 9.3 percent to its 10 percent target allocation to the asset class by 2017. SDCERA is also looking to adjust its real estate portfolio from its current 50-50 split between core and noncore investments to a 70-30 split and will expect to achieve returns of approximately 7.5
percent with the new allocation. As of Sept. 30, 2014, SDCERA’s real estate portfolio achieved a 10.4 percent one-year return. The capital will be invested primarily in a separate account that will be complemented by the existing portfolio and niche investments on the edges. REIT investing will also be considered. Also SDCERA anticipates potentially committing $75 million to $100 million to energy and $50 million to $75 million to timber by the end of first quarter 2015. Commitments to both sectors would be with new managers.
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Infrastructure news
Obama Proposes Tax to Fund U.S. Infrastructure Investment
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resident Barack Obama proposed a new 14 percent tax on the approximate $2 trillion of overseas earnings accumulated by U.S. companies as part of his 2016 U.S. budget blueprint. The move could directly impact future infrastructure spending — on highways and transit systems in particular
— since it would help pay for part of a proposed six-year $478 billion infrastructure upgrade. Initial reaction has been positive from both sides of the aisle, a distinct rarity in Washington, D.C., political circles. “I can’t think of a better place to invest right now than in infrastructure. It’s a
Houston Pension Commits $25M to Energy Fund
Oil Prices Drag on Global Infrastructure Securities
The Houston Municipal Employees Pension System has made a $25 million commitment to Riverstone Global Energy and Power Fund VI, according to Peter Koops, communications specialist with HMEPS. Fund VI is a $7.5 billion fund that invests in a wide range of energy subsectors such as exploration and production, midstream, energy services, and power and coal. Its predecessor closed in June 2013 after raising $7.7 billion, according to IREI’s FundTracker database. HMEPS houses the investment in its inflation-linked assets class investment bucket. The $2.4 billion pension system has a 12.5 percent target allocation to the bucket, and it had 8.8 percent of its assets invested in it as of Sept. 30, 2014.
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For the fourth quarter of 2014, the MSCI World Index returned 1.1 percent, with significant dispersal across regions. Infrastructure securities underperformed the broad equity market, ending the quarter up 0.3 percent. The Americas region returned 2.8 percent, Asia Pacific returned 1.7 percent and Europe returned 1.2 percent. These regional returns, however, do not capture the effect of master limited partnerships on the Americas region. The MLP sector, representing approximately 16 percent of the index, was the weakest performer during the quarter, down more than 12.3 percent due to the effects of falling oil and natural gas prices. Aside from MLPs, sector performance was fairly robust during the quarter. Stand-
desperate need we have,” said Rep. Marlin Stutzman (R-Ind.), a member of the House Budget Committee. U.S. corporations, however, are naturally taking more of a wait-and-see attitude. The change would be effective with the government’s new fiscal operating budget starting Oct. 1, 2016.
out performers included electricity transportation and distribution, and water, which returned 8.2 percent and 7.6 percent, respectively. Other sectors with positive performance included communications (2.6 percent), toll roads (2.0 percent), airports (1.7 percent) and ports (1.7 percent). The oil and gas storage and transportation sector, which does not include MLPs, and the diversified sector returned –2.0 percent and –1.0 percent, respectively. Brookfield Investment Management expects continued weakness in Europe, Japan and China, as well as a lower global inflation outlook due to slower economic growth and declining commodity prices. Brookfield continues to favor securities that offer a reasonable combination of yield and growth. realAssets Adviser | March 2015
Massachusetts Pensions Seek Energy, Infrastructure Managers The Norfolk County (Mass.) Retirement System has issued an RFP for a private equity manager to manage up to $15 million for the retirement system. NCRS’s investment consultant, Wainwright Investment Counsel, is assisting with the search. Among other factors, the retirement system requires that a potential manager has raised at least four previous funds in the energy space, has raised at least $1 billion in equity commitments in previous funds and is not offering a fund of funds. As of Sept. 30, 2014, the $774 million retirement system had 8.01 percent of its assets invested in private equity. In addition, NCRS had 10.24 percent of its assets in real estate and 5.67 percent in real assets. The $575 million Bristol County (Mass.) Retirement System, meanwhile, has issued an RFP for a core, open-end infrastructure fund. Investment consultant Segal Rogerscasey is assisting in the search. The investment, which will be for up to $20 million, will be Bristol County’s first ever infrastructure investment, confirms Roxanne Donovan, executive director with the retirement system. Both domestic and international funds will be considered. The retirement system has a target allocation to infrastructure of 5 percent of its total assets. Though the actual allocation to the sector is currently 0 percent, it will total approximately 3.5 percent after this investment.
P3s Get Help from New Municipal Bond Proposal The Obama administration has proposed a new municipal bond, a Qualified Public Infrastructure Bond, that “could be a low-cost approach to stimulating much -needed infrastructure investment,” notes Standard & Poor’s. “But there is a cost associated with it, and as a result extensive deliberation in Congress is likely.” The proposal is part of the Build America Investment Initiative launched in July 2014 by the administration. S&P notes the QPIB is meant to extend the benefits of municipal bonds to P3s, “with the goal
How Multiplier Effect Could Impact Infrastructure Investment If U.S. infrastructure spending were boosted by 1 percent (about $160 million), it could create 730,000 new jobs in 2015, according to “Global Infrastructure Investment: Timing Is Everything (And Now Is the Time)”, by Standard & Poor’s. Across the G-20 countries, an increase in infrastructure spending of 1 percent of real GDP would create immediate economic benefits, S&P notes.
The “multiplier effect” is stronger in developing economies such as China, India and Brazil, with analysis showing a GDP boost of more than two times the increase in investment for some countries. Beth Ann Bovino, S&P’s chief U.S. economist, estimates that increasing the national infrastructure budget by 1 percent of real GDP would result in a $270 billion increase in economic output over a three-year period.
U.S. Amtrak System Carries Infrastructure Deficit
Moody’s Investors Service reports in “Amtrak’s Infrastructure Funding Deficit Exerts Long-term Negative Credit Pressure,” that “Amtrak does face an infrastructure funding deficit that will eventually exert negative credit pressure if left unaddressed.” The rating agency has affirmed its A1 rating and stable outlook despite the infrastructure needs. “Amtrak has historically received sufficient federal funding for its capital needs, but this support is exposed to political risk, and has not kept pace with expansion needs,” Moody’s notes. realAssets Adviser | March 2015
of lowering the cost of borrowing and attracting new sources of capital.” The proposal was included in the executive budget released in February.
The rail operator has $52 billion in long-term capital projects through 2030 that need to be completed to maintain its Northeast Corridor route alone, as well as another $11 billion in a five-year program of network-wide upgrades. “While this includes $1.8 billion for components of the Gateway Program improvements between Newark, N.J., and New York, it falls short of the current $15 billion estimate for all Gateway work targeted for completion in 2025,” Moody’s comments.
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ene rgy n e ws
Energy Transfer to Become 2nd Largest Mlp
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nergy Transfer Partners LP (NYSE: ETP) has agreed to purchase Regency Energy Partners (NYSE: RGP), a company it already controls, in a deal that values Regency at approximately $18 billion (including the assumption of nearly $7 billion in debt) and would make ETP the second largest master limited partnership. The deal follows a trend of pipeline company consolidation and simplification
that includes Kinder Morgan’s $44 billion merger last year and comes on the heels of a 22 percent drop in Regency’s stock value over six months amid rapidly falling oil and natural gas prices, according to Bloomberg. “In light of the current volatility in commodity prices and the changes in the capital markets, it became apparent over the last several months that Regency needed more scale and diversification,
Abengoa Yield Opens 280 Mw Solar Plant in California
Oregon Lawmakers Consider Ban on Electricity from Coal
Total return company Abengoa Yield (NASDAQ: ABY) has announced the opening of Mojave Solar, a 280-megawatt solar plant located 90 miles northeast of Los Angeles, near Barstow, Calif., in the Mojave Desert. The plant immediately becomes one of the largest in the nation, though it still trails the capacity of the nation’s (and world’s) largest solar plant, First Solar’s 550-megawatt Topaz Solar Farm located in nearby San Luis Obispo County, Calif. Topaz, which just became fully operational during fourth quarter 2014, will soon be joined by First Solar’s Desert Sunlight Solar Farm, a 550-megawatt solar farm in Riverside, Calif., that is projected to be fully operational during first quarter 2015. Desert Sunlight is co-owned by NextEra Energy Resources, GE Energy Financial Services and Sumitomo Corporation of America. Mojave Solar, which should be able to provide energy to approximately 91,000 homes in California, has a 25-year power purchase agreement with Pacific Gas and Electric Co.
