D e c e m b e r 2 0 1 4 | A p u b l i c at i o n o f I n s t i t u t i o n a l R e a l E s tat e , I n c .
Team Approach
Adviser Melissa Joy is part of a growing trend toward multigenerational ensembles tackling wealth management
Forecast 2015
Six advisers discuss their plans and strategies for the year ahead
Catching Rays
Outlook for solar industry is clouded by few investment options
Building Momentum Public-private partnerships key to driving infrastructure investment
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 34
December
2014
VOLUME 1 | NUMBER 3
features
34 | Team Approach
Adviser Melissa Joy is part of a growing trend toward multigenerational ensembles tackling wealth management. By Ben Johnson
40 | Six Sides
For 2015, real assets strategies will continue to play a key role in advisers’ portfolio construction. Here are six views on what’s ahead. By Anna Robaton
44 | Joining the Crowd
Crowdfunding is poised to take an Amazon.com-sized chunk out of the commercial RE capital market. By Matt Hudgins
40
44
50 | Building Momentum
Deal flow for P3 infrastructure projects has slowly increased in the past few years. So what can investors expect? By Mard Naman
56 | Catching Some Rays
A somewhat bright outlook for the solar industry is clouded by few viable investment options.
50
56
By Doug Bartholomew
On The Cover Melissa Joy is a partner and director of wealth management at the Center for Financial Planning in Southfield, Mich. Photo Credit: Rosh Sillars
realAssets Adviser | december 2014
1
Contents
December
2014
r e a l a ss e t s a d v i s e r . c o m
News & views
26
28
30
32
Real Estate
Infrastructure
Energy
Commodities
26 | Two Funds Raise $4.3B American Realty funds core and value-add opportunities
28 | P3 Market Growing Use of public/private partnerships is growing in the U.S.
30 | Shell Lands Record Firm raises $920M in largest MLP IPO of 2014
32 | Silver to Shine? Demand for the metal is set to rise, but will pricing follow?
27 | Iconic Gherkin Sells London office tower fetches a cool $1.2B
29 | Water Sector Stabilizes U.K. water services considered stable by Moody’s
31 | Goldman Slashes Oil Oil benchmark pricing dropped by 17% for 2015
33 | PE Digs Mining Private equity firms dig into new mining investments
27 | CMBS to Mature Nearly $70B in loans are set to mature in 2015
29 | Aussies Eke Out Gains IPD index rates high returns on Australian infrastructure
31 | Energy Demand Drops Consumption dips well below long-term averages
33 | Farmland Falls Major farmland index points to lowest returns since 2010
26 | REITs to Rise REITs are expected to outpace the broader equity markets
28 | Century Bonds Grow New bonds are helping to grow infrastructure investment
30 | Chesapeake Sells Energy firm unloads $5.4B, backs off natural gas
Coming Next Month
departments
4 | Notes & Trends
17 | The Big Picture
60 | Ad Index
8 | Contributors
20 | Up Front
61 | Editorial Board
24 | people
64 | Last Word
13 | Market View
32 | Iron Ore Drops S&P has cut price assumptions for iron ore through 2016
ee our tips for buying S into direct real estate.
The publisher of Real Assets Adviser, Institutional Real Estate, Inc., is not engaged in rendering tax, accounting or other professional advice through this publication. The opinions expressed in articles or columns appearing in Real Assets Adviser are those of the author(s) or person(s) quoted and are not necessarily those of Real Assets Adviser or Institutional Real Estate, Inc. Advertisements appearing in the magazine do not constitute or imply endorsement by Institutional Real Estate, Inc. Although the information and data contained in this publication are from sources the publisher considers reliable, its accuracy cannot be guaranteed, and Institutional Real Estate, Inc. accepts no responsibility for any errors or omissions. No statement in this magazine is to be construed as a recommendation to buy or sell any security or other investment. The contents of this publication are protected by copyright law and may not be reproduced in whole or in part or in any form without written permission. Š 2014. All rights reserved. Printed in the USA.
2
realAssets Adviser | december 2014
KBS REIT III continues its public offering
KBS REIT III is a non-traded real estate investment trust encompassing up to:
200,000,000
SHARES OF COMMON STOCK* AT A CURRENT PRICE OF $10.39 PER SHARE KBS REIT III will use the proceeds to invest in and manage a diverse portfolio of real estate and real estate-related assets, including the acquisition of core commercial real estate properties.
KBS STRATEGIC
OPPORTUNITY REIT II has commenced an initial public offering
KBS Strategic Opportunity REIT II is a non-traded real estate investment trust encompassing up to:
100,000,000
SHARES OF COMMON STOCK** AT A PRICE OF $10 PER SHARE KBS Strategic Opportunity REIT II will use the proceeds to invest in and manage a diverse portfolio of real estate and real estate-related assets located in the United States and Europe.
This announcement is not an offering. No offering is made except by the prospectus filed or registered with appropriate state and federal regulatory agencies, including the Department of Law of the State of New York. Neither the Attorney General of the State of New York nor any other state securities regulator has passed on or endorsed the merits of the offering. Any representation to the contrary is unlawful. *Up to 200,000,000 shares of common stock are currently available in the primary initial public offering for $10.39 per share, with volume discounts available to investors who purchase more than $1,000,000 of shares through the same participating broker-dealer. Discounts are also available for other categories of investors. Up to 80,000,000 shares are also being offered pursuant to a dividend reinvestment plan at a purchase price currently equal to $9.88 per share. **Up to 100,000,000 shares of common stock are available in the primary offering for $10 per share, with volume discounts available to investors who purchase more than $1,000,000 of shares through the same participating broker-dealer. Discounts are also available for other categories of investors. Up to 80,000,000 shares are also being offered pursuant to a dividend reinvestment plan at a purchase price initially equal to $9.50 per share. For additional information about these offerings, please contact your financial advisor or KBS Capital Markets Group. You can also learn more about these offerings by visiting www.kbs-cmg.com.
KBS Capital Markets Group Member FINRA & SIPC 660 Newport Center Dr., Suite 1200 Newport Beach, California 92660 (866)-KBS-4CMG (866-527-4264) www.kbs-cmg.com
[
notes & trends
By Ben Johnson Managing Director, Editor-in-Chief Real Assets Adviser
]
Look Before Leaping into the Great Tech Conundrum
Today’s genre of crowdfunding firms provides the latest intersection between technology and real assets investing.
T
his December issue of Real Assets Adviser, our third on the trot coming to you every month, attempts to tackle a variety of topics that are relevant to investing trends in the real assets space, but one in particular is proving to be more divisive and yet potentially game changing — crowdfunding. Firstly, it was an easy decision to cover the subject, since it has gained a great deal of mainstream attention. There are even entire conferences devoted to it. Then, as with any new technology that is adopted, it took time to learn. During the discovery phase, it was important to decide something simple, yet oh so telling. Is that term — crowdfunding — to be treated as two separate words or should it appear as a more unified phrase? We settled on the unified approach as the industry standard and set off from there.
I have decidedly mixed emotions about crowdfunding and its role in the future of the investment profession. I realize this is minutiae stuff in the grander scheme of things, but in fact, today’s crowdfunding space looks more like the wild wild west than a mature industry. And that’s not such a bad thing. What is important is understanding how
4
it works, who benefits and is it right for accredited investors? Our mantra continues to be siding with what is in the best interests of both investors and advisers, so we continue to ask: Is it safe? And will advisers who use crowdfunding platforms for their clients be able to look them in the eye and provide a straight answer when the client asks, “Will I be OK?” To be sure, I have decidedly mixed emotions about crowdfunding and its role in the future of the investment profession. On the one hand, the concept itself, one rooted in disintermediation and bringing the depth and breadth of technology to bear on the age-old, time-honored approach to investment transactions and traditions, is eerily similar to the dot-bomb era of the late-1990s. I not only lived through that era, but saw firsthand the power and the aura of all things shiny, new and digital, as well as their ability to fail spectacularly. Having worked for two Internet startup firms that imploded under the weight of their own hubris and debts (once the millions in VC money ran out), not to mention their general lack of a coherent or even rational revenue model, I know what I know. I could create an entire issue of this magazine devoted to “where are they now” stories about so many of those former top technology executives who have either returned to more traditional vocations or are now working on their fifth startup. Today’s strategies appear to bear a few similarities to those early-era brethren. For many firms realAssets Adviser | december 2014
GLOBAL PERSPECTIVE, ACCESS AND EXPERTISE IN REAL ESTATE INVESTING. For more than two decades, Morgan Stanley Real Estate Investing (MSREI) has been one of the most active global real estate investors, acquiring approximately $190 billion of assets in 36 countries.1 With 17 offices across 13 countries worldwide, MSREI leverages the perspective, relationships and expertise of Morgan Stanley to provide our clients with access to real estate globally. To find out more, visit morganstanley.com / realestate.
1 As of June 30, 2014 Š 2014 Morgan Stanley CRC1043040 exp 10/15
[
notes & trends
] A publication of Institutional
in the space, it is all about gaining a first-mover advantage by creating a model that is “different” from the traditional industry norm, fulfills an untapped need and simplifies the transactional process. Making actual money along the way is not necessarily mandatory, but demonstrating there is a demand in the marketplace and providing a service are paramount. The end game is nearly always the same — to build an enterprise as quickly as possible via several rounds of venture capital funding, in hopes of selling it off to a deep-pocketed mega-technology firm for an unbelievably high valuation, and then using the proceeds to start up the next venture. The real challenge is to create and maintain differentiation in the market once the field of players itself becomes “crowded,” if you will pardon the pun. And the crowdfunding space has certainly become crowded and much more competitive over the past three years. It is getting more and more difficult to tell the players apart without a scorecard. Many of the advisers that I speak with have asked if the genre is only technology for tech’s sake. And has anyone really learned anything from history? When money is flowing virtually unabated into any sector, discipline has a tendency to fly out the window. And that is the situation in which I believe we find ourselves today. On the other hand, technology can be a wonderful thing when it works, and anyone who knows me understands how much I like “industry disruptors” as much as, or more than, the next person. New vision is always required, no matter the industry or profession, to spark innovation and change for the better. But in today’s investment marketplace, in particular, there is precious little room for error. We are, after all, talking about peoples’ real money and future retirement savings. As you flip a few pages ahead in this issue, you will see Hugh Kelly’s column starting on page 17, in which he is rightly pessimistic and not so kind to the crowdfunding genre. You will also see a major feature starting on page 44 in this issue that is devoted to the subject and attempts to dissect the state of the sector and why a few of its major players feel they have invented the Next Great Thing. Just as it happened some 15 years ago, the market and its forces will ultimately dictate the success or failure of both crowdfunding as a viable concept (which it is) and the entities that will be long-term players in the sector. As usual, time will tell, and we will all be watching.
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 Contributing Editors Drew Campbell Loretta Clodfelter Reg Clodfelter Mike Consol Denise DeChaine Richard Fleming Jennifer Molloy Andrea Waitrovich vice president, marketing
New vision is always required,
Sandy Terranova
to spark innovation and
Suzanne Chaix
change for the better.
Karen McLean
marketing & client services Elaine Daniels Brigite Thompson Michelle Tiziani Caterina Torres SPONSOR SERVICES Wendy Chen Salika Khizer DATA SERVICES MANAGER Ashlee Lambrix DATA SERVICES Justin Galicia Derek Hellender Karen Palma Administration Andrew Dohrmann
On Twitter: @RealAssetsAdv and @Bjohn9
6
Jennifer Guerrero
realAssets Adviser | december 2014
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[
contributors
] Anna Robaton Six Sides (page 40) Anna is an experienced business journalist, with expertise in real estate, investing, personal finance and healthcare. She 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.
Matt Hudgins Joining the Crowd (page 44) Austin-based freelancer Matt has covered commercial real estate since 1997. He writes regularly for The Wall Street Journal, and his byline has also appeared in The New York Times, National Real Estate Investor, Shopping Centers Today and Commercial Investment Real Estate.
Doug Bartholomew Catching Some Rays (page 56) Doug is a former contributing editor for Euromoney and Corporate Finance Magazine, and has written for Institutional Investor and Chief Executive. His articles on solar energy and electric cars have appeared in New York Magazine, the New York Daily News Sunday Magazine, and Mechanix Illustrated.
Frances Hudson Accessing Real Returns from Real Assets (page 13) Frances is the global thematic strategist within the multiasset investment team at global fund manager Standard Life Investments. She joined the strategy team as an investment director in 2001 and is responsible for the development and articulation of thematic ideas, investment insights and market analysis.
Jennifer Garrison Optimizing a PE Real Assets Program (page 64) Jennifer is partner, investor relations and marketing of Verdis Investment Management, a privately held investment management firm specializing in private equity investments in real estate, energy and natural resources.