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Two Oregon lawmakers have introduced a new bill that could deal a symbolic blow to fossil fuels and drastically change the state’s electricity consumption. Senate Bill 477, known as the “Coal to Clean” bill, would require electric companies to eliminate coal-derived electricity in Oregon by January 1, 2025, and replace it with a mix of energy resources that are at least 90 percent cleaner (eliminating natural gas as an option). The bill, if eventually brought into law, would cause a major shake-up in Oregon electricity sources, as approximately 33.4 percent of the state’s electricity currently
along with an investment-grade balance sheet, to continue its growth,” said Mike Bradley, chief executive officer with Regency, in a statement. According to the terms of the deal, which is expected to close during second quarter 2015, unit holders of Regency will receive 0.4066 ETP common units and a cash payment of $0.32 for each common unit of Regency.
comes from coal, compared with only 5.2 percent from wind energy and .02 percent from solar energy, according to the Oregon Department of Energy. Though the bill could face stiff resistance, a recent poll conducted by Strategies 360 suggests that 71 percent of Oregon voters support the bill. Whether the bill eventually passes or not, it is evidence of a changing of the guard for energy investors, who will need to be increasingly aware of regulatory uncertainty regarding long-term fossil fuel investments, a concern typically reserved for investments in renewable energy. realAssets Adviser | March 2015
Energy Mega-Funds Continue Chugging Forward Despite crude oil’s tough second half of 2014, energy funds, many of which invest in assets and operations tied to oil, have hardly skipped a beat, with a number of billion dollar funds chugging along full steam in their fundraising efforts. Ridgewood Energy has already raised $300 million for its recently launched Ridgewood Energy Oil & Gas Fund III, which is targeting a $1.5 billion haul for investments in North America and Mexico. The firm closed its Ridgewood Energy Oil & Gas Fund II in January 2014 with $1.1 billion in equity commitments, significantly exceeding its $750 million target. Boston-based ArcLight Capital Partners, meanwhile, is further along in its fundraising having collected $1.57 billion in total, including $800 million between midDecember and mid-January, for its ArcLight Energy Partners Fund VI. The fund launched in the second half of 2014 and is reportedly seeking a $4 billion final close. ArcLight invests across the energy industry, including in the midstream, power and production sectors, and focuses on North American energy infrastructure assets. These are just two of a handful of energy mega-funds ($1 billion or more) currently on the market, including The Carlyle Group’s Energy Mezzanine Opportunities Fund II, which is targeting a $2.5 billion haul, according to IREI’s FundTracker database. Still, the most impressive haul belongs to NGP Energy Capital Management, which has received $5 billion for NGP Natural Resources XI and could reach its $5.3 billion hard cap by press time after more than 18 months on the road. The fund, which launched over the summer of 2013, pulled in $4 billion during the second half of 2014. It invests in oil and gas production, midstream and oilfield services companies, and will give capital to management teams to purchase existing oil and gas assets, reduce realAssets Adviser | March 2015
Gas Ends Dramatic 17-Week Price Slide The U.S. average regular retail gasoline price ended its 17-week slide in early February when it increased 2.4 cents to $2.07 a gallon, according to a weekly survey by the U.S. Energy Information Administration. The 17-week slide was the longest streak of decreasing prices since they fell 14 cents per gallon over a 24-week period in 1995, and the largest proportional drop in gasoline prices since a 58 percent drop in late 2008. U.S. gas prices have only declined for a period of 13 weeks or more four times since the turn of the century. The decline corresponded with the free-fall in oil prices through the second half of 2014 that saw the Brent crude price decline from $115 a barrel on June 19, 2014, to $45 a barrel on Jan. 13,
2015. U.S. gasoline prices tend to follow the price of the Brent crude oil international benchmark more closely than the West Texas Intermediate domestic benchmark, according to the EIA. Subsequently, the end of the gas price slide corresponded with a small yet steady recovery in the Brent price in the latter half of January that led to the price eclipsing the $50 per barrel mark the same day that the EIA survey recorded an increase in gas prices. The turnaround in the decline of crude oil prices (and gas prices with them) was due in part to declining prices causing petroleum refinery outages in the Midwest and Gulf Coast regions in January, according to the EIA.
cost structures and increase volumes in order to create value. The fund will generally invest in North America, though global opportunities will be considered as they arise. The fund will make six to 10 investments per year at an investment size of $50 million to $250 million, and it is expected to make 20 to 30 investments in total. NGP has co-invested $325 million into the fund. Recently off the market is Energy Spectrum Capital’s Energy Spectrum Partners VII, which has had a $1.2 billion final close after just six months of fundraising. The fund targets “throughput” midstream assets within the energy industry, including oil and natural gas gathering and transportation systems, processing and treating plants,
and storage facilities, as well as energy service and power development companies on a selected basis. “This is our seventh fund, and we have been investing in the lower middle market of the midstream oil and gas business since 1996,” explains Tom Whitener, president and founding partner of Energy Spectrum. “Our extensive experience in this sector rivals any other midstream fund managers out there today.” The success of these funds, and their ability to raise billions of dollars in just a handful of months, has shown where investors’ long-term confidence lies, despite the shortterm volatility seen in much of the energy market in 2014.
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Commodities news
Timber Has Biggest Quarter in Seven Years
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imberland had a huge fourth quarter in 2014, leading the NCREIF Timberland Index to return 6.02 percent, marking the index’s best quarter since it saw a 9.38 percent return in fourth quarter 2007 and only the fourth time the index’s quarterly return has exceed 6 percent since the year 2000. The stellar quarter brought the year’s total return to 10.48 percent, also the highest mark in seven years and the fifth consecutive year the index has increased. The annual return was divided between a 2.86 percent return from income and a 7.46 percent from appreciation. The index’s
2014 return was just below the NCREIF Property Index’s 11.82 percent return for the year and well above the Alerian MLP Index’s 4.8 percent return. The fourth quarter is often the index’s best quarter each year, and 2014 was no different as none of the year’s first three quarters exceeded 1.6 percent. The Lake States was the index’s top performing region during the fourth quarter with a 7.16 percent return, just eclipsing the Northwest region’s 6.98 percent return. For the year, the Northwest region had the highest return at 12 percent, while the
Mining Industry Struggles at Year-End 2014
Pension System to Invest in Metals Fund
The global mining industry had a “disappointing end to 2014,” according to the latest industry monitor from SNL Metals & Mining. The mining industry has seen its combined market capitalization drop from $2 trillion in February 2012 to less than $1.3 trillion in December 2014. The firm notes, “The final month of 2014 mostly added to the gloomy market conditions that prevailed throughout the year for the international mining industry.” Financing activity during the final month of 2014 also was lower than in previous years. December’s total, at $334.8 million in financing across 49 transactions, was down from the $463 million raised in December 2013. For the full year, 2014 saw $5.55 billion raised across 329 financings, down from $5.92 billion in 399 financings in 2013.
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Some institutional investors are continuing to invest in the metals market, even as prices have fallen for most precious and base metals. The $11.9 billion Orange County (Calif.) Employees Retirement System (OCERS) has approved a commitment of $90 million, subject to due diligence and negotiation, in Galena Asset
Northeast region had the lowest return at 8.83 percent. “Timberland returns remained strong in 2014, with annual appraisals contributing to a sizeable bump in fourth quarter returns,” Ryan Reddish, chair of the timberland committee and acquisitions analyst for Forest Investment Associates, said in a statement. “Increasing EBITDA returns show that timberland managers are capitalizing on the renewed demand for wood in domestic markets.” The NCREIF Timberland Index consists of 452 investment‐grade timber properties worth just under $24 billion.
Management’s Galena Metals Fund, confirms Robert Kinsler, communications manager with OCERS. Galena has asset management teams based in London, Singapore and Switzerland. The firm’s funds focus on investing in metals, commodity trade finance and real assets through derivatives and equities. realAssets Adviser | March 2015
Pacific West Farmland Outpaces Other Regions in 2014 In 2014, NCREIF’s Farmland Index was unable to match its impressive 2013 pace, which produced an annual return of 19.61 percent, but the index still had a strong 2014 that yielded a 12.63 percent annual return after being capped off with a 6.56 percent return in the fourth quarter. But those returns varied widely by region. The Pacific West was again the best-performing region by a significant margin with a 14.11 percent fourth quarter return (split 4.20 percent appreciation and 9.92 percent income), well above the runner-up Pacific Northwest’s 2.92 percent fourth quarter return and significantly outpacing the Corn Belt and Mountain region’s returns of –1.05 percent and –0.99 percent, respectively. The Pacific West was also the only region to produce a 2014 return of more than 20 percent. More strikingly, only one other region, the Pacific Northwest, even eclipsed a 10 percent return in 2014. All six other regions produced annual returns of 6 percent or less in 2014. The Pacific West’s impressive returns are primarily driven by almond and pistachio properties, according to NCREIF. The NCREIF Farmland Index consists of 623 investment‐grade farm properties, 198 of which are located in the Pacific West.
realAssets Adviser | March 2015
Copper Drops Under Pressure from China
Copper prices fell during January to a low of $5,340 per ton for three-month contracts on the London Metal Exchange — and many in the market point to “bear-raids by Chinese funds,” reports SNL Metals & Mining. Trading by Chinese hedge funds is believed to be responsible for a precipitous drop for the metal, which hit its lowest
level since 2009 late in the month. By early February, copper had climbed back up to $5,755 per ton. Still, it remains to be seen where the metal — used across a variety of industries — will go in the rest of the year. SNL is forecasting an average price of $6,294 per ton in 2015 and $6,519 per ton in 2016.
Timbervest’s Fund I Sells More than 10,000 Acres Atlanta-based Timbervest, on behalf of its Timbervest Partners I investment fund, has sold more than 10,000 acres of timberland in Florida, South Carolina and Vermont for $14.2 million. The $230 million fund closed in 2005 and has institutional and high-networth investors.
Timbervest sold 6,710 acres in Lafayette County, Fla. The property was acquired in 2006. In addition, the firm sold 2,416 acres in Kershaw County, S.C., which Timbervest had owned for nearly nine years. And Timbervest sold 1,234 acres in Washington County, Vt., to a high-net-worth investor. The firm had owned the asset since 2006.
Beef Industry Continues Strong Performance in 2015 The global supply of beef and cattle remained tight at the end of the fourth quarter, according to Rabobank’s food and agribusiness research and advisory group. In the United States, cattle prices are hitting record levels. “The U.S. continues to be the driver in the global beef market with constrained supply and strong demand keeping prices high,” says Angus Gidley-Baird, an analyst with Rabobank. “A recent strengthening in the U.S. economy and dollar will support continued imports to the U.S.; however, we are watching a drop in the oil price and depreciation of the Russian ruble given Russia’s status as the world’s largest beef importer.” According to a recent article by Chris Hurt, a farm economist at Purdue University, declining cattle supply since 2007 can be attributed to poor margins from high feed prices, which have been exacerbated by drought conditions in the Southern
Plains. With the global price of beef surging, though, cattle supply increased by more than 1 percent in 2014, notes Hurt. The USDA’s January Livestock, Dairy and Poultry Outlook forecasts retail beef prices will be slightly higher in 2015 than in 2014, but it cautions that an abundance of pork and poultry could limit beef prices from going too high, as consumers substitute one for the other.
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By Ben Johnson
Simple Adviser Eric Flett leveraged an accounting career to serve high-net-worth clients through his Concentric Wealth Management.
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rowing up in the Bay Area east of San Francisco and Oakland, Eric Flett was introduced to the investment world by his grandparents. What started as a gift of stock in Del Monte and U.S. Steel became a lifelong passion and, ultimately, the creation of Concentric Wealth Management. Flett started his career as a CPA, but after several years of monotonous work, he became bored and had an epiphany. “It turned out that one of the great lessons from my experience as a CPA is that I could look at companies and look at financial statements and determine whether they had a good business model and whether they would be profitable companies,” says Flett. “That has been invaluable in my career, and from that experience I have learned that some of the
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most profitable companies are the least glamorous and often most publicity-shy companies out there.” Flett recalls how accounting became a natural segue into investment advisory as a profession. “When I was coming out of college, an adviser explained that there are rarely unemployed accountants because there is always a need for financial and analytical skills in many businesses. However, after several years I learned that I’d prefer to develop ongoing relationships with individuals, not companies, and that I wanted to work with people in a comprehensive manner.” As with so many of today’s advisers, Flett landed his first job in the profession with a mentor. “When I decided that I had this interest in investing, I started talking to people in the industry, and I landed a job with my first mentor in the industry, realAssets Adviser | March 2015
realAssets Adviser | March 2015
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David Gemmer [founder of Gemmer Asset Management in Walnut Creek]. Right away I could see that working as an adviser, I was able to combine my quantitative and analytical skills, which were integral in being a successful CPA, with helping people accomplish their goals. That is incredibly satisfying to me, and that is what makes this a fun profession, a fun job, and makes me want to get up in the morning.” After eight years working with Gemmer, Flett became grounded in the basics of investment management. Then along came the dot-com era of 1999–2000, a time when many of Flett’s clients were receiving stock options. He searched for a firm that did individual stock research, eventually landing at Bay Isle Financial in Oakland, where he met his next set of mentors, Gary Pollock and Bill Schaff. “When your hair starts to thin and gets a little grayer, it is interesting to look back and see how a few people supported you, gave you growth opportunities, and were so generous in sharing their experience, all of
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which results in shaping where I am today,” says Flett. “I look back with tremendous gratitude for having these mentors in my career.” Flett spent the next eight years at Bay Isle, developing an expertise in research and buying and selling individual stocks. Bay Isle was eventually purchased in 2007, and Flett felt he had become nearly anonymous within the organization. That sparked his interest to strike out on his own. “I really decided I needed to go build my own firm using this 15-16 years of values and principles that I had developed — and start with a blank piece of paper,” he says. “The acquisition gave me the impetus to leave and kind of forced me to go out and be entrepreneurial.” Over the course of his career, Flett noticed that other successful firms had formed two-person partnerships. “The real key was that the individuals had complementary skills. So I set out to find a business partner that had some of the skills that were not my strengths, and I made a list of people.”
tewart McGuire (left) and Eric Flett, S co-founders of Concentric Wealth Management.
In 2007, he connected with Stewart McGuire, and together they launched Concentric Wealth Management in Lafayette, Calif., the following year. The timing was slightly imperfect, coming at the early stages of the Great Recession, but Flett and McGuire prevailed. “We had a plan to reach a certain number of clients, which we did, but the value of those assets was about 50 percent of our target. Luckily, we used conservative assumptions, had the wherewithal to withstand 2008 and 2009, and eventually caught up to our plan.” That experience also taught Flett something important about client behavior. “During financial panics, the first instinct for clients is to do the ostrich effect and just stick their head in the ground and forget about it. It takes three or four or five years for things to fall out and get better before people come around. I saw this in 2003, and I am seeing it now. Here we are five years after the correction and people are now saying, ‘I probably haven’t been investing as well as I could, and I probably haven’t made realAssets Adviser | March 2015
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the money I could — maybe I should get an adviser.’ It took them five years to get through that fear to be able to make a decision; they are so paralyzed by fear that they can’t make those decisions.” MANAGING THE MONEY Concentric works with just over 100 families and manages approximately $190 million in assets. The bulk of the firm’s clients are aged 50 to 70. “We really like that sweet spot, because the clients are large enough to need personalization and customization.” In terms of client services, the firm focuses on only two things: financial planning and investment management.
boat and watch it go up and down for three hours, you are going to feel that motion, and you are going to feel every wave, and you are going to get sick. “I think financial planning helps people stare at the horizon and focus on things that are really important. It is important to send your kids through college. It is important to save for retirement. Do any of those things change because of the daily headlines? Usually not, so I think the financial planning component is very critical in this process and delivers a lot of value to most of our clients.” The financial planning piece naturally leads clients into the asset management function. “With high-net-worth individu-
I needed to go build my own firm using this 15-16 years of values and principles that I had developed. “That is it, and obviously we think we are pretty good at both of those things and we do them well,” says Flett. Keeping it simple, transparent and focused best describes Concentric’s mantra. “One of our philosophies is that the financial industry is very complex and not very transparent, and certainly one of our values is to be transparent and cost effective. We want to be transparent about the fees and we want to be cost effective both in what we charge, any fees the brokerage firm charges and any tax impact. By keeping a handle on all those costs it goes straight to the bottom line and helps the client,” says Flett. When it comes to offering financial planning services, Flett relates a story first told by his grandfather. “When I was a kid I went fishing with my grandfather, and we were out in the ocean off Pacifica fishing for salmon. The captain of the boat said to stare at the horizon to avoid getting seasick. I didn’t quite understand what that meant, so my grandfather explained to me that if you stare off into the horizon, you see the ocean and the sky come together and there is a flat line and that line doesn’t move. If you stare at that line, the signals to your brain are stable. If on the other hand, you stare down at the water below the
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als, you have to understand their individual goals before you can go construct the portfolio for them, so the financial planning really provides the framework for the investment management,” relates Flett. Concentric’s asset management philosophy is straightforward, primarily focused on global diversification. “We want to own a lot of different asset classes, and we want to own asset classes that are not correlated. Then within that allocation, we seek to purchase individual securities in the U.S. large cap space for a bulk of the portfolio. We also buy individual REITs and individual bonds, and we will use mutual funds and ETFs for other asset classes, such as small cap and international and emerging markets.” This results in diversified portfolios with typically 35 to 40 individual stocks, plus other investments. The firm custodies client assets with Schwab. REAL ASSETS STRATEGY When it comes to real assets, Flett focuses on publicly traded REITs, and for good reason. Early in his career, he was introduced to the sector through working with Ralph Block, whose Investing in REITs book became the seminal treatise on the sector.
“When I worked at Bay Isle Financial, I began to appreciate many of the benefits of investing in publicly traded REITs, since they tend to be less correlated to the stock market; they avoid the double taxation of dividends so they can provide higher income to investors; they tend to be driven by economic growth factors and interest rates; and they tend to be a good hedge against inflation,” says Flett. “All of those characteristics meet what we are looking for in a diversified asset class, so we have always had an allocation of REITs. Today all of our clients own REITs in their portfolios, and that has paid off handsomely obviously in the last few years.” Concentric also invests in commodities to a lesser degree. “We definitely believe that commodities over the long term will be less correlated to the stock market, and so we invest in commodities through an ETN, and then we also invest in energy directly by owning the large energy companies, including Chevron and Exxon,” says Flett. A GROWING CONCERN Like most advisers, Flett is interested in growing the firm, but not for the sake of growth itself. The primary driver is referrals. “Like the two things that we do, our growth plan is very simple,” says Flett. “We spend all of our time focusing on doing a great job for our clients, and we believe if we do a good job for them, then we will get introduced to other like-minded people who can use our services. Our growth plan is to grow one client at a time and we are really lucky — our clients are amazing, smart, successful people, and I am very honored to work with them.” Interestingly enough, Flett is not a huge fan of outsourcing and prefers to keep many of the firm’s administrative functions in house. “A lot of people talked about how you should outsource as much as possible and outsource your investing and outsource your HR, outsource this, outsource that, outsource your reporting,” notes Flett. “We are control freaks, so we want to control all of it, and we outsource very little. We do outsource our employee payroll, but other than that we want to do our own investment research, we do our own trading, we do our own reporting, we write our own investment commentary. realAssets Adviser | March 2015
We do as much as we can inhouse because we want to keep the quality really high, and we can control that by doing it ourselves.” SCARY DREAMS As an independent firm, Flett knows there are a myriad of challenges facing Concentric every day. “Right now, bonds keep me up at night. It is hard to believe that after 21 years in the business, bonds scare me more than anything else today. With bond yields being historically low and prices being historically high, at some point there will be a correction. There are a lot of people who weren’t in this business 40 years ago, the last time we had a rising rate environment for a prolonged period, so I am a little scared about how people are going to react to rising interest rates.” Clients, too, are expressing their own concerns. “Most clients are worried about not receiving enough income from their bond portfolios, stock prices reaching all-time highs and how long this bull market will continue,” says Flett. This is where Concentric’s “simple” approach works best, he says. “Advisers to realAssets Adviser | March 2015
high-net-worth clients really deliver value by simplifying this ridiculously complex financial industry and financial environment that we live in. The Information Age has made things so complicated that most people just don’t understand it. We think clients need help filtering out the noise, staring at the horizon and simplifying things. If we can help them understand their financial goals, simplify their financial goals and put the headlines in perspective, we think that long term we are going to have a great relationship with them and they are going to be very successful.” With the long term in mind, Flett says the firm rebalances client portfolios on a regular basis. “We have a quarterly cycle we go through. We review all of our market assumptions and go through each asset class, all of the industry sectors, and then look at each investment. We prepare quarterly reports for our clients in which we show their allocation, holdings and performance. I’m always amazed when I see a client of another adviser and they have no idea how their portfolio has performed. We also write our own commentary to communicate with
our clients about important topics, discuss how the portfolio is positioned, and we throw in a few other nuggets as well.” As a keen observer of several previous economic cycles, Flett is less concerned about the actual future cycles themselves and more about establishing sustainable long-term value. “For me, the challenge is not weathering the next bear market, because the timing is completely unknowable. We know that corrections occur regularly, and we view them as normal and healthy. The real challenge is building a portfolio that is going to weather what looks like a 30 to 40 year retirement for many of our clients,” he says. “If you are going to retire at 50 and live until you are 90, a Treasury yield of 2 percent is not going to get you there. You’ve got to be willing to invest in a diversified portfolio. So going back to our asset allocation and using REITs, it is really important to teach our clients that diversification into a variety of asset classes, including stocks and REITs and commodities, will improve their portfolio returns and allow their buying power to keep pace with inflation over the 30 or 40 year retirement period.”