8
ISSN 2328-8833 Institutional Real Estate, Inc. Vol. 1 No. 3 December 2014 PURPOSE Real Assets Adviser is dedicated to providing actionable information on the real assets class and facilitating important business connections for investment advisers, wealth managers and family offices. Through print, online, conference and data p ro g r a m s , R e a l A s s e t s A d v i s e r provides thoughtful, cutting-edge analysis, helping advisers make informed decisions to diversify clients’ portfolios, provide long-term income and hedge against inflation. Real Assets Adviser (ISSN 2328-8833) is published 12 times a year for $195 per year, by Institutional Real Estate, Inc., 2274 Camino Ramon, San Ramon, CA 94583; www.irei.com; Tel +1 925-244-0500; Fax +1 925-244-0520.
CHANGE OF ADDRESS: Send address changes to Real Assets Adviser, 2274 Camino Ramon, San Ramon, CA 94583 USA. Copyright © 2014 by Institutional Real Estate, Inc. Material may not be reproduced in whole or in part without the express written p e r m i s s i o n o f t h e p u b l i s h e r.
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Editorial Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Advertising Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Sponsorship Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Requests for Reprints: Susan Sharpe, Tel +1 925-244-0500, x110; s.sharpe@irei.com Visit us online: RealAssetsAdviser.com
realAssets Adviser | december 2014
advocacy / collaboration / education / resources / awareness
Leadership for the Direct Investments industry. The Investment Program Association (IPA) was formed in 1985 to provide the Direct Investment industry with effective national leadership. We support individual investor access to asset classes generally not correlated to the traded markets, and historically available only to institutional investors. Our membership includes product sponsors, broker-dealers, investment banks and service providers that manage and distribute a wide variety of Direct Investment products including: Non-Listed REITs Business Development Companies (BDC’s) > Oil & Gas Programs > Equipment Leasing Programs > >
Since 2003, IPA member firms have purchased 443 million square feet (US & international) of commercial Real Estate Assets and corporate debt with a value of approximately $87 billion.
For a weekly summary of the biggest news articles across the Direct Investment industry, sign up at: www.smartbrief.com/ipa
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Opening
VIEW
10
realAssets Adviser | december December 2014
Number One?
realAssets Adviser | december December 2014
Houston ranked as the most-favored U.S. real estate investment market in the 2015 Emerging Trends survey by Urban Land Institute/PwC, ahead of both Austin and perennial favorite San Francisco.
11
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people data insights
[
Accessing Real Returns from Real Assets
Market View
]
By Frances Hudson
Patience is the best strategy when it comes to real assets investing, as global markets continue to open.
L
ong-term investors are attracted by prospective real returns and the enhanced diversification associated with real assets. The assets in question range from inflation-linked bonds to infrastructure to commodities to timberland and farmland. A diverse mix of attributes includes relatively stable and historically robust absolute returns, bond-like income streams, and the potential for capturing equity upside with lower volatility and global exposure. Real assets find favor based on their diversification potential; historic correlation with mainstream assets and with each other has been low. Overall, their track record in terms of generating inflation-adjusted returns is also impressive. However, especially in today’s low inflation environment, investors may need to exhibit considerable patience in order to benefit. In addition, the global markets for real assets are opening up and developing in ways that should broaden their appeal further.
CHANGING PLAYERS, RULES Significant changes are taking place that should foster growth in the markets. Firstly, in the regulatory aftermath of the global financial crisis, investment and commercial banks have scaled down their involvement in and exposure to physical real estate, infrastructure and commodities. The withdrawal of the banks as active investors represents an opportunity for other active investors to enter into markets where inefficiencies may lead to more persistent returns. realAssets Adviser | december 2014
Secondly, bank divestments and the liquidation of maturing funds, such as first-generation European infrastructure funds, have increased supply to secondary markets. The assets concerned can be repackaged into equity and debt tranches and represent later stages in project lives, which will increase the menu of risk and return profiles on offer. This allows longer-term investors to align their time horizons and risk appetites by, say, investing in mid-market brownfield assets and avoiding front-loaded construction costs. However, there is still some way to go before liquid secondary markets exist. Thirdly, there are moves on the part of various national, state and local authorities to diversify the sources of funding for long-term financing by “fostering” non-bank financial involvement, particularly
There is a compelling case for portfolio allocations to real assets. by institutional investors. This may also have been spurred on by the realization that, even if governments were best placed to carry out these massive long-term projects, there is a liability mismatch — the tenures of elected bodies are typically four to five years, while real asset projects can take more than 10 times as long. Also, in difficult financial times many
13
[
Market View
] public sector balance sheets and budgets cannot easily afford or sustain the commitment. The change would be welcome. The categorization of infrastructure as “strategic” has not always been limited to social entities, and interaction has been far from “arm’s length.” Changing regulatory frameworks and risk transfer associated with public sector–supported projects has detracted from the appeal of related equity investments. The determination of regulated prices in energy and utilities via complex formulas can be off-putting, while in some markets the prospect of windfall taxes has loomed large. LOCAL TO GLOBAL In terms of liquidity, the complex nature of physical real assets such as infrastructure, real estate, forestry and farmland means investment activity is rarely a desktop exercise. Local contacts, operators, contractors and agents remain critical to the transaction and operating process — which has supported a local bias. As illiquid credit markets develop and become more structured, there is more analytical interest. Some investors will derive comfort from the recently published detailed guidance from credit rating agencies on their criteria for assessing a range of infrastructure assets. Elsewhere, new analytical tools have been developed to quantify “real risks” across a range of instruments and markets, in order to move from single country to global exposures. For instance, Standard Life Investments’ real estate
Overall, a careful and considered approach is essential. team utilizes a GREIR (global real estate implementation risk) score by which returns can be adjusted for local risks. It is important to factor in variations in political, ownership, tax, transparency and liquidity risks across global markets. These risks are significant when you own a sizable real asset in any global location and should be taken into account. MORE DIVERSE ACCESS The traditional division between bond-type real assets (inflation-linked bonds, TIPS and floating-rate notes) and those with equity-like characteristics (commodity futures, infrastructure, timberland, farmland and real estate) is being blurred as new instruments are introduced and new avenues for investment are opened. Examples include real estate debt, infrastructure ETFs and securitization related to infrastructure.
14
The U.S. financing market has been more diverse in terms of instruments. For example, banks, commercial mortgage–backed securities (CMBS), insurance companies, federal and state governments, and mortgage REITs all play a part in financing U.S. real estate. The securities markets remain underdeveloped in Europe relative to the United States, partly as a consequence of Europe’s historic over reliance on bank financing. However, there has been a volte-face on the part of European politicians toward securitization. What we have also witnessed recently is a growing IPO market in Europe and also significant volumes of bond issuance. It is difficult to reach general conclusions about the health of real asset bond markets because they differ substantially. The market for private loans in Europe is at a nascent stage; infrastructure bonds relating to U.S. power-projects carry high levels of default risk associated with construction. Despite new sources of supply, secondary markets are still illiquid and each issue requires careful bottom-up analysis. Some markets are growing rapidly while others are not keeping up with investor interest. THE FUTURE FOR REAL ASSETS There is a compelling case for portfolio allocations to real assets. However, they do not represent a universal solution. Lumpy returns, sizable shifts in asset valuations and protracted timeframes for entering and exiting positions make for frictional investing. There are huge variations within and between the relevant public and private markets and no smooth transition between them; i.e., they are not fungible. Despite the name, commodities are anything but generic — but they do influence forestry and farmland valuations. The long-term inflation-hedging qualities of real assets may require decades of patience on the part of investors. Overall, a careful and considered approach is essential, in relation to the selection and location of assets as well as to contract and regulatory analysis. Leverage, transparency and liquidity are recurring themes when considering the risks. Looking ahead, one concern is that the development of the more liquid avenues for investment comes with the potential that in the public (listed) markets, at least, real assets become a crowded trade. The danger is that the prevalence of low policy rates prompts more investors to engage in a hunt for yield and the returns available diminish. In private (and less liquid) markets returns may be more sustainable. Frances Hudson is a global thematic strategist at Standard Life Investments. realAssets Adviser | december 2014
Don’t Forget To Mention Discount Code “RAA” For 10% Savings A partial listing of companies already registered for 2015: Managing Principal, Walton Street Capital, LLC
President & CEO, The Swig Company
President, Related California
President, Inland Institutional Capital Partners
President and CIO, GTIS Partners
Principal, Walton Street Capital, LLC
Principal, The Blackstone Group
Principal, Westport Capital Partners LLC
Principal, Colony Capital LLC
Managing Director, BlackRock
Managing Director and Group Head, Fund Finance, Union Bank, N.A.
Portfolio Manager - Real Assets, UPS
Managing Partner, The Milestone Group
Vice President, China U.S. Chamber of Commerce
President, Teamster Local 237; Trustee, Board of New York City Employee Retirement System (NYCERS)
Managing Principal, Parmenter Realty Partners
Principal, Post Brothers Apartments
Managing Principal, AmCap, Inc.
Principal, Red Cedar Residential
Managing Director, Head of Retail Rockwood Capital, LLC
Chief Financial Officer, Redwood Real Estate Partners
Managing Director, Strategy & Research, Global Real Estate, TIAA-CREF
Chief Financial Officer, Tricon Capital Group Inc
Director, Private Investments, UNC Management Company Executive Director, Real Estate Investing, Morgan Stanley Investment Management
SVP, Global Development and Strategy, Gansevoort Hotel Group Principal and Executive Vice President, Noble Investment Group, LLC
Managing Director, Clarion Partners
Chair, International Real Estate Advisory, Harvard Board University
Partner and Chief Operating Officer, GreenOak Real Estate
Investment Committee Member, Greater Cincinnati Foundation
Senior Managing Director, CBRE Global Investors
Chief Investment Officer, Waterton Associates
Managing Director, The Blackstone Group
Chairman and CEO, Reven Housing REIT, Inc.
Chief Investment Officer, Doral Property Finance
Co-Head and COO, Morgan Stanley Alternative Investment Partners Real Estate Team
Chief Financial Officer, Independence Capital Partners
Chief Investment Officer, Peachtree Hotel Group
CEO, CFO and Chief Investment Officer Digital Realty Managing Director and Co-Head of Investments, NorthStar Realty Finance Corp.
Head of Acquisitions, AmCap Inc.
Senior Research Analyst, Real Estate and Infrastructure Private Equity, Russell Investments
Head of Real Estate, Raymond James
1st Vice President, Investments CIM Group
Managing Director and Head of Asset Management, Canyon Capital Realty Advisors
Senior Vice President, General Counsel,Corporate Secretary, Chief Compliance Officer, Acadia Realty Trust
Chief Acquisitions Officer, Digital Realty Trust Managing Director & Chief Investment Officer, Arixa Capital Advisors, LLC Founder, CEO, and Portfolio Manager, Real Assets, Verdis Investment Management
Call: 212 224 3428 | www.imn.org/winteropps2015 | Email: hotline@imn.org
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[
Crowdfunding’s Status: Shiny New Vehicle?
The Big Picture
]
By Hugh Kelly, Ph.D., CRE
While the packaging looks great, there are economic questions surrounding the new crop of retail-level vehicles.
I
n 1970 there was a number one hit song from the one-hit-wonder band, The Ides of March. The song was “Vehicle,” and it led with the words, “I’m the friendly stranger in the black sedan / Won’t you hop inside my car / I’ve got pictures, got candy, I’m a lovable man / And I’ll take you to the nearest star.” Who among us would advise our kids to listen to the friendly stranger? Not many, I hope. A sign that the commercial real estate recovery is now widely perceived can be found in the entry of retail-level vehicles into the marketplace. Without a doubt, individual real asset investors will be hearing from crowdfunding promoters in 2015, if they have not already. As someone who is an optimist by temperament, but who has acquired some skepticism by analytical training and as a witness to history, I believe that there are a number of economic questions that should be asked in examining crowdfunding “opportunities.” Like any new product, crowdfunding investments will come in terrific-looking packages. And inside the package, there may well be something of value. But before hopping inside the vehicle, there are some industry-level (macroeconomic) and investment-level (microeconomic) questions that ought to be posed, and their answers carefully considered. Let’s start with the current state of the real estate investment industry. By all reports, we have an abundance of capital from all kinds of sources: domestic and foreign, debt and equity, institutional and entrepreneurial, public and private markets.
realAssets Adviser | december 2014
Experienced investors are asking whether the market is becoming too frothy. There seems to be more capital looking for good investments than there are good investment opportunities to be found. So the first question is, “Why does the market need an additional source of capital to competitively drive down yields and inflate prices?” The immediate next question is, “What assets remain for crowdfunding investment in a market where established investment firms have already scoured the terrain for properties?” To get comfortable with committing capital to a crowdfunding investment, at minimum an investor should have a clear and satisfactory answer to those two questions. Crowdfunding advocates correctly discern an enormous pool of potential capital that at present does not have a significant toehold in the real property asset class. Pension fund investment has been a significant contributor to real estate since the 1970s,
The list of questions could go on ... and should go on. but fewer and fewer Americans have access to defined benefit retirement plans, the kinds of plans that have used real estate as a diversifier, inflation hedge and yield enhancer. Meanwhile the amount of capital residing in defined contribution plans such as 401(k)s and Individual Retirement Accounts has
17
[
The Big Picture
]
Consultant support for inflation-fighting assets
mushroomed to $12.6 trillion, roughly four times the amount in traditional pension plans. Reports about the rise of real estate crowdfunding contain some impressive numbers. Fundrise, for instance, indicates that it has attracted 36,000 investors. The Wall Street Journal reported the capital raise for this niche product at $135 million as of last June. The Carlton Group identifies doctors, lawyers and small business owners as target investors for itself and its crowdfunding competitors. However, a close reading of a recent ULI report on the crowdfunding panel at its national meeting in New York City raises a few more questions. For instance, Fundrise is focusing on “below the radar” projects and asserts that “crowdfunding offers modest-size developers access to thousands of investors.” The Prodigy Network recently made a splash with its $25 million equity contribution to an $85 million hotel development purchase in Lower Manhattan. Question: Isn’t development the riskiest form of real estate investment, and isn’t modest-sized projects the development segment that faces the most intense competition? There are other entities, such as Realty Mogul, that focus on cash-flowing properties. Or, from the same ULI report, “It’s a question of diversification. Until at least 10 percent of everyone’s portfolio is invested in commercial real estate, we’ll all have plenty of business.” Diversification sounds like mom and apple pie, but it is really a portfolio concept most applicable to core investors with very large mixed-asset exposure where real estate serves as a hedge to stocks and bonds. The whole point of diversification is to get beyond the “alpha” characteristics of individual deals. Question: Are the assets seeking crowdfunding truly “core,” or are they value-add or opportunistic deals? Value-add is extremely dependent upon man-
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agement skill for returns, and development — especially smaller-scale development — is opportunistic just about by definition. As such, a “beta” concept such as diversification is a red herring. It sounds good, but is actually pretty irrelevant. “Alpha-seeking” investments are all about asset selection and market timing, and this is an entirely different skillset from the portfolio diversification skills of asset allocators. A question to ask before committing money to a crowdfunding platform is: What investment style category does the sponsor claim to be in: core, value-add or opportunistic? And, as a follow-up: Are the returns anticipated tested on a risk-adjusted basis, and the prospective volatility of those returns quantified appropriately? Real estate investment is an exceptionally complex exercise, and no one should commit capital without due diligence. A recent background paper for the 2014 Crocker Symposium at UCLA’s Ziman Center notes, “So far, investors are trusting in the underwriting being done by the online [crowdfunding] platforms.” Question: Why is this safer (or at least as safe) as trusting in the ratings on real estate securities issued by Moody’s Investors Service, Fitch and Standard & Poor’s in the middle of the past decade? Realty Mogul, for instance, explicitly disclaims “recommending” the investment opportunities it offers, indicating in its FAQs that “each investor must do their own due diligence before making a decision to invest.” That’s honest, but not a piece of cake, as getting good information relevant to real property is by no means as simple as clicking a few sources on the Internet. The list of questions could go on … and should go on. But here is one last question to ask a prospective crowdfunder. What is the experience of the capital-raising firm, its principals and its team? Look for solid real estate operational and financial experience, rather than a background in venture capital funding or in the building of technology platforms. Stress substance over form. Look for a plan that takes real estate cycles into account. And, critically, ask the question: Will it be as easy getting my money out of this investment as it is to put my money in? First and foremost, investing is about return of and return on capital. So ask the promoters the twofold question: What is the exit strategy for the asset? And what is the exit strategy for me? Hugh F. Kelly, Ph.D., CRE is a clinical professor of real estate at NYU’s Schack Institute’s master’s degree programs, and the 2014 chair of the Counselors of Real Estate. realAssets Adviser | december 2014
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TIAA-CREF Opens London Real Assets Office
Commonwealth Adds NTR To PlaTForm
The asset management arm of the big U.S. insurer has opened a new overseas office to build up its European real assets business
Broker-dealer Commonwealth Financial Network has added the first non-traded REIT to its platform in the form of Jones Lang LaSalle Property Trust
Schwab’s Annual IMPACT Packs a Punch
Scalability, Succession to Fuel More RIA Deals
Charles Schwab & Co.’s annual shindig known as IMPACT, the nation’s longest-running and largest gathering of RIA firms, held this year in Denver on Nov. 4-7, yielded several major announcements, but much of the talk in the aisles was focused on the firm’s earlier announcement that it would launch its own “robo-adviser” called Schwab Intelligent Portfolios. Introduced by CEO Walt Bettinger, SIP will be available to retail investors in the first quarter of 2015, with a white label version for RIAs available shortly thereafter. With as little as $5,000, investors will be able to open individual, joint, IRA and revocable living trust accounts that offer technology-driven automated portfolios and a modern, streamlined client experience designed for ease and efficiency. During IMPACT, which was 3,600-attendees strong this year, Bernie
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Clark, Schwab executive vice president and head of Schwab Advisor Services, challenged RIAs to pay attention to generational changes impacting the industry at both the firm and client level, as well as the environment of disruption happening on an even larger scale in well-established industries — from transportation and payment systems to healthcare and vacation lodging. Also announced at the conference were winners of the ninth annual IMPACT Awards, which included: • Bingham, Osborn & Scarborough, LLC, Best-in-Business IMPACT Award • Alliance Benefit Group of Minnesota & Kansas, Best-in-Retirement Business IMPACT Award • Beacon Pointe Advisors, Trailblazer IMPACT Award • United Capital Financial Advisers, LLC, Pacesetter IMPACT Award.
Some of the largest registered investment advisers not only expect industry consolidation to accelerate in the coming year, many plan to contribute to this trend directly by making an acquisition, according to a survey conducted by TD Ameritrade Institutional during its 2014 Elite Summit. According to the survey, about 72 percent of RIAs predict deal activity will rise in the coming year, and 10 percent expect a “significant” increase. Roughly half of the advisers, moreover, said they are looking to make one or even multiple acquisitions. The firms of the Elite Summit attendees on average managed more than $1 billion in client assets. The majority of these larger advisers view themselves as buyers. More than two-thirds of the respondents don’t expect to sell or merge in any time horizon, though 11 percent said they would consider a sale or merger of their firm in the next five years. “Advisers are eager to continue expanding, but there is intense competition for new clients and organic growth by itself takes time,” says Pete Dorsey, managing director of sales at TD Ameritrade Institutional. “The key for advisers, in any scenario, is finding the right cultural fit.” Another source of growth is the continuing flow of advisers from broker-dealers to the independent RIA space. This trend, which accelerated in the wake of the financial crisis, is expected to continue and even increase. Nearly 20 percent of the advisers surveyed said they expect to add new talent from independent broker-dealers while 10 percent anticipate adding advisers or teams from the national “wirehouse” brokerages. realAssets Adviser | december 2014
GLOBAL WEALTH GROWING AT RECORD PACE
CALPERS Targets $7B in New Real Estate
Global wealth grew at its fastest rate ever over the past year to a worldwide total of $263 trillion, according to Credit Suisse’s Global Wealth Report
Largest U.S. public pension fund ditches hedge funds, but plans to beef up real estate allocation to pre-financial crisis levels
Study: Real Estate Enhances Risk-Return Profile of DC Plans
New: First IPD Canada Property Fund Index
An allocation of as little as 10 percent to a mix of listed and unlisted real estate enhanced the risk-return profile of a defined contribution (DC) plan portfolio, improving the probability of successfully achieving desired retirement outcomes, according to the results of a new study released today by the Defined Contribution Real Estate Council (DCREC). The study, A Path to Better Retirement Outcomes: Allocating Real Estate Assets to Retirement Portfolios, was conducted by Michael E. Drew, PhD, a Professor of Finance at the Griffith Business School at Griffith University, Adam N. Walk, PhD, also from the Griffith Business School, and Jason M. West from Bond University. Ultimately, it determined that the sequence of portfolio returns plays a critical role in the ability of DC plan participants to achieve their retirement savings goals, and this is particularly important late in the accumulation phase and early in the transition to retirement. Further, a portfolio strategy that includes real estate could deliver a smoother transition, improving longterm participant outcomes, and helping DC investors avoid adverse responses to temporary market setbacks — for example, switching out of risky assets and moving out of the market altogether after a significant downturn. This gradual transition increases the likelihood that participants will “stay the course” and achieve their goals.
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Covering the period from January 1976 to January 2014, the authors examined historical DC-style asset allocations, including target date and target risk funds, and added a 10 percent allocation to real estate for their research. The study notes that listed real estate, represented by REITs, has often played a role in DC portfolios as REITs provide an easily implemented exposure to the asset class due to their liquidity, generally diverse holdings, and valuation cycles that mirror stocks and bonds. Plan sponsors have been slower to adopt unlisted real estate. The authors point out that unlisted core real estate has a number of characteristics that should make it attractive to plan sponsors as well, including returns closer to that of bonds but with significantly lower (reported) risk than stocks, regular income (making it a reasonable bond substitute), low (reported) volatility and low correlation to listed markets. In addition, some types of unlisted real estate have demonstrated inflation hedging characteristics, potentially making the asset class a reasonable defensive asset from the perspective of a liability-driven investor.
MSCI has announced the first consultative release of the IPD Canada Quarterly Property Fund Index, a significant initiative to measure net asset value performance of private real estate funds in Canada. The new index initially encompasses open-ended entities pursuing a core investment strategy. The annual Canadian fund return stands at 7.4 percent for the year to June 2014, while underlying property returns within the component funds averaged 7.4 percent as well. The returns were calculated based on initial data collected during the consultative release. The formal release planned for early 2015 will contain 10 years’ worth of return history.
Canadian Funds Most Pessimistic On Market
Canadian pension funds are the most pessimistic in the world about coming market upheavals, reporting in a new global pension survey they anticipate market bubbles and crashes will become more frequent. A survey of 811 pension fund managers by Pyramis Global Advisors, the pension asset management division of Fidelity Investments, shows Canadians are concerned about future market volatility, while fund managers in Europe and Asia strongly believe market volatility will decrease in the long term. The survey found 60 percent of Canadian pension fund managers believe that over the long term, volatility is increasing and market bubbles/crashes will become more frequent, while 42 percent in the U.S. agreed with the statement.
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up front
Direct Investment Industry Convenes ’Tis the season for direct investment conferences, as leading executives gathered in Phoenix for the Investment Program Association’s (IPA) annual conference and in Las Vegas for the Alternative Direct Investment Securities Association (ADISA) fall conference to discuss the legislative, regulatory and product trends that are shaping their landscape. The biggest news during the most recent IPA three-day event was the accounting troubles besetting American Realty Capital Properties, a former non-listed REIT sponsored by AR Capital that went public in 2011. Speculation was rampant among attendees regarding how the negative news might impact the non-traded REIT space, both in the short term and longer term. Suffice to say that opinions were divided on that issue, at best. 1 IPA president and CEO Kevin Hogan introduces Real Assets Adviser to conference attendees 2 W.P. Carey Inc. managing director Mark Goldberg 3 Goldberg opens the conference (center) is honored for his past year as IPA chairman by Kevin Hogan and Griffin Capital chairman and CEO Kevin Shields, the incoming IPA chairman 4 Harley Davidson brand visionary Ken Schmidt talks about how the company came back from the brink 5 Griffin Capital’s Kevin Shields 6 Inland Real Estate Investment Corp. president and CEO 7 Mitchell Sabshon Keith Allaire, managing director of Robert A. Stanger & Co., gives his annual outlook for the direct investments industry 8 Political pundit Tucker Carlson talks up the 2016 election field 9 Over 400 attendees were treated to 30+ educational sessions 10 Panelists Dale Brown, president and CEO of Financial Services Institute; Kristen LeClair, SVP of NFP Advisor Services; John Rooney, managing principal of Commonwealth Financial Network; and Adam Antoniades, president of Cetera Financial Group, talk about the new era of change for broker-dealers
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1 Members of ADISA’s founding executive team formally unveil the new name for the organization, formerly known as REISA 2 Tony Chereso of United Development Funding moderates a panel on preparing for liquidity events including Lance Murphy of Franklin Square Capital Partners; Brian Jones of Realty Capital Securities; Mitchell Sabshon of Inland Real Estate Investment Corp.; and Kevin Shields of Griffin Capital 3 More than 1,000 broker-dealers and RIAs attended the ADISA conference 4 Realty Capital Securities president John Grady moderates a popular legislative and regulatory panel, including Tom Selman of FINRA, and Justin Nazari of Financial Services Institute 5 Amy Lynch talks about marketing to the next 6 investor genera t ion ADISA chairman Mark Kosanke welcomes conference attendees
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CBRE Appoints Brian Stoffers to Global Finance Role Brian Stoffers has been appointed global president, debt and structured finance at CBRE Group. Stoffers is a 30-year veteran of CBRE and previously served as president, debt and structured finance, Americas and chief operating officer, capital markets. The appointment is part of CBRE’s overall growth strategy and global unification of its capital markets business. Stoffers will help expand and integrate CBRE’s debt and structured finance offering globally, with practices in the Americas, Asia Pacific, and Europe, Middle East and Africa, including global loan servicing, loan sale advisory and investment banking reporting to him directly. Stoffers will continue to report to Chris Ludeman, global president, capi-
tal markets, while aligning with CEOs in all three global regions. “Our debt and structured finance business line is closely aligned with our sales business and together with our investment banking group creates the service spectrum that clients demand from CBRE as the global market leader,” said Ludeman. Under his leadership, CBRE’s debt and structured finance practice has originated nearly $112 billion in loan volume since 2007. With Stoffers’s promotion, Jeff Majewski will be named chief operating officer, capital markets, Americas in a role that combines the debt and structured finance and investment properties platforms.