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Bumper
Farmland returns have averaged nearly 12 percent per year since 1991.
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realAssets Adviser | March 2015
U By Anna Robaton
Making a play in America’s farmland is easier than ever thanks to a growing presence in the REIT market.
realAssets Adviser | March 2015
til recently, the average investor who wanted to play the U.S. farmland sector had few options. But two newly public companies investing in U.S. farmland have given investors a liquid way to gain exposure to the sector and, by extension, food demand. Institutions, including pension funds and insurance companies, have been active in the sector for years, although most of these investors simply rent their land holdings to actual farmers. Less than half a percent of the $2.5 trillion U.S. farmland market is owned by institutions, according to the TIAA-CREF Center for Farmland Research at the University of Illinois. Farmers still own the vast majority of American farmland. It is not hard to see why deep-pocketed investors have been drawn to the sector. As an asset class, farmland has outperformed major real estate sectors as well as stocks and bonds over the past two decades, according to Green Street Advisors. Farmland also has a low correlation to major asset classes and provides a hedge against inflation because its price tends to rise with inflation, reports Green Street. The country’s first-ever publicly traded farmland companies, Gladstone Land Corp. and Farmland Partners are hoping that has a nice ring to investors. Run by investment adviser Gladstone Management Corp., Gladstone Land went public in January 2013 and elected to become a real estate investment trust last fall. Farmland Partners Inc. followed in Gladstone’s footsteps with its IPO in April of last year. The company plans to elect REIT status this year. Both Gladstone Land and Farmland Partners have undertaken a spate of acquisitions since their IPOs, diversifying their geographic footprints and tenant mix. Neither company actually farms the land it owns. Rather, each leases land to large-scale farmers, many of them family-owned businesses, on a triple-net basis, which means that tenants pay rent and all property-related expenses, including taxes, insurance and maintenance. Many of the country’s most successful farming operations own anywhere from 20 percent to 40 percent of the land they cultivate and lease the balance of it in order to spread their costs out over a larger land base, particularly when it comes to rowcrop farming, says Paul Pittman, president and chief executive officer of Denver-based Farmland Partners. Rental demand is also driven by the steep price of high-quality farmland and the dwindling supply of good farmland in some parts of the country. Many farmers also want to avoid tying up their capital in land, says David Gladstone, president and CEO of Gladstone Land.
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“Just like any other small businesses, farmers can save money by renting farmland as opposed to buying it,” explains Gladstone, who, like Pittman, has a background in farming, farmland acquisitions, as well as finance. In some cases, Gladstone Land structures acquisitions as sale-leaseback deals, as does Farmland Partners. In other words, the companies buy land from farmers who want to free up capital for their operations (or some other purpose) and then lease it back to the sellers. At the time of its IPO, Gladstone Land owned 12 farms in California and Florida. As of last December, the company owned 32 farms, comprised of more than 8,000 acres, in California, Oregon, Arizona, Michigan and Florida. Its portfolio was valued at about $191 million. The company reports its net asset value per share on a quarterly basis so that shareholders can track the value of underlying assets. While Farmland Partners owns land that is used to grow corn, soybeans and wheat, Gladstone Land focuses on land used to grow berries, potatoes, lettuce and other fruits and vegetables. Such land tends to be highly productive, expensive to acquire and in strong demand among farmers, especially in California and Florida, where the supply of farmland has contracted over time as a result of development, says Gladstone. In California, the supply of farmland shrinks each year by about 10,000 acres and that has pushed up farmland values in the state, he notes. Gladstone knows the California farm economy well. In the late 1990s, he bought California’s Coastal Berry, one of the largest berry growers in the United States, from Monsanto. He ran the company until 2004, when he sold the operating side of the business to Dole Food. He held on to the farmland and leased it to Dole. Those farms were part of Gladstone Land’s portfolio when it went public two years ago. “When you have an excellent piece of U.S. farmland, you don’t have to worry about somebody making a new one next door, which is what happens in the industrial business,” and other commercial real estate sectors, says Gladstone, who is also CEO of McLean, Va.–based Gladstone Management, which runs four publicly traded companies, including Gladstone Land, as well as privately held funds. Gladstone Management’s other publicly traded firms include a commercial property REIT and two business development companies (BDCs) that make debt and equity investments in small- and mid-sized businesses.
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Gladstone says Gladstone Management puts prospective farmer tenants through the same kind of “stress test” it would apply to businesses seeking investments through its BDCs. Gladstone Land, he added, decided not to hitch its star to farms that grow corn, wheat and other grains sold around the world because of the price volatility associated with such crops. Domestic growers of fruits and vegetables have benefitted from the robust demand for fresh produce in the United States, explains Gladstone. Farmers who sell their products domestically also do not face currency risk, he adds. California farms, he continues, grow about 90 percent of the fresh strawberries consumed in the United States. Corn and soybean prices have softened over the last couple of years, mostly due to high crop yields. Corn prices hit a record high of $8 per bushel during a drought in the summer of 2012, but high yields in 2013 and 2014 put downward pressure on prices. Pittman of Farmland Partners says high yields and strong exports have offset lower prices for many grain farmers. Many of them turned a profit in 2014 thanks to strong yields and came into the year with healthy balance sheets, he says. Grain farmers enjoyed a long bull run in prices leading up to 2013. “We haven’t seen any real pushback on rents,” says Pittman. “If this low profitability for farmers was to go on for several more years, we certainly would. But it will take multiple years to drive declining rents into our system because our leases tend to be on a three-year cycle.” Farmland Partners has sought to insulate itself against volatility in the farming business by structuring most of its leases so that tenants pay all of their annual rent in advance of each spring planting season. “My real question is: What are corn prices doing in the next several years?” says Pittman, adding that “one significant weather event” in any of the world’s major grain-growing regions likely would push corn prices back up to $8 per bushel. Those regions include parts of South America, Ukraine and America’s Corn Belt, where Pittman has deep ties. He grew up in a farming family in Illinois but decided to pursue a different path. Pittman spent the early part of his career in law, investment banking and corporate finance. In the late 1990s, he started investing in farmland in his home state, while continuing to work in investment banking. In the early 2000s, he started a
realAssets Adviser | March 2015
Average U.S.Farm Real Estate Value 3,500 3,000
Dollars per acre
2,500 2,000 1,500 1,000 500 0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: USDA
farming business, Astoria Farms, and eventually devoted himself to it full time. In 2014, he spun off the majority of its land holdings into Farmland Partners. As CEO of Farmland Partners, Pittman has overseen a steady stream of acquisitions that has grown the company’s portfolio from 38 farms, totaling about 7,300 acres, to 78 farms totaling 48,680 acres at the end of last year, including some properties under contract. The company owns farms in the Corn Belt, Plains, Delta and Southeast regions. The farmland market remains highly fragmented in terms of ownership, Pittman notes. An estimated $30 billion of farmland trades hands each year, although several states have put limits on the ownership of farmland by large corporations. “There is no theoretical limit on our ability to find good deals,” explains Pittman, adding that his company avoids “elephant hunting” by concentrating on acquisitions ranging in size from $2 million to $7 million, where there is a deep pool of potential buyers at the smaller end of the market. “If you do a $20 million deal, the only other buyer is an institution, and institutions might all of a sudden wake up and decide they don’t like
realAssets Adviser | March 2015
this asset class,” notes Pittman. Of course, that all depends on how farmland performs in the long run. Farmland returns, as measured by the National Council of Real Estate Investment Fiduciaries’ Farmland Index, have averaged nearly 12 percent per year since 1991. The index is tied to a pool of more than 600 investment-grade properties, and its returns are based on land prices and rental income. Last year, farmland, as measured by the NCREIF index, returned almost 13 percent, which was far below its 21 percent return for 2013 but still strong by historical standards, according to NCREIF. The NCREIF Property Index, which tracks returns on commercial real estate, gained almost 12 percent in 2014. In recent history, the only period of “meaningful depreciation” in the value of U.S. farmland was during the farm crisis of the 1980s, says Bruce Sherrick, director of the TIAA-CREF Center for Farmland Research and a professor of farmland economics at the University of Illinois. That crisis was caused by a combination of factors, including high debt among farmers, high interest rates and collapsing commodity prices, owing partly to the
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Carter administration’s embargo on grain shipments to Russia, a huge export market for American farmers. Today, the widespread use of crop insurance in the United States provides a backstop for the farm economy, explains Sherrick, who is not alarmed by the recent decline in commodity prices. Prices tend to decline when yields are high and vice versa, he explains. “There is a lower correlation than most people understand between the price of commodities and operator income,” says Sherrick. Despite weaker grain prices last year, the average value of farm real estate in the United States increased by slightly more than 8 percent on a year-over-year basis, according to the U.S. Department of Agriculture. The Corn Belt had the highest farm real estate values. The Mountain region, which includes Arizona, Colorado and Idaho, had the lowest. “Farmland values have not responded much to lower incomes, but if we get two to three years of down income, they might. It is a slow adjustment process,” based in part on farmers’ income expectations, explains Sherrick.