Karen Barr been named president and CEO of The Investment Adviser Association (IAA). Barr has served as general counsel of the IAA since March 1997. Prior to joining the IAA, Barr was in private practice at the Washington, D.C., law firm Wilmer, Cutler & Pickering, where she represented clients in SEC investigations, securities class action litigation, administrative proceedings, internal corporate investigations, and securities regulatory matters. She succeeds David Tittsworth, who had announced earlier this year his intent to retire from the IAA.
She has been with Ventas, an S&P 500 company and a leading real estate investment trust, since 1999.
Stephen Brown and James Goetz have joined Stifel, Nicholaus & Co. as an adviser team. The pair were fired in September by Bank of America Merrill Lynch, where they had managed $2.5 billion in assets for clients with around $10 million or more in investible assets at Merrill Lynch. Debra A. Cafaro, chairman and CEO of Ventas, was recognized by the Harvard Business Review in its 2014 list of “The Best-Performing CEOs in the World.” Cafaro was ranked 27th out of 100 CEOs.
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Fabrice Centeno has been appointed as director for JCRA Financial’s new West Coast office in San Francisco. JCRA Financial LLC is the only U.S. broker/dealer that is a member of FINRA and is focused solely on providing independent financial risk management advice to U.S. private equity firms, corporations and governmental entities. Prior to joining JCRA, Centeno headed a team at J.P. Morgan Securities Ltd. in London, marketing derivative-based solutions to hedge balance sheet risks. Nehal Chokshi has joined Maxim Group LLC as a vice president and senior enterprise and consumer technology analyst as part of the firm’s expansion of its equity research platform. Maxim Group is a leading full-service investment banking, securities and wealth management firm headquartered in New York City. Prior to joining Maxim Group, Chokshi founded Technology Insights Research, which provided technology equity research as well as
Brian Stoffers
Jeff Majewski
channel and end-user surveys to buy-side clients. Gardner Ellner has joined CBRE Global Investors as an acquisitions director for the U.S managed accounts group. He will be responsible for preparing, recommending and implementing a portfolio-wide acquisitions/dispositions strategy including sourcing, underwriting, completing due diligence for and acquiring investments in the Western region. Ellner previously served as the Western U.S. acquisitions manager for Equus Capital Partners. Additionally, Jeff Felder has joined the strategic partners U.S. team at CBRE Global Investors as senior director focused on acquisitions and new investments for the U.S. value-add fund series. Felder joined the firm in 2010 and has served in various roles, including evaluation of global corporate acquisition opportunities, such as the 2011 acquisition of ING’s Real Estate Investment Management business in Europe and Asia as well as the firm’s global securities business, and the development and marketing of new investment programs. realAssets Adviser | december 2014
Charles Hopkinson-Woolley has joined NewSmith as head of alternatives and product. Previously he was with Tyrus Capital, Deephaven Capital Management, Deutsche Bank and Cazenove. NewSmith is a specialist asset management firm, based in London and Tokyo, providing investment services to institutional and high-net-worth investors around the world. Chuck Kingswell-Smith is retiring as vice president and treasurer from Plains All American Pipeline LP (PAA), effective May 2015. Effective Oct. 1, 2014, Sharon Spurlin has joined PAA as vice president and treasurer and will report to Kingswell-Smith in his new role as vice president – finance until his retirement. Kingswell-Smith has served in his current role since joining PAA in 2008. Spurlin brings more than 25 years of financial experience to PAA. Most recently, she served as senior vice president and CFO for PetroLogistics LP until it was acquired by Flint Hills Resources LLC in July. Russ Mayerfeld has joined Allstate Corp. to oversee private equity, infrastructure and real assets and real estate. He will report to Judith P. Greffin, chief investment officer. Recently, Mayerfeld served as an independent consultant to private equity funds and corporations and as a board member for private and public companies. Also, Peter Keehn has been promoted to managing director, private equity. Keehn will continue to lead Allstate’s global private equity investing group, which includes the infrastructure and real assets team, managing a portfolio of approximately $3 billion. Allstate will expand its alternative investment portfolio over the next several years, with much of the growth coming from direct investments. John O’Neal has joined Northern Trust as senior real estate asset manager in the firm’s real estate division based in Dallas. He is responsible for the asset management of a portfolio of real estate projects directly owned by high-net-worth individuals, institutions and various types of trusts. He will also further develop Northern Trust’s real estate business in the State of Texas. Prior to joining Northern Trust, O’Neal worked at Hartman Income REIT, LLC as vice president of asset management and development. Laura Pomerantz has joined Cushman & Wakefield as vice chairman and head of the newly formed strategic accounts group. Pomerantz most recently served as principal realAssets Adviser | december 2014
and founding partner of Laura Pomerantz Real Estate LLC and is joined by five professionals from her firm, including her longstanding associates Betty Ende and Ilyssa Schwartzberg. Pomerantz has successfully completed more than 8 million square feet of office and retail assignments for clients including Bloomberg LP. Leo Quinn is the new CEO of Balfour Beatty, a leading international infrastructure group. He starts in his new position and joins the company’s board of directors on Jan. 1, 2015. Quinn joins Balfour Beatty after five years as group CEO of QinetiQ, which he reshaped into a strong commercial competitor providing technology solutions in defense, security and aerospace. From 2004-2008, Quinn served as CEO of De La Rue, the largest non-government printer of banknotes, and prior to that led a number of international business transformations as global president of Honeywell Building Controls and COO of Production Management, the largest division of Invensys PLC. John Reinhart has joined Aubrey McClendon’s American Energy Partners as the chief operating officer for its affiliates American Energy-Utica and American Energy-Marcellus. He previously worked for Chesapeake Energy Corp. for eight years in various roles, including manager of engineering technology, vice president of operations in the Eastern division and senior vice president of operations and technical services. AEU and AEM have built an industry-leading position in the southern Utica Shale in eastern Ohio and a strong position in the Marcellus Shale in northern West Virginia. They plan to drill over 3,000 gross wells in Ohio and West Virginia over the next decade, a planned investment of approximately $20-25 billion in those two states. Lisa Ross has been elected as chief financial officer of Behringer Harvard Opportunity REIT I, Inc. She will continue to serve as senior vice president and treasurer o f Behringer Harvard Opportunity REIT I, Inc., positions that she has held since October 2013 and January 2012, respectively. Ross has been the company’s principal accounting officer since January 2012. With her election to CFO, Ross became the company’s principal financial officer. She began her tenure with the company in January 2011 as senior controller and director of financial reporting. Carolyn J. Simon has joined BNY Mellon
Wealth Management, based in the firm’s Madison, N.J., office, where she is responsible for generating business in the New Jersey region. She is a former vice president and senior relationship manager at PNC Wealth Management. BNY Mellon also hired Gregory J. Lentini as a senior wealth director for business development in Garden City, N.Y. The two hires are part of the firm’s campaign to increase its sales force in key wealth markets. BNY Mellon has hired more than 25 wealth directors nationwide so far this year, with several more to join in the coming months, the firm said. Anne E. Sutherland, an attorney well known in the mortgage banking industry for her work with mortgage loan origination and servicing clients, has joined Ballard Spahr as of counsel in the mortgage banking and consumer financial services groups. She brings more than 20 years of experience to the firm. Peter Sweeney has been appointed chief financial officer by the board of trustees of Calloway Real Estate Investment Trust, one of Canada’s largest REITs. He was most recently CFO of Allied Properties Real Estate Investment Trust. Arno van Geet has been appointed as CFO at Bouwinvest Real Estate Investment Management, one of the largest property investment managers in the Neth- e r lands. Van Geet will sit on the board of directors and be responsible for financial and risk management, accounting, reporting, corporate control, internal audit, business process management, IT and research. He joins from Allianz Nederland, where he was also the chief financial officer. In other news, Tjarko Edzes has been appointed as regional manager, Asia Pacific at Bouwinvest Real Estate Investment Management. The firm aims to double its investment portfolio in Asia Pacific during the next couple of years to 20 percent of the total international portfolio. Edzes will be primarily responsible for non-listed real estate investments in the Asia Pacific region. He was previously head of transactions for continental Europe for CBRE Global Multi Manager. Christopher White and Joshua Zierten have joined Veritas Investments and will help lead acquisitions and financings for the firm. White was most recently at Stockbridge Capital, a real estate investment manager, and previously was a senior analyst with London Group Realty Advisors. Zierten was formerly with W. P. Carey, Mesa West Capital and American Realty Capital Partners.
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R ea l E stat e news
REITs to Rise, While Yields and Inflation Fall
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EITs will outperform the broader equity markets in the current environment, according to a report by Oppenheimer. In the past 10 years, REIT returns were more sensitive to changes in the real yield, and less sensitive to inflation expectations, relative to the broader market. Recently, REIT, S&P 500 and real-yield correlations have diverged. The data show REITs had a higher negative correlation to changes in real
yields than the S&P 500 Index, but for inflation expectations, the relationship switched. In addition, the correlations will not affect the interest rates in the long term. The real estate environment is the key driver dictating REIT stock performance. An improving real estate environment typically means REIT stocks outperform, while a declining environment typically causes underperformance.
And REIT absolute valuations are approaching long-term averages, while, relative to the broader stock and bond markets, they appear modestly more attractive. REIT dividend yields still look attractive compared to the U.S. 10-year Treasury, and less attractive to the S&P 500, although the yield spread with stocks widened considerably during the financial crisis.
Colony Financial Merges with Colony Capital Colony Capital has agreed to combine management with Colony Financial. It will be led by Colony Financial’s executive chairman Thomas Barrack, Jr. and CEO Richard Saltzman, with Colony Financial becoming a self-managed real estate investment trust. The proposed deal would include aggregate consideration of up to about $657.5 million, to be paid in the form of Colony Financial units convertible into shares.
The Blackstone Group Sells 1740 Broadway for $605M Vornado Realty Trust has purchased 1740 Broadway, a 601,000-square-foot office building in Manhattan. The seller was The Blackstone Group. The sales price was $605 million, or approximately $1,000 per square foot. The tax gain will be approximately $483 million, which will be deferred as part of a like-kind exchange for the acquisition of the retail condominium of the St. Regis Hotel and the adjacent retail townhouse.
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American Realty Raises $4.3B for Two Funds American Realty Advisors has raised approximately $4.29 billion for two of its funds, according to two separate SEC filings. For its American Core Realty Fund, the firm has raised $3.94 billion. The fund invests primarily in high-quality core stabilized income-producing properties located in or near major metropolitan markets nationwide that demonstrate growth potential and/or supply constraints. The fund is diversified geographically, economically and by property type. The core fund achieves this by acquiring institutional-quality multi -tenant office, industrial, retail and multifamily properties in the middle-market range, $20 mil-
lion to $150 million. Targeted investments will be substantially leased properties with minimal deferred maintenance needs. In addition, American Realty has raised $341.6 million for its American Strategic Value Realty Fund, according to an SEC filing. The fund launched in 2008. American Realty’s value-added strategy is opportunity-based with a secondary goal of diversification to reduce overall investment risk. Investment structures are expected to include direct equity investments and joint ventures, mezzanine/participating debt, preferred equity, and senior and subordinate debt structures. realAssets Adviser | december 2014
London’s Gherkin Tower Sells for $1.2B One of London’s most iconic office towers, 30 St. Mary Axe, otherwise known as The Gerkin, has been sold for $1.2 billion to The Safra Group. Deloitte, the receiver for the London property since it was placed into bankruptcy in 2013, announced the agreement. Completed in 2004, 30 St. Mary Axe, is the second-tallest tower in the City
of London and was designed by noted architect Lord Norman Foster. Its largest tenants include Swiss Re and Kirkland & Ellis. The Safra Group is an international network of businesses and investments controlled by Joseph Safra, and collectively have assets under management of over $200 billion and aggregate stockholder equity of approximately $15.3 billion.
CNL Snaps up Medical Offices for $238M
North Carolina Investing Up to $1.75B in Real Estate Annually The North Carolina Retirement Systems is looking to invest $300 million to $750 million annually in noncore real estate through 2016 and $700 million to $1 billion annually in core real estate over the same period. The $104 billion pension plan is transitioning toward its target of 5 percent of total assets invested in core real estate and 3 percent in noncore. Currently, NCRS has 3 percent of its total assets invested in core real estate and 4.7 percent invested in noncore real estate. In 2014 and 2015, the pension plan is planning between $500 million and $750 million of new noncore real estate commitments. The new commitments are expected to focus on a number of different investment themes, including taking advantage of distress in Europe, focusing on managers that emphasize current income, exploring sales of secondaries, focusing on managers who apply a “rifle shot approach,” as well as exploring some build-to-core development in either the multifamily or industrial sectors, according to a presentation given by NCRS’ investment advisory council. NCRS’ total real estate portfolio beat its three-month benchmark as of June 30 by 105 basis points by returning 4.08 percent, though it was nearly 180 basis points short of its custom benchmark for the year ending June 30, returning 12.03 percent. realAssets Adviser | december 2014
CNL Healthcare Trust has bought a nine-property medical portfolio from Meadows & Ohly for $238.1 million. The portfolio totals 881,726 square feet. The properties are located in Georgia and North Carolina. The largest medical office property is the 192,000-square-foot Midtown Medical Plaza in Charlotte, N.C., which sold for $51.1 million. The lowest priced asset was the 44,332-square-foot Outpatient Care
Center, also in North Carolina, which sold for $12.9 million. In a separate deal, CNL Healthcare Properties acquired the Lee Hughes Medical Building, a 76,758-square-foot class A medical office building, for approximately $29.9 million. Built in 2008, the property is located on the campus of the 500-bed Glendale Adventist Medical Center in Glendale, Calif.
Two San Francisco Office Buildings Sell for $522M Two office buildings in San Francisco’s CBD are set to change hands for a total of $522 million. The city’s office market has been very active of late, and these deals continue the trend. Bentall Kennedy is under contract to purchase the 362,000-square-foot office located at 600 California St. in the San Francisco CBD. The sales price is approximately $215.1 million, or $593 per square foot. The seller is Clarion Partners, which bought the 20-story office in 2012 for $180 million.
The property at 600 California St. is located at the intersection of California and Kearny streets, set across the street from 555 California St. — formerly known as Bank of America Tower — and within a few blocks of the iconic Transamerica Pyramid. Three blocks away, the 475,000-square-foot Embarcadero Center West is in a pending deal between Rockpoint Group, the buyer, and TIAA-CREF, the seller. The sales price is approximately $307 million. The 32-story office sold for $295.8 million in 2005 to TIAA-CREF from Boston Properties.
$69.2B in CMBS Set to Mature in the Next Year Just over $69.2 billion in U.S. CMBS loans are set to mature by Sept. 1, 2015, according to Trepp. The maturities are the first in the wave of nearly $400 billion in CMBS loans set to mature by the end of 2017, says Ed Shugrue, CEO of Talmage. Of the maturing CMBS loans, more than $10.92 billion, or 15.8 percent, are currently delinquent and present opportunities for note sales, discounted payoffs or restructurings, leading Trepp to point out that “now is the time to capitalize on this opportunity.” The high influx of under-
performing loans coming due should only continue in the coming years, as large portions of the 2006 and 2007 vintage CMBS loans were aggressively underwritten and overleveraged and will have likely run out of maturity options. Of the regions with a significant amount of CMBS loans coming due, the Southeast has the greatest proportion of delinquent loans at 16.5 percent. More than $2.12 billion of the $12.82 billion of loans coming due in the region have DSCRs over 1.2x.
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Infrastructure news
Century Bonds for Infrastructure Grow in Popularity
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he issuance of 100-year bonds for infrastructure offer several advantages, according to Century Bonds Create Opportunities and Challenges for U.S. Public Infrastructure, a report by Moody’s Investors Service. Century bonds are primarily issued by colleges and universities; however, other entities have recently begun to also use these vehicles, including the Cleveland Clinic, a nonprofit hospital that issued a $400 million century bond this year.
The advantages of the bond include “the ability to match the long-term service lives of the assets being financed to long-term debt maturities, deferring rate increases and long-term capital cost recovery,“ Moody’s notes. In addition to the Cleveland Clinic, Moody’s reports the District of Columbia Water and Sewer Authority sold a $350 million century bond this summer to help finance a $2.6 billion mandate by
the Clean Rivers Project. The D.C. Water Authority is the first infrastructure issuer to offer a century bond since the New York and New Jersey Port Authority did it in 1994. According to the report, adding century bonds to a debt portfolio can give an issuer increased flexibility by “deferring debt service costs far into the future.” However, they also can lessen long-term financial flexibility and raise long-run costs.”
Following Bankruptcy, Indiana Plans More Transportation P3 The Indiana Toll Road Concession Co. (owners and operators of the Indiana Toll Road) have filed for bankruptcy, but the move may not be all bad for transportation investment in the state. Since the original transaction in 2006, Indiana has used the lease proceeds to fund Major Moves, a 10-year statewide program that has paid for 33 percent of the state’s cumulative transportation construction as of 2013. Moody’s also notes the toll road bankruptcy highlights the demand risks private investors can take on in road P3 transactions if traffic volumes and revenues do not perform as expected. With the Major Moves program expiring in 2015, the state “has been actively engaged in entering into availability-payment model P3s in order to address its transportation budget gap,” Moody’s reports. The Indiana legislature also approved a $400 million transfer from the general fund to address this shortfall.
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U.S. P3 Market Set for Growth The United States is poised to become the largest P3 market in the world, according to Global P3 Landscape, a report by Moody’s Investors Service. Given the sheer size of its infrastructure and growing urban population, the United States is ripe for P3 infrastructure activity, and “an increasing number of U.S. states are authorizing the use of P3s for transportation projects, typically the first type of P3 projects in a new market,” Moody’s notes. The use of the P3 model also has been steadily increasing during the past three to five years in the United States. According to the report, Canada has the most mature P3 market, where availability
-payment models have helped attract private investors to P3 infrastructure projects. Mexico, meanwhile, primarily uses demand-risk P3s, where investment returns are generated by traffic user fees and the risk is borne by the private developer and investors. Moody’s notes the United States has a history of demand-risk P3s, but availability -payment based P3s are increasing. “Aided by supportive legislation and public-policy initiatives, more P3 availability-payment projects are reaching financial close or are in procurement than ever before,” says John Medina, assistant vice president with Moody’s. realAssets Adviser | december 2014
U.K. Water Sector Outlook Remains Stable Moody’s Investors Service has issued a stable outlook for the U.K. water sector, despite the publication by the sector’s regulator — the Water Services Regulation Authority, or Ofwat — of a challenging draft regulation model. “The 3.7 percent wholesale return proposed by Ofwat earlier this year for the next regulatory period from April 2015 is 1.4 percent below the total allowed return for the current period, and may be reduced further at the final determination,” Moody’s notes in 2015 Industry Outlook — U.K. Water Sector: Stable outlook despite challenging price review.
Despite the mildly surprising regulatory ruling, Moody’s notes the reduction is in line with its expectations and is due to the low interest rate environment. “Lower allowed returns will reduce flexibility, but companies may be able to improve their cash flow through operational or financial outperformance,” says Stefanie Voelz, vice president and senior analyst with Moody’s. “Whilst companies with higher embedded cost of debt are particularly exposed to a lower return environment, we expect that the sector will be able to maintain adequate financial flexibility by reducing dividends or leverage,” Voelz adds.
Infrastructure Securities Outperform Market, but Give Back Gains in Third Quarter Asian Infrastructure Markets Prove Challenging Although billions of dollars have been raised for infrastructure investment, a lack of commercially investable projects in Asia has investors and investment managers frustrated, according to Institutional Investors Struggle to Find Investable Infrastructure Projects, a report by Standard & Poor’s. “The risk-reward equation does not justify the huge political and economic challenges of Asia’s emerging countries, on top of project construction, design and technical risks,” S&P notes. “Second, the lack of a strong credit culture and legislative framework in some Asian countries make enforcement of contractual rights uncertain and untested. And lastly, banks have largely soaked up project financing, offering low financing costs that capital markets aren’t able to or willing to match.” S&P defines an investable project as one that meets investors’ minimum credit quality and return expectations. Despite the huge numbers quoted as needed for infrastructure investment in the region, the reality is “the number of available investable projects — particularly public-private partnerships — is insufficient to soak up increasing amounts that investors are considering allocating to infrastructure,” S&P concludes. realAssets Adviser | december 2014
Reversing momentum gained in the second quarter, global equity markets ended the third quarter down 2.1 percent, as measured by the MSCI World Index. Infrastructure securities outperformed the broad equity market, ending the third quarter down 0.9 percent. The Americas region was the sole positive performing region, leading the performance of infrastructure securities with a return of 0.6 percent. Performance in the Americas was driven by continued growth in the U.S. economy. This was partially offset by Brazil, where concern over the outcome of the Brazilian presidential election weighed on the markets. The Asia Pacific region underperformed, declining 3.4 percent during the quarter, as investors responded to a slowdown in the Chinese economy and pro-democracy rallies in Hong Kong. Europe was the largest underperformer during the third quarter, declining 5.6 percent amid weakening European economic indicators and close economic ties
to Russia where sanctions were imposed during the quarter. Performance declined across most sectors during the third quarter, with only the master limited partnerships, communications and ports sectors posting gains. MLPs led the asset class, returning 3.5 percent. Transaction activity in the MLP space during the third quarter led to a continued focus on valuations in the sector and to outperformance within the asset class. We continue to favor securities that offer a reasonable combination of yield and growth rather than securities with higher current yields but lower growth potential. Though the securities we favor tend to be more sensitive to volatile periods such as this past quarter, we believe these growth-oriented securities are fundamentally well positioned for the economic environment moving forward. (Contributed by Craig Noble, CEO, CIO and global portfolio manager of Brookfield Investment Management Inc.)
Australian Infrastructure Ekes Out Q3 Gains Infrastructure funds, as measured by the IPD Australia Quarterly Unlisted Infrastructure Index, returned 0.4 percent for third quarter 2014 and 17.9 percent during the past 12 months. The index tracks 164 investments made by 23 funds. The index portfolio comprises investments in Austra-
lia (61 percent), Europe (26 percent) and North America (9 percent). Most of those investments are in the airport sector (34 percent), followed by transportation (22 percent), water (11 percent), power transmission (11 percent) and power generation (10 percent).
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ene rgy n e ws
Chesapeake Energy Moves Assets for $5.4B, Backs Off Natural Gas
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hesapeake Energy Corp., the second-largest producer of natural gas and the 11th-largest producer of oil and natural gas liquids in the United States, has agreed to sell more than 400,000 net acres and approximately 1,500 wells in northern West Virginia and southern Pennsylvania, along with related property, plant and equipment,
to Southwestern Energy Co. for $5.4 billion. The average net daily output from these properties, 435 of which are in the Marcellus and Utica formations, was approximately 56,000 barrels of oil equivalent during the month of September, consisting of 184,000 Mcf of gas, 20,000 barrels of natural gas liquids and 5,000 barrels of condensate.
The transaction, which should lower the company’s dependence on natural gas, comes on the heels of the firm’s July announcement that it and other producers in the Marcellus shale experienced significant weakening of natural gas price differentials relative to the Henry Hub benchmark natural gas price.
Shell Lands Year’s Biggest MLP IPO Royal Dutch Shell finally took a dip in the Master Limited Partnership (MLP) pool, as Shell Midstream Partners raised $920 million in its late October IPO, becoming the year’s largest MLP, and the largest MLP IPO since Plains GP Holdings brought in $2.8 billion in October 2013. The IPO exceeded expectations, as reports in the lead-up to the offering estimated a $750 million haul, and Shell planned to sell 37.5 million shares at around $20 each, though it eventually moved 40 million shares that were priced at $23 a pop. The success of Shell’s IPO, among other MLPs, shows investors are still clamoring for the high annual returns and dividend yields offered by MLPs. The Alerian MLP Index had a dividend yield of 5.2 percent as of Sept. 30, 2014, higher than REITs, bonds and the S&P 500 Index. Shell Midstream shares trade on the New York Stock Exchange under the ticker symbol SHLX.