When you have an excellent piece of U.S. farmland, you don’t have to worry about somebody making a new one next door. Pittman is bullish about the long-term outlook for commodity prices and farmland values. He says global population growth will continue to drive food demand, and U.S. farmland is some of the most productive in the world. What’s more, rising levels of disposable income in emerging markets will lead to stronger consumption of milk, cheese, meat and other high-protein foods associated with Western diets. Grains are used in both food products for human consumption and to feed livestock. “Through good times and bad, the amount of food people eat is continually and gradually going up and doesn’t go down easily,” says Pittman, adding that high-quality farmland has a near “zero vacancy,” unlike the major commercial real estate classes. Still, Farmland Partners and Gladstone Land have struggled to gain traction among investors. The stocks
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of both companies have essentially languished since their IPOs, in terms of their performance through January of this year. That is partly a function of the size of both companies. Despite their robust level of acquisitions, both companies are still relatively small players within the REIT universe, which remains a deterrent to some investors, particularly large institutions. Concerns about softer commodity prices and their impact on rental rates have also weighed on Farmland Partners’ stock, says Dave Rodgers, an analyst with Robert W. Baird & Co. His firm covers Farmland Partners, but not Gladstone Land. “Near term, investors worry about farmers asking for big reductions in rent. But I don’t think these farmers are living year-to-year or crop-to-crop anymore. These are big operations. The costs involved in farming are too high for very small players” to compete, explains Rodgers. “A one- or two-year decline in corn prices could have a mildly negative effect on rents,” but tenant demand should remain strong because of the limited supply of good farmland, adds Rodgers. Of course, many investors do not really understand the farming business or the farmland sector — or the interplay between the two — and that is a challenge for both companies. Ralph Block, a REIT historian, says most investors gravitate toward brand-name REITs focused on major asset classes because they do not understand the dynamics of esoteric sectors such as farmland. Of course, there may be value embedded in small-cap stocks that do not have a big following. “The question for investors evaluating a REIT that owns a lesser-known property type is: What are the dynamics of that particular business? The dynamics are going to be very different from one type of real estate to another,” explains Block, author of the book Investing in REITs. “One of the most important considerations when evaluating a REIT is: What is the value of the underlying real estate? With traditional REITs, the types of properties they own are trading in the markets every day. We know, for instance, what office properties in Chicago are worth because there is a deep and liquid market for them,” adds Block. And farmland pricing is considerably less transparent. Anna Robaton is a veteran business writer and former staff reporter at Investment News, Crain’s New York Business and other publications.
realAssets Adviser | March 2015
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realAssets Adviser | March 2015
By Tyson Freeman
Exchange-traded funds (ETFs) are gaining traction among investors looking to real assets allocations.
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eal assets and exchange-traded funds. Both are all the rage among investors across the spectrum, but do they belong in the same discussion? Despite the inherent challenges — some might even say inadequacies — of various real asset ETFs, they are increasingly finding a place in wealth managers’ strategies for real asset investment. In some cases, there are really no better choices to gain exposure to some of the underlying assets. Prateek Mehrota, chief investment officer at ETF Model Solutions, a firm that creates ETF-based model portfolios, says that equities and fixed income are simply not sufficient to build a well-diversified investment portfolio. Investors need to include that “third bucket” of alternative investments that includes real assets. “We feel strongly that this third bucket is necessary,” he says. “With the proliferation of ETFs, we can now
realAssets Adviser | March 2015
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build a totally liquid real asset allocation. It’s a huge deal.” Investors across the spectrum have embraced exchange-traded funds (ETFs) as an efficient, low-cost way to diversify portfolios and add a liquidity component. The universe of ETFs has expanded rapidly and now reaches into nearly every investment niche and into nearly every geography. There were 204 ETF launches in the United States alone last year, according to First Bridge Data, a provider of independent ETF data and analytics. Overall, 22 of the ETFs that launched in 2014 — more than 10 percent — had attracted more than $100 million in assets by the end of 2014. The ETF craze has dovetailed with steadily building interest in real asset investing. Growth in emerging markets and a world economy increasingly powered by potentially inflationary central bank monetary policy is producing what some view as secular, long-term global demand for real assets. The question for investors — from retail to institutional — has been how best to gain exposure. Might ETFs have a role? BROAD STROKES The potential benefits of ETF investing are well documented. Low costs, active and passive management, deep line-up of choices that span the investment world, and now increasingly complex, managed options that seek to address volatile markets or to enhance index returns. So what are the limitations for real asset investing? The first point made clear by ETF industry watchers: Investors need to be very clear what their goals are, and they must understand the ETFs they are considering. Mehrota says the process of including ETFs to build a real assets portfolio — or any portfolio — begins with asset allocation and the structure of the portfolio. Mehrota believes a blended approach to building a real assets ETF portfolio, which he calls “core-satellite,” is a compelling approach. In this case the real assets portfolio is comprised of core and satellite holdings across four main market segments: REITs, infrastructure/
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MLPs, commodities and precious metals, and inflation-linked fixed income. This approach, Mehrota says, allows for a reduction in overall investment costs but also increases the potential for improved risk-adjusted returns. Mehrota says the core holdings are made up of low-cost, primarily market cap– weighted ETFs. The satellite allocations include ETFs that track alternative indices and attempt to add alpha. Examples of satellite holdings might include dividend weighted ETFs, sector/thematic ETFs, long/flat commodity indices, fixed-duration inflation-indexed ETFs, or actively managed senior bank loan ETFs. Investors can also leave the portfolio allocation exercise to others — for better or worse — by holding a mixed real assets portfolio by investing in an ETF such as the SSgA Real Assets ETF. This ETF of ETFs invests in exchange-traded products in four asset classes: Treasury Inflation-Protected Securities (TIPS), domestic and international real estate, commodities, and equities of companies in the natural resource/commodity industry. Similar ETFs include the WisdomTree Planning Global Real Return Fund (RRF) and the Purpose Diversified Real Asset Fund (PRA). OPPORTUNITY AND PITFALLS As with many discussions about investing, there is no single answer to whether ETFs are right for a real assets allocation. It depends on many factors. “These decisions must begin with what index the ETF has chosen to follow,” says Mehrota. “You need to look at the index, who built it and what the goal of it was.” Mike McGlone, director of research U.S. for ETF Securities, says, “The investor needs to understand how the ETF provides exposure to the various assets and what they can expect from the returns.” The most glaring deficit of real assets ETFs is that very few underlying assets can be held directly. Consequently, there will always be some level of distortion of risk and return from the underlying asset. “Only the most simple ETFs can invest in assets directly,” says McGlone. “For exam-
The universe of ETFs has expanded rapidly.
ple, with crude oil and natural gas, we are forced to use a derivatives approach. An investor can buy into energy companies to gain some amount of that real asset exposure, but buying equities of operating companies often adds an unacceptable dose of additional equity risk.” The one exception to this dynamic is the real estate bucket. There are scads of REIT ETFs that reach into every corner of the world and cover just about every property type. The REIT structure inherently strips at least some measure of operating return from the exposure. (Real estate is such a wellrealAssets Adviser | March 2015
covered real asset class that this piece will largely focus on other sectors.) The timber market is just the opposite, since there still are no true timber commodity ETFs available. Investors can gain exposure to the physical assets through ETFs that track global timber-related companies, such as the Guggenheim Timber ETF (CUT) and iShares Global Timber & Forestry ETF (WOOD), but a cursory look at these two ETFs highlights the challenge of obtaining access to underlying timberland. Both CUT and WOOD hold REITs and operating companies that do not even realAssets Adviser | March 2015
hold timber. Both include stocks that are not part of the traditional paper and forest products industry. In fact, WOOD has recently invested as much as 25 percent of its holdings in packaging firms. There are timber REITs that are more correlated to timberland such as CatchMark Timber (CTT), but it is still not 100 percent comprised of timber assets since they own saw mills and other tree-based side businesses. COMMODITIES: ALL ABOUT FUTURES Aside from gold and silver, nearly all the
other commodities, whether they be industrial or agricultural, need to be invested in using futures and other derivatives. Most commodities are simply too expensive to take physical delivery of, making the futures approach necessary. Prior to joining ETF Securities, McGlone was head of commodities at S&P Indices, where he led the development and oversight of the S&P GSCI, a benchmark for investment in the commodity markets. He also tried to launch a physically backed copper ETF, but he eventually had to cancel those plans. “Copper costs about
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3 percent to store, the copper needs to be shipped and insurance [runs] to around $5,000/ton,” says McGlone. “So once you purchase the physical copper, you are effectively down 4 percent.” “The most difficult challenge in achieving access to real assets is the exposure to futures,” says Mehrota. “You simply can’t buy the spot price of a commodity, so you have to buy the futures. It’s the nature of the beast. And since futures contracts are constantly expiring, managers must continue rolling into new contracts, which
better reflection of underlying oil prices. “There are many ways, mostly multicontract holdings, where an ETF might hold futures in different contract months, to address the challenges of futures,” observes McGlone. “But the need to buy and trade those futures comes with some costs and complexity.” Precious metals (PM) ETFs are among the few physically backed commodity ETF products since it is relatively easy and cost effective to gather and store bullion in vaults.