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Appalachian Natural Gas Prices Continue to Lag In what has been a summer to forget, natural gas prices at four major trading hubs in the Appalachian Basin’s Marcellus Shale have been dipping increasingly below the national benchmark spot price at the Henry Hub in Louisiana since April, and have dropped below half the benchmark price in October. Despite fluctuating rapidly on a weekly basis, prices at the Dominion North and Dominion South Hubs, the Leidy Hub and the Tennessee Zone 4 hub have all been trending downward for months, and each of which dipped below $2 per million British thermal units (MMBtu) at some point in October while spot prices at Henry Hub and throughout much of the United States have traded near $4 per MMBtu during the same period. The TCO Appalachia Pool
Hub is one of the few in the central and northeast portions of the Marcellus region that have held firm, keeping pace with Henry Hub prices while its neighbors have struggled. The decline in prices in the region has been due to increasing production over the past two years that has outpaced growth in the region’s available pipeline takeaway capacity, and this backed-up supply has made prices increasingly volatile, causing them to drop by as much as $1 per MMBtu on moderate temperature days when Northeast demand is low, according to the EIA. The TCO Pool has been able to lean on a more diverse pipeline network that provides access to multiple markets in the Northeast and Midwest, allowing it to keep parity with national prices. realAssets Adviser | december 2014
Goldman Sachs Slashes Forecast for U.S. Oil Benchmark Price by 17%
Consumer Energy Expenditures Dip Below Long-Term Average With energy prices dipping across sectors, and energy use becoming increasingly efficient, U.S. household energy consumption expenditures relative to disposable income have dipped below the long-term average of 5.5 percent and now rest at approximately 5 percent, according to new data from the U.S. Energy Information Administration. Historically, energy prices have fluctuated to a greater degree than energy use, leading to big swings in energy expenditures as a share of disposable income. If the recent price drops in oil continue, it could lead to energy expenditures dipping even more, and prices are contingent on enough factors globally that industry sources have been unsure if prices will bounce back in 2015 or not. Since 1960, energy expenditures’ share of disposable income has gone as high as 8 percent in the early 1980s and as low as 4 percent in the early 2000s, having fluctuated between 4 percent and 5.5 percent since then, according to the EIA. Not only have price drops weighed in, but increasing vehicle fuel efficiencies and changing fuels used for home heating have contributed as well, the EIA notes, as electricity and transportation spending accounts for more than two-thirds of consumer energy expenditures in the United States. realAssets Adviser | december 2014
With global oil production continuing to grow while demand growth slows, a number of financial institutions, including U.S. investment bank Goldman Sachs, have cut 2015 oil price projections. Goldman Sachs now expects West Texas Intermediate, one of the two most commonly used oil price benchmarks, to drop to $75 per barrel by the end of first quarter 2015, $15 below its previous projection. “I think the estimates of oil prices for early 2015 are surely possible scenarios, and prices may even go lower than that,” says Tim Boersma, fellow, energy security initiative, with the Brookings Institution. The benchmark dropped 25 percent from June 2014 to the end of October, limping in to Halloween at just over $81 per barrel
— the lowest it has been since 2011 — after climbing up to $104 a barrel in May. The benchmark has been quite volatile over the past five years, dipping as low as $65 per barrel and reaching as high as $111 per barrel, while crossing over the $100 per barrel mark nearly 20 times. Goldman Sachs also dropped its oil price projection for Brent crude oil, the other common price benchmark, by $15 to $85 per barrel. The forecast is not far from current levels as Brent prices experienced six consecutive weeks of loss between September and October 2014, the longest decline since 2002 according to Bloomberg, ending October at just over $85 per barrel after staying above $105 per barrel for much of August.
U.K. Green Investment Bank Mobilizes $8B+ in First Two Years Making for a landmark second birthday, the United Kingdom’s Green Investment Bank has now mobilized £5.2 billion ($8.2 billion) worth of investment across 37 projects in the United Kingdom’s green energy sector since forming in late October 2012. The 37th project, announced Oct. 30, 2014, is a £5.2 million ($8.2 million) transaction to help Citibank reduce energy use at its data center in Lewisham, London. The bank, which was the first of its kind globally and is the United Kingdom’s most active renewable energy investor, is not simply making an environmental move, but is making cash as well, as it is expected to deliver an annual return of 9 percent. “We have set out to be an innovative but always commercial investor,” says Shaun Kingsbury, chief executive of the Green Investment Bank, in a statement. “All of our investments have been both green and profitable but, more than that, each deal demonstrates to a significant international market that the U.K. renewables sector is a good place to invest.” From a purely financial standpoint, 9 percent annual returns do not necessarily hold up against other energy classes — the Alerian MLP Index, for example, which primarily comprises oil and
natural gas companies, has a one-year return of 25.8 percent as of Sept. 30, 2014 — though the Green Investment Bank is certainly interested in accelerating investment in green energy infrastructure as well as generating strong risk-adjusted returns. And, to a large extent, it has accelerated that investment, mobilizing £3.6 billion ($5.7 billion) in private capital alongside the £1.6 billion ($2.5 billion) in capital the bank has committed, which has led to a 3.6 million metric ton reduction in greenhouse gas emissions, the equivalent of taking 1.6 million cars off the road, and the production of 13.1 terawatt-hours of renewable energy, the equivalent energy consumption of 3.1 million U.K. homes, according to the Green Investment Bank.
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Commodities news
Standard & Poor’s Cuts Iron Ore Price Assumptions
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tandard & Poor’s has reduced its price assumptions for iron ore by 11 percent. With a new assumption of $85 per ton through 2016, the firm also took a number of negative ratings on global iron ore mining companies. The drop in iron prices is due to slowing growth in China, which is expected to reduce demand, while supply continues to be strong. S&P took negative rating actions on ArcelorMittal, Atlas Iron Ltd., CAP S.A., Cliffs Natural Resources, Companhia Siderurgica Nacional and Eurasian Natural Resources Corp. Ltd. However, S&P did not immediately change its ratings on Anglo American Plc, BHP Billiton Ltd., Ferrexpo Plc, Fortescue Metals Group Ltd., JSC Holding Company Metalloinvest, Rio Tinto Plc, Samarco Mineracao S.A. and Vale S.A. S&P also updated its assumptions for other metals prices during the next couple years. Aluminum and zinc prices were shifted upward, while copper and gold price assumptions held steady from the previous guidance issued over the summer. Nickel price assumptions were shifted downward, influenced by the slowing growth in China.
Global Silver Investment Set to Rise If current trends continue, investors could accumulate 1 billion ounces of silver in the next decade, according to Silver Investment Demand, a report by CPM Group for the Silver Institute. An increase in demand from investors could push silver prices higher. “Even in these days of precious metal price volatility, we are seeing areas of growth within the silver investment arena,” says Michael DiRienzo, executive director of the Silver Institute. The report also notes that the dollar value of the existing silver market and the newly refined supply totaled $5.1 billion in 2013, and at least 2.3 billion ounces of silver was held around the world in bars and coins at the end of 2013.
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Metals price assumptions
2014 2015 2016
Aluminum (US$ per pound)
$0.85 $0.90 $0.95
Copper (US$ per pound)
$3.10 $3.10 $3.10
Nickel (US$ per pound)
$7.85 $8.00 $8.00
Zinc (US$ per pound)
$1.00 $1.00 $1.00
Gold (US$ per ounce)
$1,250 $1,200 $1,200
Iron ore (US$ per metric ton)
$85
$85
$85
Source: Standard & Poor’s, as of Oct. 2, 2014
Golden Peanut Acquires U.S. Pecan Producer Alpharetta, Ga.–based Golden Peanut Co., a subsidiary of Archer Daniels Midland, has acquired the processing facilities and certain assets of pecan producer Harrell Nut Co. The firm also has changed its name to Golden Peanut and Tree Nuts. The acquisition of the North American pecan assets from Harrell Nut follows Golden Peanut’s purchase of a 50 percent stake in South African Pecans. “In recent years, we’ve seen the demand for healthier, more convenient foods drive up nut consumption,” says Kris Lutt, president of Golden Peanut, in a state-
ment. “U.S. pecan demand has grown almost 40 percent over the last decade.” According the USDA, pecans are one of the three most popular tree nuts in the United States, along with almonds and walnuts. “Our new name and logo reflect our commitment to growing and diversifying our business,” Lutt adds. “Peanuts will remain a core part of our business. We are building on that core, enhancing the range of products and solutions we can provide to our customers.” Golden Peanut has 10 processing facilities in the United States, three in South Africa and one in Argentina. realAssets Adviser | december 2014
Timber Sees Best Third Quarter Since 2007
Mining Positioned to Be Next Frontier for Private Equity The private equity industry has turned its attention toward natural resources, and a new report from BerchWood Partners — Global Mining: Private Equity’s Next Frontier — suggests private equity is well suited for investing in the global mining sector. Investment in mining is still a small part of the overall private equity industry. The report notes that only $30 billion — just 7 percent of the $454 billion in private equity capital raised in 2013 — targeted natural resources, and of that only $3.4 billion targeted mining-focused funds (the majority was focused on oil and gas, followed by timber). Jonathan Leslie, CIO of Sandown Bay Resource Capital, is quoted in the report, noting: “A decade of high commodity prices has concealed widespread operating inefficiencies and development failures which have become increasingly apparent. As a result, there is a need to provide operational and capital allocation discipline, which are essential to good private equity investing, particularly in the junior sector.” According to BerchWood, the private equity asset class is well suited to provide experienced management and capital discipline, which will both be needed as the industry adapts to changing conditions. realAssets Adviser | december 2014
Timberland experienced the best third quarter since 2007 in 2014 — and the second-best third quarter in the past 10 years — as the NCREIF Timberland Index returned 1.47 percent in the quarter, up from the second quarter’s 1.08 percent and third quarter 2013’s 1.05 percent return. Third quarter 2014’s return was evenly split between 0.74 percent appreciation and 0.73 percent income. The rolling four-quarter return of 10.38 percent was not as evenly split, with 2.71 percent of the return coming from income and 7.51 percent coming from appreciation. The Northeast was the strongest performing region in the quarter with a 1.69 percent return, marking the first time the region has topped the index in more than three years. The Northwest had been the strongest region for most of the past year and still has a 17.55 percent rolling four-quarter return that is nearly double the next closest region.
A few institutional investors have taken a shine to timberland in 2014, including two pension funds from Florida, the Pembroke Pines (Fla.) Firefighters & Police Officers Pension Fund and the City of Tallahassee (Fla.) Pension Plan, which each committed to timberland funds, and the Ohio Police and Fire Pension Fund. The NCREIF Timberland Index consists of 456 investment-grade timber properties worth more than $23 billion.
Farmland Posts Lowest Returns in Third Quarter Since 2010
After posting the lowest returns since 2011 during the second quarter at 1.73 percent, farmland’s struggles have only gotten worse as the total return for the NCREIF Farmland Index dropped to 1.45 percent during the third quarter, the lowest return the index has seen since third quarter 2010 and more than 140 basis points below the long-term average of 2.86 percent. Despite the easing in the strong momentum the index had been showing, the recent results are still slightly above the long-term average of 1.40 percent for the usually slow third quarter. The results still represent a change of pace for the index, which has a one-year return of 15.48 percent even with two consecutive weak quarters, and posted a 2.94 percent third quarter return a year ago. The strong returns the farmland sector was previously posting were certainly invit-
ing to some institutional investors, such as the Washington State Investment Board, which committed $400 million between two agriculture funds earlier this year. The 1.45 percent return from third quarter 2014 was divided between 0.48 percent appreciation and 0.97 percent income. The Mountain region and the Delta States were the best performers, returning 1.87 percent and 1.85 percent, respectively. For the fifth consecutive quarter, the Pacific West remains the star performer on a rolling four-quarter basis, returning 26.62 percent — more than double the next closest region, the Pacific Northwest. The NCREIF Farmland Index consists of 623 investment-grade farm properties across the United States divided between 405 annual cropland properties and 218 permanent farmland properties.
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By Ben Johnson
Adviser Melissa Joy is part of a growing trend toward multigenerational ensembles tackling wealth management.
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We had a long evolution to become a true ensemble practice and today we really are that.
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wo of the hottest topics in financial advisory circles today are how best to serve clients who span multiple generations, as well as firm succession planning. We at Real Assets Adviser like to find firms that have tackled these issues head on, in hopes of providing valuable information. The Center for Financial Planning is such a firm. Founded in 1985 and based in Southfield, Mich., CFP manages about $880 million in assets, working with more than 700 families. The center has always been a comprehensive financial planning firm, but it kicked off in the mid-1980s with several CFPs who came together in a space-sharing arrangement. Three of the original founders — Dan Boyce, Marilyn Gunther and Estelle Wade — were each successful in their own right, and yet found over time that not only did they like having the same roof over their heads, but they thought they could get more value and power from their business if they collaborated. That led to the fateful decision to build a business that is more of an ensemble enterprise than just individual siloed entities.
As it prepares to celebrate its 30th anniversary in 2015, Melissa Joy, CFP’s director of wealth management, says the firm looks to be in fine succession shape. “We had a long evolution to become a true ensemble practice and today we really are that,” says Joy. “We are in the process of completing a succession from that first generation of ownership to what will be the second generation of ownership, which includes myself as an owner, as well as Timothy Wyman, who is our managing partner, Matt Chope, Laurie Renchik and Sandy Adams, and all of us are in our 30s, 40s and 50s, so one of the things that a lot of planning professionals and people in our profession are thinking about is succession planning. It is something that we are proud as a firm to have successfully accomplished.” CFP is part of the Raymond James Financial Services hybrid select custodial program. “That means that we have most of our assets in discretionary, fee-based management programs that we invest for ourselves, but we do still have some commissionable assets. Almost 85 percent of our revenue over the last 12 months has come from fee programs, or from fee-based assets.” realAssets Adviser | december 2014
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Financial planning has evolved into being much more of a wealth management approach to working with clients.
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A BIT OF SERENDIPITY Like many advisers, Joy did not know early in her life that she would be managing other peoples’ money. As she puts it, “My background is more serendipity than a well-laid plan.” In the late 1990s, she was graduating from the University of Michigan with a political science degree but still searching for her true vocation. “I had a liberal arts background, but I also had experience. My dad had worked in the mortgage business, and I had always worked at his mortgage company on spring breaks and in the summers.” She was good with numbers, but was less interested in transactions and more into relationship building. “I was interviewing at law firms and other financial-related places and happened to answer an ad at a financial planning office in Ann Arbor, Mich. It was a small office and I got to learn pretty much anything, which was a great initial experience.” Shortly thereafter, she was introduced to partners at the Center for Financial Planning through a mutual acquaintance. In a little over a year, she was working at the center and learning its operations from the ground up, holding a variety of positions. “But I always had an interest to really wrap my head around the investing side of things,” she says. It was not long before Joy put her high school debating abilities to work and helped the firm launch an investment department. “At first it was just doing a few research projects and research was an area that I had a lot of confidence in doing on my own,” she says. “If there is one thing that debating teaches you, it is how to find things out for yourself, having different points of view and not just trusting what you learned first, but seeing both sides of an issue. Those are excellent skills for anyone involved in the investment business, to be always looking for more and not just relying on your instincts, but looking for answers.”
For several years, she focused on developing a due diligence process that was similar to institutional investment firms. “It is something that is growing within our profession, to have a more disciplined due diligence approach and selection process,” says Joy. “As a firm we really recognize that we had both the research and process and the technological capabilities to begin to use discretionary investment management in 2009, so that was when we made the transition.” Joy became a partner in 2012, the first person to become a partner in the firm who had not risen directly through the financial planner ranks. Today, Joy is managing both the investment department, as well as the financial planning department, along with operational responsibilities and some client facing duties. TIME TRAVELER Joy has seen significant changes in the profession over the past 15 years, and remains a keen observer of trends. “Our industry is so multifaceted that there is not one template for what a firm looks like, but I think that there has been an evolution and an increasing maturity,” she says. “Financial planning has evolved into, for many firms, being much more of a wealth management approach to working with clients. Then also there has been increasing maturity in firms to really be sustainable enterprises and not just kind of a charismatic leader who has a team around them to deliver financial planning services. “This is very much the story of our firm,” says Joy. “We are much more team oriented than we were when I joined 15 years ago, and we think that is an exceptional opportunity for those of us who own the firm to deliver services to clients. And we think it is great for clients as well. That has been happening across firms more and more. There were a few really robust ensemble practices 10 or 20 years ago, but that is becoming more and more the norm.” realAssets Adviser | december 2014
realAssets Adviser | december 2014
value intellectual curiosity when you get a group of people that are really focused and passionate about financial planning and investing for people and let them work together for years. “The second unique value proposition is that we are multigenerational and that has to do with us as a firm. We have evolved from the first generation of ownership to the second generation. Now the second generation is working really hard to make sure that we are identifying young talent to continue to look down the line. But also for our clients we want to focus on their needs from one generation to the next, and we think that is a huge concept that is emerging as an area of specialization for financial planning and wealth management firms. “The third thing is our focus to help clients to live their plan. It is not just about creating a plan, but how do you integrate that into your life? How can we help to implement things?” On the issue of robo advisers, Joy is surprisingly open minded. “I think it is really interesting. It is a disruptive force in our business today,” she says. “One thing that I haven’t seen is a study that says that the market is saturated with good financial advice, so I take that into consideration when there is news about robo-advisers. There may be people that this is really the right service for them.” The rise of robo advisers also raises the bar for the profession as a whole. “It is uncovering an area of our profession that is underdeveloped or needs a refresh, which is what are the technological capabilities of firms and how do you really provide integrated solutions for technology and make those relevant to today and going forward.” And it goes deeper than mere technology and systems. “For a firm like ours, we are asking ourselves the tough questions: Do we offer the right services for the clients that we want to be working with? Do we have a weakness where this could be targeting our clients or our future clients? But I
think that is a healthy conversation, especially in a profession that is really young and a profession where there seems to be a lot of growth in terms of opportunities to manage money and help with financial planning. “But there don’t seem to be a lot of new entrants in the area. The average age of our profession is getting older and older, so as a younger financial planner, it is certainly interesting. I don’t think they will go away, but I also think there is always going to be value for very complex, sophisticated financial advice and planning that goes beyond just a logarithm.” Client demands are an ever-moving target, and at least two demand drivers are most on Joy’s mind. “More and more we are thinking about our clients’ lives and, more than just the dollars and cents, also how they manage transitions, whether that transition is an inheritance or the sale of a business or a windfall or a significant change in their lives, like retiring.” Another area of interest to many advisers is thinking about multigenerational planning. “It’s about helping the parents of adult children to very intentionally work with their families so that there is both the legacy of money passed from generation to generation and a legacy of a financial perspective that the parent can help to pass on to their children and prepare them for that financial legacy,” notes Joy. For CFP as a firm, this means offering family meetings to work with the next generation to make sure that they are independently successful with their finances, but also preparing some of its higher net worth clients to be receiving significant inheritances of wealth over time. “I think that it is very applicable to millionaire clients as well,” says Joy. “You don’t have to have $50 million or $100 million. When you offer that type of service it is so well received by the clients, because at the end of the day, for so many people, being good
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This approach seems to be working, especially in an age of real-time information and economic change. “I don’t know if things are changing more rapidly or if there is just more information being distributed about what is going on, and people are hearing about more minutiae. The thing that people want to know is ‘Am I going to be okay?’” Joy admits to loving today’s ease of access to information, “but it can also create a really short-term mindset for people that is not necessarily the most effective way to look at their life or set financial goals or manage their money.” “There has been an evolution in communications,” says Joy. “I wouldn’t be posting my investment commentary on my LinkedIn page five years ago, but that is something that I do today and there are a lot of different ways for you to be forward thinking in terms of how you communicate.” Communication is a powerful tool for client retention and peace of mind, as well. “We hope to begin to work with people in their 40s and 50s, but our goal is to be working with them throughout their lives, so we need to be able to communicate just as effectively with someone in theirs 80s as we are communicating with someone in their 30s or 40s. Having the capability of modifying or tailoring your communications to your specific client needs is something that we have been thinking about.” Today’s investment clients are getting anything but less vocal and demanding. And value for the service is more tantamount than ever. To help deliver its value proposition, CFP has identified three unique client deliverables. “We are team based, and so we think that is a huge advantage,” says Joy. “We are better as a group than any one of us is individually, we offer more robust services and we get a lot of intellectual challenge. We really
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stewards of your money and good stewards for your family is their number one goal. It is just extraordinarily rewarding work. It is complicated and it is not the same from one situation to another, and it is, I think, going to be increasingly more process driven and sophisticated over time.”
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REAL ASSETS STRATEGY CFP client portfolios provide for a 7.5 percent allocation to real assets. “Real assets play a very important role. They are diversifiers, and one of the interesting things about real assets is there have been increasing opportunities to invest in them over time,” says Joy. “Whereas 15 years ago you could choose from some natural resources funds or U.S. domestic REIT funds and REIT stocks, today it is a very different kind of ball game. It would be easy if you just looked at the returns over the last five years to say you would be alright with just two asset classes, U.S. stocks and U.S. bonds, right? But what studies tell us, and I know as a long-term investor, is that truly diversifying a client’s portfolio offers opportunities when there is volatility, when there are disruptions, to provide a risk-adjusted portfolio that will get better returns.” On the fixed-income side, CFP is looking at income-producing real assets, including securitized bonds backed by real estate, REITs, global REITs and infrastructure that provides income. On the equity side, it includes more natural resources and commodities, as well as REITs that are structured to deliver more capital appreciation. Joy says the firm is not invested in non-listed REITs. “I know that for many advisers and investors they have offered attractive income streams, but many of them are still complicated by high expenses, lack of liquidity and especially because of our discretionary management for our clients, it offers some additional
hurdles that we would rather not get into for our clients.” Reinforcing the firm’s “Am I OK?” mantra when it comes to real assets investing, Joy wants to learn more about is which of these real assets are a marketing scheme and which of them are durable investing opportunities. “I think there are some of both in this space. I am looking for experience and strong management teams, and reasonable expenses,” notes Joy. In the real asset space you can’t just buy it for five or six basis points like you can the S&P 500 Index. It’s really getting our heads around the expenses and just understanding who is going to get the traction to really be relevant, be really durable with a resilient investment strategy.”
Rising interest rates is another potential concern. “We have been in a very low interest rate regime certainly in anticipation of higher rates and in recognition that you just can’t get the same income from bonds that you could in the past,” says Joy. That has been probably the biggest differentiator in our portfolios today from our portfolios of the past, and that is going to continue to be a very strong influencer of how we are invested going forward, as I am sure it is for many or our peers.” According to Joy, her experience has taught that preparation is key. “The one thing that I know is that you need to be prepared for almost anything. We can’t just say we know what the future is. Probably 99 percent of people last year thought that interest rates
There is always going to be value for very complex, sophisticated financial advice and planning that goes beyond just a logarithm.
Looking ahead to potential economic concerns, Joy is most concerned about rising inflation. “We haven’t dealt with a significant bout of inflation throughout my investing career. But it is something that over the next 30 years is sure at some point to be a significant concern and will be a very interesting time for real asset investments. I can’t predict when that might occur and we won’t know we are in it until we are in it, but that is certainly something on my mind that could significantly change allocations in that area.”
would be higher today. The biggest threat to anybody in this profession is down markets, so we are always thinking about being prepared for any type of weather for the future for our clients and our clients’ portfolios.” Being proactive and out in front is the key. “The other key is not only managing investments, but managing adviser and client behavior, so making sure that when the day comes that things are difficult that you have a strategy, to not be your own worst enemy, and to be ready to carry on.” realAssets Adviser | december 2014
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Six
sides By Anna Robaton
For 2015, real assets strategies will continue to play a key role in advisers’ portfolio construction. Here are six of their views on what’s ahead.
W
hile the U.S. economy got off to a strong start this year, the country’s upbeat mood seemed to crumble this fall with the autumn leaves. The stock market suffered a sharp correction in October, the sell-off stoked by fears over the prospect of a global economic slowdown. Geopolitical events, from the protests in Hong Kong to the advance of ISIS in the Middle East, also weighed on the minds of investors.
Gil Armour, CFP, Financial Adviser, SagePoint Financial Inc.
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Yet many financial advisers are convinced that the U.S. economy and the global economy for that matter remain headed in the right direction. They expect the United States to continue to enjoy at least modest economic growth next year and are cautiously optimistic about the European Central Bank’s efforts to stave off another regional recession. Many also remain bullish on the long-term outlook for China and other emerging markets, and thus commodities.
Gil Armour invests in nontraded REITs on behalf of clients who have sufficient net worth to diversify beyond cash equivalents, stocks and bonds. He considers real estate “a fourth major asset class” and likes nontraded REITs because they provide investors with exposure to real estate “without the headaches associated with being a landlord,” Armour says. Nontraded REITs, which are registered with the Securities and Exchange Commission and sold through broker-dealers, have surged in popularity in recent years partly because they offer relatively high dividends and their share prices are not as volatile as stock prices. Yet nontraded REITs are highly illiquid, which means clients who invest in them should have sufficient cash reserves to fund any immediate needs, notes Armour. Nontraded REITs must undergo a liquidity event — in the form of a sale, merger or public listing — before cash is returned to shareholders.