There are scads of REIT ETFs that reach into every corner of the world and cover just about every property type. leads to the risks of contango [where the futures price of a commodity is above the expected future spot price] or backwardation [meaning that as the contract approaches expiration, the futures contract will trade at a higher price compared to when the contract was further away from expiration].” One of the most glaring examples of this dynamic took place with USO (the oil commodity ETF) during the oil price run-up. Crude oil prices were up 80 percent, while USO gained just 20 percent over the same period. Investors were hurt by performance of the investment vehicle rather than the performance of the underlying real assets. Mehrota approaches commodities in three ways: buying equities of commodity companies, buying commodities futures, and a commodity ETF that takes a long/flat exposure, which helps mitigate volatility. “There is constant evolution of these products to address the challenges of contango, backwardation and volatility,” he says. “And they will continue to develop.” The United States 12 Month Oil Fund (USL) is an example. It ladders 12 months of futures to help dampen the effects of contango and backwardation to offer a
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McGlone’s firm offers one of the more popular PM ETF options: the ETFS Physical Precious Metals Basket Shares (GLTR) ETF. It holds a diversified basket of metals: around 55 percent gold, 30 percent silver, with the balance invested in platinum and palladium. “There are no futures,” he says. “The metals are allocated in vaults in Switzerland, so the only difference between the price of the ETF and the spot price is the ETF fee. It’s very simple.” “PURE PLAY” INFRASTRUCTURE Infrastructure might be one of the most widely defined sectors in the investment world. Some indices and funds include utilities, telecommunications companies and builders. Many infrastructure investors are attracted to assets that are less tied to traditional market forces — whether it be GDP, supply and demand forces, or interest rates. Since most so-called “pureplay” infrastructure assets are regulated in some way, pure-play infrastructure effectively reduces exposure to these “market” risks in favor of regulator risk. The underlying cash flows of pure-play infrastructure are fundamentally different. For that reason, among others, investors seeking true, real asset benefits of
the sector seek to limit their investments to vehicles that derive cash flows directly from assets such as airports, toll roads, ports, communication towers, electricity distribution, oil and gas storage and transport, and water. There are still challenges in capturing the benefits of the underlying assets, though. With such a broad range of assets and businesses, the risk of picking up too much equity exposure from ETFs investing in the equities of related industries is high. There are now a decent selection of infrastructure ETF options that cover a broad array of assets and companies in both developed and emerging markets. The trick is sidestepping the tendency of these funds to hold equities in operating companies that benefit from, but are not directly driven by, the underlying infrastructure assets. In order to do that, investors should seek ETFs that hold socalled “pure-play” infrastructure companies that derive the majority of their cash flow from the operation of infrastructure assets, not from closely related businesses such as construction, engineering or materials. These options would include ETFs that follow the Dow Jones Brookfield Global Infrastructure Composite. In order for holdings to be included in the index, the companies must derive more than 70 percent of their cash flows from infrastructure assets. The index excludes companies that supply services such as construction and engineering to the overall infrastructure industry. There are also more asset specific and geographically specific infrastructure ETFs and a decent list of master limited partnership ETFs that provide exposure to energy storage and distribution infrastructure. At the end of the day, employing ETFs to build a real assets portfolio is indeed possible. The key question, however, is how well the strategy captures the risk and return characteristics offered by the underlying assets. Tyson Freeman is a freelance writer and wine maker based in Sebastopol, Calif. realAssets Adviser | March 2015
FAMILY OFFICE & PRIVATE WEALTH MANAGEMENT FORUM “THE RACE FOR RETURNS� A Private Wealth Series Event JULY 20-22, 2015 HYATT REGENCY NEWPORT, NEWPORT, RI
The Family Office/Private Wealth Management Forum is Opal's premier conference and the preeminent event in North America for high net worth individuals and family offices from around the world. Some of the most well established and senior family offices, private investors, money managers, and private wealth service providers from around the globe will return to this picturesque setting for three days of engaging discussions on the latest investment trends and soft issues surrounding this generation and future generations of families. The event will take place in historic Newport, Rhode Island, which is rich in history and wealth alike. Opal will kick off the event with its Annual Regatta Cup, in which attendees will have the opportunity to work with a professional sailing crew while competing against industry peers.
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Rising By Suzanne Franks
Up
Houston
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realAssets Adviser | March 2015
Secondary cities across the U.S. offer unique investment opportunities removed from traditional (and often more favored) primary gateway markets.
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ommercial real estate can serve as a powerful portfolio diversification tool, and understanding the industry’s trends can give advisers and their clients a leg up, especially when it comes to property transactions and pricing movements. With gateway cities having turned hyper -competitive and overpriced, a slew of second-tier markets are on the rise and attracting investor capital. Cities such as Atlanta, Austin, Houston and Miami are looking second-to-none in the eyes of investors looking to put their capital to work. It is about time for the bridesmaids to take center stage as they scramble for the bouquet. We have reached the point in the real estate cycle where the usual belles of the ball — the gateway cities — are becoming less attractive as prices rise and yields fall, while the charms of so-called secondary cities are tugging at investors’ heartstrings and wallets.
Atlanta realAssets Adviser | March 2015
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There is general agreement as to which U.S. markets are the perennial “belles.” Real Capital Analytics cites the metropolitan areas of Boston, Chicago, Los Angeles, New York City, San Francisco and Washington, D.C., as “gateway” markets. In fact, RCA data indicates that during the past 10 years these six markets alone generated about 60 percent of all transaction dollars in the United States. But beyond the gateways there is less of a consensus as to which markets are prime investment targets, or even how they should be labeled. SIZING UP THE MARKETS Though it may just be semantics, typically an institutional investor’s list of “primary markets” includes not only the gateways but 10 to 15 additional metro areas. This broader list of the top markets is often defined as “primary.” Atlanta, Dallas and Houston, for example, appear on many institutional lists and are considered “core” markets in executing portfolio strategy. Across the industry, however, this list is somewhat fluid; it can vary over time and by property type. How then should investors determine which next-tier markets are the most promising candidates? Which offer the best return potential? And what are the possible downsides that could trap capital and depress yields? “Everyone has their own definition of primary versus secondary markets,” says Richard McLemore of MetLife Real Estate Investors. “And they often use their definitions to suit their strategy.” MetLife
has a list of 21 primary markets, and that includes six “gateways.” The company views the next 15 markets as “core” — key targets for both debt and equity investing. In addition to Atlanta, Dallas–Fort Worth and Houston, its roster includes Austin; Denver; Portland, Ore.; San Diego; Seattle; and South Florida. In general, primary markets are large — among the nation’s top metropolitan statistical areas. They are also highly liquid and economically diversified, as well as globally familiar, an important criterion for international investors who want to own buildings that will grace their brochure covers. “Gateway markets are defined by capital demand, not by market size,” says Robert Bellinger of ASB Real Estate Investments. “Gateway markets are established by investor preferences, and investors often prefer markets that are globally interconnected through transportation, commerce and trade.” Strong secondary markets are typically smaller than the primaries, but they too boast a sizable, diversified employment base, solid job growth and some institutional investor presence. Many of these markets are in southern states, where affordable housing, lower taxes and warmer climates all serve as a powerful draw. During the past decade, the lion’s share of national job growth has taken place in such southern cities as Atlanta and Miami. Size is less important than the dynamism of a market, says Jeff Kanne, CEO of National Real Estate Advisors. He looks
for vibrant intellectual capital, major institutions such as universities and diverse local economies with industries that can capitalize on the energy generated by both. Start-up businesses in smaller markets that are close to a gateway can often leverage this proximity at a lower operating cost. P.J. Yeatman of CenterSquare Investment Management uses the National Football League as a guide to secondary markets. Looking beyond the traditional gateway cities, he cites a number of potentially interesting investment targets such as Baltimore; Charlotte, N.C.; Nashville; and Philadelphia — all of which boast professional football franchises. “The NFL has done a great job of identifying compelling secondary cities for its franchise expansion efforts,” Yeatman says. “U.S. institutional capital is often happy to invest in these markets, although international capital may not be ready yet. These markets may not be the most attractive to international investors looking for core properties today, but for us they represent great opportunities to acquire primary assets with solid supply/demand fundamentals that provide a meaningful yield premium over their gateway counterparts.” Lee Menifee, head of Americas investment research at Prudential Real Estate Investors, points out: “Gateway markets have concentrations in expanding global industries; as a result they have strong employment and growth prospects. New York, for example, is a financial capital while San Francisco is a nexus of technol-
It is about time for the bridesmaids to take center stage as they scramble for the bouquet.
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realAssets Adviser | March 2015
ogy. If investors identify secondary markets with similar global exposures, they can invest at lower price points.” Menifee uses Portland as an example of a city with a growing technology base but more reasonable valuations than the gateway city of San Francisco. Sometimes, next-tier markets benefit from familiarity; air links and tourism can enhance investors’ comfort level, particularly for international players. Lufthansa Airlines has long had direct routes to Atlanta, and today there is a solid German capital base in that city. Mercedes Benz recently announced a relocation of its U.S. headquarters to Atlanta from northern New Jersey. Similarly, many South American and European investors find South Florida attractive, thanks to vacations and family ties. REFINING THE RANKS The nuances of property type and submarket can introduce shades of gray into straightforward market rankings. David Gilbert, CIO of Clarion Partners, points out that “primary versus secondary market definitions differ significantly by property type. The Inland Empire, for example is a prime industrial market akin to midtown Manhattan in an office context.” Miami is ranked by some investors as a core location for residential, retail and hospitality, but not necessarily for office. Memphis, normally considered a tertiary market, rises to second-tier status in the industrial sector.
In addition to property type distinctions, unique submarkets within any MSA can present opportunities. Melissa Reagen of MetLife points to the investment potential of what she calls “emerging submarkets.” These niches are found in both primary and secondary cities, and tend to be property-type specific. She cites examples such as the Arts District in downtown Los Angeles and the Pearl District in Portland as promising for both apartment and retail investments. Gilbert points to the natural tendency of investors to expand their horizons through each cycle as they continue to search for yield. After an initial concentration on prime market centers, investors begin to look outward to concentric suburban rings around the core. These investments are still within the MSA, but pricing may be more favorable and competition somewhat less. “In L.A., for example, investors are migrating from Beverly Hills and Century City to the evolving, emerging submarkets that are still within Los Angeles,” he explains. Later in the economic cycle, investors will often also consider smaller “secondary” markets for additional yield. SECONDARY MARKET UPSIDES The most compelling reason to look beyond the primary markets is, of course, the opportunity for higher returns due to more favorable pricing. Annualized total return data from IPD indicates that Dallas, Denver, Miami and Portland all outperformed five of the six gateway markets
during the 12 months ending Sept. 30, 2014. Only San Francisco ranked above all 16 U.S. cities in the survey. Urban Land Institute studies indicate that when initial cap rates in secondary markets exceed those achievable in gateways, additional cash yields of about 100 basis points to 125 basis points can be achieved. Higher cash flow returns are linked to in-place leases and, therefore, tend to be less volatile during the holding period, while the income stream is more durable. This means that higher cash flow yields can result in a greater portion of total return — nearly 90 percent — realized from property cash flow, as opposed to NOI growth which is driven by increases in rents. Greater portfolio diversification is another benefit of secondary market investing; the behavior of these markets tends to differ from primary markets, with somewhat different fundamental drivers of performance. Therefore, investing in secondary locations can enhance portfolio returns. At the same time, the strategy demands a solid understanding of each market as well as the role the investment will play in the portfolio. Another important secondary market advantage is the lack of significant competition relative to what continues to exist in primary markets. Yeatman of CenterSquare puts it this way: “Due to the size and scope of the investment opportunities in the primary markets, you generally find the sharpest minds, the sharpest elbows
Later in the economic cycle, investors will often also consider smaller “secondary” markets for additional yield.
Miami realAssets Adviser | March 2015
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and the greatest depth of capital competition there.” Many times, institutional capital can acquire high-quality assets with strong investment potential in secondary markets, something that has become more difficult in primary locations. “If you are not a large local player in primary markets and are forced to rely on broker channels, you are one of 20 to 30 bidders for an attractive property,” comments Bellinger. “Usually, if you don’t know the seller or the broker well, it can be very tough to win the bid.” Less competition in a secondary market also means that institutional investors often have the opportunity to partner with a strong local player in both the ownership of existing properties and in development opportunities. These experts typically bring a deep understanding of market dynamics to the project, an important advantage for investors. AND THE DOWNSIDES The potential for illiquidity is the number one downside risk to secondary market investing. These markets tend to be thinner, less well diversified and more volatile than primary markets, and an investor cannot be sure that future capital flows will be adequate to ensure a profitable sale, or indeed a sale at any price. Kanne quips, “The main difference between a primary and a secondary market is the diversity of the underlying economy. The less diversity, the closer you are
to a secondary market. In a one-horse town, you’re dead if the horse dies.” Will investor interest hold up during a downturn? This is a key consideration in selecting a secondary market. Particularly with respect to office, exit risk must be weighed against anticipated risk premium. Sometimes, an institutional investor acquires one of the largest assets in the market, further reducing the pool of potential buyers. Investors in secondary markets need staying power to carry them through the cycle; when capital is patient and a sale is not forced, the potential for higher returns over the holding period can be realized. But again, knowledge of market fundamentals is critical; rent volatility in some markets, both on the upswing and the downturn, may be low, while rents in other markets may be more volatile and thus more risky. Importantly, secondary markets often have lower barriers to new construction and a greater propensity to develop. New supply often comes on line due to capital availability rather than tenant demand. And secondary markets are often characterized by volatile economies, increasing investment risk. Paradoxically, international investors, often characterized by patience and the willingness to hold assets for long periods, would seem to be well suited for secondary market investments. But because such markets are less familiar and, in most cases not as “sexy,” international players
have not allocated significant capital to secondary markets. THE FUNDAMENTALS Each real estate cycle may have unique characteristics, but there are also common elements. “As you move through the cycle and enthusiasm increases, people will become more comfortable with risk and will stretch for yield,” Bellinger says. “This is true for all cycles since Adam and Eve. It may be irrational exuberance or based on fundamentals, but there are typical points that seem to repeat themselves in every cycle; each time, it’s just a question of degree.” However a market is labeled — “gateway,” “core,” “primary,” “secondary” — the fundamentals are always the same. The basic blocking and tackling needed to underwrite each asset — projections of rent growth, forecasts of employment and demographic trends, evaluations of local demand drivers, clear-eyed assessment of each property’s location — are all required for every transaction. The criteria for the best market can vary across the cycle; the search for the best investment is a constant. So it may be time for the bridesmaids, the ones often at the edges of the spotlight, to move toward center stage. Their moment in the sun seems to have come ’round once again. Suzanne Franks is a freelance reporter based in Manhattan.
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realAssets Adviser | March 2015
Don’t Forget To Mention Discount Code “RAA” For 10% Savings Themes for the conference Include: • Closed Door Discussion for Family Offices & Wealth Managers
• Starting a Real Estate Investment Program… A Preconference Discussion
• Capital Preservation vs. Investment Gain … What is your Strategy for Estate Planning /Asset Allocation of your Whole Portfolio & Real Estate
• Foreign Families Investing in US Real Estate
• Tax-Efficient Real Estate Investing
• Homes & Land as an Asset Class
• Real Estate Concentrated Families: Diversification/ Real Estate
• Getting into the Deep Weeds with Limited Partnerships
• Family Office/Family Office Joint Ventures and Co-Investments
Call: 1-212-901-0542 www.imn.org/refamilyoffice | Email: amelvin@imn.org
By Tyson Freeman
Sove Sovereign wealth funds are becoming a growing presence in global infrastructure investment markets.
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realAssets Adviser | March 2015
reign S
overeign wealth funds have earned outsized attention in recent years for their large, often aggressive, private equity deals. They certainly have had solid growth but are still a relatively small portion of the institutional universe, and as they increasingly focus on infrastructure, they are drawing similar attention. The story of what is driving the growth of certain SWFs has an element of the haves and the have-nots. The United States and Europe, for example, have accumulated massive fiscal
realAssets Adviser | March 2015
deficits in the past decade; countries on the other side of the trade have built surpluses. Whether it is from commodity exports — such as oil in the Middle East and Norway, or copper in Chile — or high domestic savings rates in countries such as China, SWFs are flush. And like much of the institutional investment world, they increasingly are targeting infrastructure assets. “SWF [assets under management] have grown, and they need to invest that capital,” says Ashby Monk, executive director, Global
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Projects Center, Stanford University, “so there is significant cash on the sidelines targeting infrastructure, including capital earmarked for direct investments. Competition for deals is expected to be intense, especially for large income-producing brownfield assets.”
SWFs have built real assets portfolios in recent years on the back of prime commercial real estate and infrastructure markets in developed economies. Industry watchers say it is difficult to draw neat trends in SWF infrastructure investment, but its activity is still closely followed. Interviewees mentioned pockets of activity rather than broad, distinctive trends. “All of these entities are very different,” says Monk. “Most of them believe holding real assets is a valuable thing, but how they go about it reflects that variety.” A lot of people also are anticipating the largest SWF in the world — the Government Pension Fund of Norway — as it moves closer to jumping into infrastructure investing. The fund has nearly $1 trillion under management between its domestic and global funds. “The Norwegians are talking about ramping up infrastructure investing but have not done it yet,” Monk explains. “They are figuring out how they want to do it.” Institutional Investor’s Sovereign Wealth Center puts SWF assets under management at $6 trillion, and most of these are active infrastructure investors. “Sovereign wealth funds, however you define them, have been quite active [in the infrastructure market],” says Georg Inderst, founder of London-based Inderst Advisory. “A number of them have been especially active recently, and we expect more activity in the future.” According to Inderst, 60 percent of the SWF universe by some measures has invested in infrastructure, and half of them invest directly and through funds.
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SOVEREIGN UNIVERSE EXPANDINGs Many countries have sovereign investment funds, but East Asian and Middle Eastern funds make up more than 70 percent of all assets. Their investment goals and strategies vary, but their influence is real. Of this $6 trillion of AUM, the Gulf Cooperation Council SWFs account for approximately 30 percent of global SWF assets. “There is no doubt that as liquidity tightened in the West, thanks largely to the lingering impact of the financial crisis and, more recently, the euro zone sovereign debt crisis, sovereign wealth funds’, particularly Middle Eastern SWFs, influence on the global economy has grown,” says Michael Underhill, chief investment officer, Capital Innovations. “Now, more than ever, these SWFs are viewed by the West as an important source of capital.” Despite their growth trend, there are several cautionary points when assessing sovereign wealth funds. Inderst says that, aside from some SWFs and larger public pension funds in Canada, Australia, Norway and the Netherlands, it is very difficult to obtain data and useful details about many of their investments and strategies. Transparency could be improved in many cases. He also asserts that few SWFs are created alike. Differences of size, maturity and mandate between SWFs can be pronounced, and one must be cautious in drawing too many generalizations. That being said, it is clear that SWFs, like much of the institutional world, have a clear interest in infrastructure investing. SWFs have built real assets portfolios in recent years on the back of prime commercial real estate and infrastructure markets in developed economies. As those markets have become more competitive, they have shifted focus to more infrastructure and infrastructure in less developed countries. EYES ON THE MIDDLE EAST SWFs in the Middle East are drawing a lot of attention. With more than 10 funds and close to $2 trillion worth of assets under management, the six GCC countries represent the world’s highest concentration of SWFs. With state budgets heavily reliant on commodity prices, these funds have benefited greatly from years of record-high oil prices and are driven by the need
realAssets Adviser | March 2015
to achieve long-term diversification from their energy sector. Brian Chase, an energy and infrastructure specialist at Campbell Lutyens & Co., recently met with several of the larger SWFs in the Middle East and says the teams there did not believe the swoon in oil prices would have a significant effect on their investment pace. “They have experienced these price cycles many times,” Chase says. “Most believe that oil prices will remain in the $50 range for the next three years, but few expect that will have a huge impact on their investment plans for private equity and infrastructure.” Much of the activity from Middle Eastern SWFs in recent years has focused on brownfield assets in developed countries, especially in Europe. For example, late in 2014 Kuwait Investment Authority, through its infrastructure unit Wren House Infrastructure Management, teamed up with Macquarie Group on the $3.1 billion purchase of the German power utility E.ON SE’s Spanish assets. But after years of pouring capital into European real estate and infrastructure, as well as in their equities and bonds, many funds are shifting focus. The Qatar Investment Authority, for example, has a large number of assets in Europe and is now looking to diversify its portfolio with more investments in Asia. In November 2014, QIA’s chief executive Ahmed Al Sayed said that the fund expects to invest between $15 billion and $20 billion in Asia during the next five years. He specifically noted that China’s property, infrastructure and healthcare sectors are of interest to the QIA for future investments. Chase believes some of the Middle East investors are also warming up to North American energy investments. “They are becoming more interested in North American energy infrastructure — coal retirement deals, power transmission and power generation, both renewable and conventional,” he says. “Though they also think that, with oil prices so low, it’s also a good time to invest in domestic oil storage in the Gulf.” Low oil prices additionally have stoked interest in distressed energy plays such as Marc Lasry’s distressed energy hedge fund Avenue Capital Group, Chase says. Despite the capital Middle Eastern SWFs bring to the deal markets, experts caution
realAssets Adviser | March 2015
they also come with unique business risks and challenges. “The SWFs there tend to be less transparent than some of their European and Australian counterparts,” Chase says. “There is relatively less publicly disclosed information, whether it is about their commitment levels, deal structures or future plans. And while they
There are signs that at least some SWFs are teaming up with each other to invest in their respective regions. tend to have well-developed and highly experienced teams, they are still government-owned and can be cautious and conservative in their decision making.” Chase notes that quite a few SWFs are looking to invest in middle-market energy infrastructure funds in the United States for their proprietary deal flow and strong returns. “It’s an interesting dynamic. The smaller funds often have better performance and are in demand by Middle East sovereigns, but the Middle East can be kind of a black hole for mid-market funds,” Chase says. “New relationships are hard to establish in any investor geography but can seem even more challenging in that environment where such funds are not as well known as they are among U.S. investors.” SWFS GO DIRECT One distinctive feature of SWFs is that, for those that invest in infrastructure, about half have made direct investments, according to Inderst. “These are often very large funds,” Inderst says, “So they have the capacity, and necessity in some cases, to go direct.” SWFs also have something of a competitive edge in making direct deals work. They often have few if any of the short-term liabilities that other institutional investors have, and they also do not have many of the post financial crisis accounting rules and regulations that require greater transparency and reporting by traditional public pension funds. The market is keeping an eye on SWF direct investments in infrastructure in much the same way they observed them strike some of the largest pri-
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vate equity deals in recent years. How SWFs are tackling direct investment is of particular interest to the rest of the market. There are signs that at least some SWFs are teaming up with each other to invest in their respective regions. Korea’s sovereign fund, the Korea Investment Corp., recently signed an agreement
For those that invest in infrastructure, about half have made direct investments. with the QIA to create a $2 billion investment fund — with equal contributions of $1 billion — to jointly invest in Qatar and Southeast Asia. KIC signed a similar $500 million “joint investment platform” deal with the Russian SWF, Russian Direct Investment Fund, in 2014. The RDIF seems to favor this approach. It has made similar platform deals with several countries including China and India. In India, it agreed to team up with the Indian SWF, IDFC, to invest $1 billion — $500 million committed by each partner — in Indian infrastructure and hydroelectric projects. Kuwait launched Wren House Infrastructure Management to invest in direct infrastructure deals. Soon after, it teamed up with the Canadian pension fund OMERS and the Universities Superannuation Scheme in an unsuccessful $8.2 billion bid for the London-based water utility Severn Trent. While there are certainly examples of SWFs teaming up with each other, Inderst notes, given their size and objectives, he expects them to make more investments alongside operators, developers, contractors, industrial companies or maybe even a large pension fund. “SWFs typically try to profit from their partners’ complementary expertise when they co-invest,” Inderst says. Mike Burns, CEO of the Alaska Permanent Fund Corp., agrees. “We do not plan to co-invest with other SWF-type investors,” he says. “Any co-investment will be alongside our existing infrastructure managers or new managers that come on board. Our staff looks for the managers with the best track
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records and capabilities, and if in the course of their activities they come across transactions that require equity investment beyond what they want to take down in their fund, we will evaluate them.” SHIFTING FROM BROWNFIELD Although SWFs typically target brownfield assets, the current strong competition for large, stabilized infrastructure assets has spurred SWF interest into emerging markets or greenfield assets. “Many large brownfield assets are considered overvalued,” Monk says. “Everyone knows the assets inside and out. The auctions are contentious and some of the valuations have ridiculous forward earnings multiples for infrastructure assets. They leave little room for equity growth. So more SWFs are looking to greenfield project finance deals and emerging markets.” Monk points out that the recent Queensland Motorway sale is telling. “At least some longterm investors are selling brownfield. It is a seller’s market when you have QIC, a governmental agency and long-term investor, selling a $7 billion asset.” Monk believes India has a challenging economic environment right now, but expects it to provide opportunity going forward. And some SWFs are looking to provide project financing alongside operators as a first move in emerging markets such as Africa. According to a recent KPMG report on SWF investing, the United Arab Emirates, home to one of the largest SWFs in the world, has played a significant role in establishing relations with African countries and has made $19 billion of commitments across 17 infrastructure projects. FINAL THOUGHTS Increasingly, SWFs are becoming a part of the global infrastructure investment market, and while they have traditionally been active in brownfield markets, they appear to be striking out in some different directions than the rest of the institutional infrastructure pack. As their moves into emerging markets and greenfield investing mature, the rest of the market will no doubt benefit. Tyson Freeman is a freelance writer and wine maker based in Sebastopol, Calif.
realAssets Adviser | March 2015
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Parting
Shot
Victory Center will be the latest addition to the burgeoning mixed-use development known as Victory just north of downtown Dallas. The 23-story office tower is a joint venture between Hines and Cousins Properties, and could break ground in summer 2015. (photo courtesy of Hines)
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realAssets Adviser | March 2015
[ Mary Adams
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realAssets Adviser | March 2015
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[
Last Word
]
Making the Case for Real Assets Stable returns and low correlation can be key benefits of investing in real assets.
R
eal assets are a broad and heterogeneous category. Oil and natural gas, real estate, infrastructure, metals and minerals, agriculture and timber, water resources, and mitigation banks, among others, constitute the universe. These broad categories themselves have many subtypes with different and complementary investment characteristics, making them valuable additions to properly constructed investment portfolios. Consider the case of commercial real estate. This includes many subtypes such as multifamily residential, grocery-anchored retail, lifestyle and power centers, office, industrial, healthcare, and hotel properties, as well as other specialized assets. Or take the case of infrastructure: it, too, has many subtypes that include transportation (bridges, tunnels,
Real assets, when held in illiquid private formats, in general provide relatively stable returns with low correlation to continuously traded financial assets. When employed using sound judgment, these assets contribute to lowering overall portfolio volatility. While they tend to have slightly lower expected returns than opportunistic corporate private equity, they often come with less risk. Also, because they are backed by physical assets, they provide a hedge against inflation. As in any investing, some real asset alternative investment programs may not be suitable for certain investors, but those who are able to tolerate a degree of illiquidity and are able and willing to invest for the long term may be able to achieve higher risk-adjusted returns. Supply and demand statistics support predictions of long-term price
Investing in real assets is for the long term and is all about active management. roads, railways, urban transit, maritime ports, airports), energy (electricity generation transmission, distribution, oil and gas pipelines, storage), communications (cables, towers and transmission networks), and water (treatment plants, distribution systems, sewage and wastewater facilities).
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appreciation of real assets. To a large extent, demographics play a leading role on the demand side. For example, population growth is expected to result in greater agriculture consumption, more energy usage, the need to invest more in infrastructure, as well as foster greater demand for various types of real estate.
By Sameer Jain
To illustrate these points, consider two very visible examples. First, we look at commercial real estate followed by infrastructure investing in emerging markets. As an asset class, commercial real estate has a significant investable universe. Predictable and stable income generation in core real estate allows investors access to low-volatility returns with capital preservation. These investments can also serve as a hedge against inflation through rent levels that increase with inflation. Further, real estate historically has demonstrated low correlation with other major asset classes and may provide considerable diversification benefits when added to a multi-asset portfolio. The ability to invest in a wide range of risk styles and return profiles can augment investor portfolios, as well. Investing in international real estate can further enhance diversification benefits with access to varied property and economic cycles. Real estate performance is driven by both structural and cyclical changes. Structural drivers such as demographic shifts can lead to fundamental changes in returns by affecting supply and demand. As individuals migrate from rural to urban cities, prices typically rise due to greater demand. Another structural driver, innovation, as in new financial products, will continue to change the way one can invest in real estate — the growth of realAssets Adviser | March 2015
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[
Last Word
]
sale and leaseback in which one party, often a corporation, sells its real estate assets to another party, which then leases the property back at a rental rate, is a huge trend now in Europe. Private real estate can be accessed by retail investors through a variety of channels including separate accounts, participating in private equity commingled vehicles, as well as making investments in publicly registered nontraded REITs. Investing in infrastructure involves applying private sources of capital to achieve meaningful public ends by investing in equity, equity-linked and debt instruments of businesses that design, build, operate, own or have long-term concessions in physical assets. The emerging and fast developing markets are home to more than
5 billion people. These markets enjoy strong macroeconomic fundamentals and good growth rates. To sustain the pace of development, these countries
for private sector investment in infrastructure. Here, attractive risk-adjusted returns are best achieved by investing predominantly in development stage
Private real estate can be accessed by retail investors through a variety of channels. urgently require new and upgraded infrastructure. The scale and urgency of requirements and increasing pressures on government budgets are prompting many governments to reform the way in which infrastructure provision is regulated and funded. As a result, emerging markets are now witnessing the start of a sustained upturn in demand
assets, which provide both yield and a significant opportunity for capital gain. Infrastructure investments, as with most real assets too, have unique properties that make them attractive to blend into portfolios. They tend to have low cyclicality by providing communities with vital services for which demand does not vary appreciably over economic cycles. They exhibit low volatility as these investments are typically exposed to a known range of risks, which can be quantified and are often contractually mitigated at the start of a project. They generate stable cash flows due to low levels of demand fluctuation. Once operational, infrastructure assets generate an attractive running yield. Moreover, they provide for capital appreciation upon favorable refinancing and/or exit of development assets. Investing in real assets is for the long term and is all about active management. It is therefore important to invest with management teams who have sterling reputations and the highest standards of integrity, those that can demonstrate depth and continuity, a history of superior execution skills and the ability to implement their chosen investment strategies with consistency over multiple economic cycles. Sameer Jain is chief economist and managing director at American Realty Capital.
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realAssets Adviser | March 2015
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