Advisers say real assets will continue to play an important role next year in mitigating risk through diversification, along with enhancing returns in a lowyield environment. Many advisers expect interest rates and inflation to inch up in 2015 and are looking to real assets to hedge portfolios. Here’s how a sampling of advisers are currently investing in real assets and how they plan to do things differently, or not, next year:
“Over the long term, REITs have had equity-like returns with probably less volatility and less risk than stocks,” Armour says, who has also bought listed REITs on behalf of clients who need more liquidity. “REITs have a higher income component than stocks or stock funds, but not as much growth potential” in terms of share price, he adds. For many of his clients, Armour allocates a minimum of 5 percent to 10 percent of assets to REITs, and for some clients as much as 20 percent of assets. He says he will continue to do so next year, but, as the U.S. recovery matures, will be careful to avoid REITs investing in sectors and/or markets that have become overheated. Many of the country’s coastal markets have already seen real estate values return to peak levels, he notes. What’s more, some real estate classes have much more upside potential than others, adds Armour. “Office space, being heavily dependent on employment, hasn’t come back fully yet and probably has some room to grow,” he says.
realAssets Adviser | december 2014
Cassaday & Co. allocates between 10 percent and 20 percent of individual client portfolios to real assets, specifically mutual and exchange-traded funds investing in commodities as well as funds investing in publicly traded REITs. A portion of its allocation to real assets is also invested in market-neutral funds. “We recognize that portfolios that don’t have exposure to REITs and commodities tend to have slightly higher risk and lower returns over the long term,” Stephan Cassaday says. Based on its belief that REITs have generally become overvalued, the firm has recently pivoted in favor of the battered commodities sector. Commodities have taken a hit lately because of concerns over the sharp decline in the price of oil, which Cassaday attributes to efforts by Saudi Arabia to fight back against U.S. competition by ramping up production. The United States is now producing almost twice the oil it produced six years ago thanks to its exploitation of shale deposits. Commodities — which also include metals, grains, minerals, livestock, cotton, sugar and coffee — will benefit from robust demand in emerging markets for everything from building materials to protein, Cassaday says. Widespread concerns over slower growth in China, he adds, are probably overblown. “The narrative is worse than the actual situation on the ground. It represents a distortion, a mispricing,” he says. “I don’t think the emerging markets story has changed. There will still be huge demand for food, metals and other types of commodities,” Cassaday adds. While REITs have outperformed the broader market this year, Cassaday & Co. has reduced its clients’ exposure to REIT funds out of concern over the recent surge in REIT prices, which the firm believes is not entirely reflective of real estate market condi-
tions. As of the end of October, the FTSE NAREIT All REIT Index had gained nearly 23 percent for the year, while the S&P 500 Index gained approximately 11 percent. “The problem right now is that retiring boomers are adopting a leave-no-yield-behind strategy, and REITs are one of the highest-yielding sectors. So people are driving up the prices of REITs without regard to the underlying fundamentals of REITs,” Cassaday says. In a recent report, Green Street Advisors, an independent research firm specializing in REITs, notes that REIT valuations are “inextricably linked to the value of other capital-market alternatives, specifically stocks and bonds.” According to Green Street, REITs have been trading within the fair-value range based on the spread between their implied cap rates (a measure of the yield embedded in current REIT share prices) and moderate-risk corporate bonds. Cassaday also worries that REIT prices could suffer if interest rates rise. In May 2013, when the Fed announced that it would consider tapering its bond-buying program, many REIT investors headed for the exits, sending REIT prices tumbling for the first time in years, according to Morningstar. Because REITs must pay out most of their income as dividends, they rely heavily on debt to fund their growth. Higher interest rates, according to Morningstar, push up the cost of capital for REITs and impede their ability to reinvest in themselves. “It is a very small market, and if you have a rush for the exits, REIT prices could get clobbered,” Cassaday says, noting that the total equity market capitalization of the listed REIT market is some $700 billion. That, he says, is less than the combined equity market capitalization of Apple, Exxon Mobil Corp. and Google, which amounts to roughly $1.4 trillion.
Stephan Quinn Cassaday, CFP, CFS, president and CEO, Cassaday & Co. Inc.
We recognize that portfolios that don’t have exposure to REITs and commodities tend to have slightly higher risk and lower returns over the long term. — Stephan Quinn Cassaday, Cassaday & Co. Inc.
realAssets Adviser | december 2014
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Leon LaBrecque, J.D., CPA, CFP, CFA, managing partner, LJPR LLC
Gustavo Vega, CFP, ChFC, APMA, managing director, Vega & Oprandi Wealth Partners
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LJPR has been ramping up its clients’ exposure to real assets since the start of the global economic recovery. Today, the firm has about 10 percent of assets under management allocated to real assets, specifically global real estate, commodities and infrastructure. It invests in real assets largely through mutual funds, with a focus on funds that have low levels of currency risk, among other qualities. “In our models, the use of real assets is both an income enhancer and a risk reducer,” says Leon LaBrecque, adding that the prices of real assets tend to rise with inflation and that real asset securities are not highly correlated with the firm’s other equity holdings. Like some other advisers, LaBrecque believes commodities have been unfairly punished lately, and his firm recently took some profits off the table in real estate and put more capital to work in commodities. While the global crude oil price has fallen sharply this year, LaBrecque argues that gas prices are not likely to remain low for too long. He attributes the sharp decline in the price of crude oil to oversupply and believes producers will probably respond by curtailing production. “A year from now, we will be bemoaning the price of oil and wishing we had 80 bucks a barrel,” LaBrecque says, adding that the recent drop in gas prices will actually help to stimulate the U.S. economy by putting more money in the pockets of consumers. Despite the recent decline in commodity prices, LaBrecque believes demand for oil and other commodities will remain strong, which is why his firm
has been increasing its exposure to energy pipeline operators, structured as publicly traded master limited partnerships, and other types of infrastructure companies that benefit from global demand. Energy pipeline operators collect fees based on the volume of oil, natural gas and other petroleum products that flows through their pipelines, not on the prices for such products. “Our thesis is that there is global growth and the things that move products are always going to benefit,” LaBrecque says. The United States, he says, is likely to outperform many other developed economies next year, thanks in part to its declining unemployment rate, stronger currency and lower budget deficit. As for the world’s second-largest economy, China, LaBrecque is not too concerned about the recent economic slowdown there. In the third quarter, China’s GDP growth was 7.3 percent, the slowest rate of quarterly GDP growth in five years. “This is a slowdown of growth, not a slowdown of an economy,” he says. With regard to real assets, LJPR’s strategy for 2015 hinges in part on the actions of the Federal Reserve. If the Fed decides to raise its target interest rate a bit, the firm is likely to slightly increase its allocation to real assets, LaBrecque says. “Right now, we are bullish on real assets and equities, particularly small-cap equities, and bearish on bonds except short-term and floating-rate bonds” given the prospect of higher interest rates, explains LaBrecque.
Like many other advisers, Gustavo Vega is keeping a close eye on Europe’s economy, which, if it worsens, is likely to be an even bigger drag on the U.S. economy. Yet Vega takes some comfort in the European Central Bank’s efforts to avert another regional recession. Since June, the ECB has cut interest rates twice, started a targeted loan plan for banks and announced an asset-purchase plan that began in late October. “We think that ECB President Mario Draghi really wants to promote quantitative easing, much like what the U.S. Federal Reserve has done,” Vega says. “Hopefully this downturn we are seeing will soon be just a memory,” he adds.
In fact, Vega believes the United States is poised to see inflation and interest rates pick up next year, which reinforces his commitment to investing on behalf of clients in funds of funds that have exposure to real estate. “Tangible property tends to perform well during periods of increasing inflation, and we believe that the United States will begin to see inflation and interest rates rise in the coming fiscal year,” he says. His firm typically allocates about 15 percent of each client portfolio to alternative assets, including commodities, Treasury Inflation-Protected Securities (TIPS) and other assets that have low correlations to conventional stock indexes. “With stock prices looking a bit frothy, it makes sense to diversify into real assets,” Vega says.
realAssets Adviser | december 2014
Catherine Valega has been allocating about 10 percent of individual client portfolios to alternative investments, specifically nontraded REITs and nontraded business development companies (BDCs), publicly registered companies that make equity and debt investments in small and mid-size firms. BDCs, which include vehicles investing in the infrastructure sector, have been able to borrow at record-low rates in recent years and make money on the spread between their cost of capital and what they charge borrowers. Like REITs, they have attracted a flood of investor capital because of the high yields they offer. Valega calls nontraded REITs and nontraded BDCs “true alternatives” because their share prices do not have the same level of volatility as shares of liquid alternatives. “I like plain-vanilla assets for most of the typical client portfolio and then true alternatives for the other part. Alternatives are meant to zig while the other stuff zags,” says Valega, who has steered some clients to a nontraded REIT that owns private-pay senior housing facilities. The REIT, she notes, offers above-average yields and provides investors with
exposure to a sector that is benefitting from the huge wave of retiring boomers. Of course, nontraded REITs and nontraded BDCs are not for every investor. They are highly illiquid and therefore generally available only to investors with significant net worth, partly because such investors tend to have ample cash reserves. What’s more, BDCs, which can be structured as traded or nontraded funds, carry a greater level of risk than traditional income-oriented products because they are investing in companies with a relatively high degree of credit risk. “You have to take risk to make money, but you want to understand what you are getting into,” Valega says. She believes many of her clients would benefit from a higher level of exposure to alternative investments, but in Massachusetts, where her practice is based, state law limits residents to investing no more than 10 percent of their liquid net worth in illiquid alternatives. Other states have placed similar caps on investing in illiquid alternatives because of the risks involved in concentration.
For high-net-worth investors who can tolerate a lack of liquidity, Matthew Westhoff believes direct real estate investing will have some distinct advantages over the next couple years. He has been helping wealthy clients in the St. Louis market acquire single-family homes that were snapped up by speculative investors during the housing bust and are now coming back on the market. Most of the homes have been upgraded, rented out and are being sold for less than fair market value because investors are eager to cash out quickly, Westhoff says. Many of the homes with tenants in place are managed by property management firms. In the St. Louis market, rental homes have been trading at cap rates (or initial yields) ranging from 10.5 percent to 18 percent, says Westhoff, who helps clients evaluate specific submar-
kets. “The cap rates suggest that the returns over the upcoming years will outpace equities,” says Westhoff, adding that rental demand remains high and interest rates remain low by historical standards. “Real estate,” he adds, “has great potential as a wealth generator. The only characteristic that it is lacking is liquidity.” While publicly traded REITs, he notes, are widely considered alternative investments, their performance is much more correlated to the performance of the stock market than actual real estate. Owning rental properties, he adds, also has distinct tax advantages for investors. “Publicly traded REITs typically have a high correlation to the stock market. When you buy specific pieces of property, that correlation goes away,” Westhoff says.
realAssets Adviser | december 2014
Catherine Valega, CFP, CAIA, owner, Green Bridge Wealth Management
Matthew Westhoff, CFP, managing partner, MBM Wealth Consultants
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By Matt Hudgins
the
Joining
Crowdfunding is poised to take an Amazon.com-sized chunk out of the commercial real estate capital market. 44
realAssets Adviser | december 2014
I
t didn’t take long to convince David Puchi and his partners at Baceline Investments that crowdfunding, or raising capital in small amounts from a large group of people, was a good way to reach new investors. Puchi is managing partner of Baceline, a Denver-based boutique private equity real estate firm that owns and manages necessity-based shopping centers in secondary U.S. markets. The firm tested the waters in October when it listed one of its three investment funds on RealCrowd, one of several online crowdfunding platforms serving accredited real estate investors. To qualify as accredited under Securities and Exchange
Commission rules, an investor must earn more than $200,000 annually or have a net worth exceeding $1 million. RealCrowd and competing companies such as Fundrise, Realty Mogul and others enable accredited investors to comparison-shop real estate deals over the Internet and make equity or debt investments in those projects for as little as a few hundred dollars. “We’ve traditionally raised money the old-fashioned way, by building relationships,” Puchi says. “The crowdfunding idea was a new one for us. It seemed appropriate to test it out, and get the word out on what we do to a broader audience.”
Puchi declines to share details about how many investors responded or how much they invested in the company’s opportunities fund after learning about it on RealCrowd, but less than a month after that first listing went live, Baceline had posted its debt-free income fund on RealCrowd as well. “It’s entirely new people, really an entirely new network, and we have touched some younger accredited investors through RealCrowd that we would not have been able to touch before,” Puchi says. “The younger investor is clearly more attuned to doing things on the Internet, including investing money, and it was a
Crowdfunding will be hugely disruptive to real estate within the next two years.
realAssets Adviser | december 2014
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Legislation Aims to Bring Equity Crowdfunding to the Masses
exemption enacted exemption in process exemption rejected
Rather than wait for the Securities and Exchange Commission to publish Title III rules governing crowdfunding by nonaccredited investors, 13 states have passed laws allowing such transactions within their borders, and another 14 states are considering similar proposals, according to attorney Tony Zeoli, who runs an informational website on crowdfunding at www.crowdfundinglegalhub.com. (See map) The SEC is long overdue to publish a final version of Title III rules it first proposed in October 2013, with a deal cap of $1 million and sheaf of compliance measures required of a company attempting to raise funds. Mark Roderick, a crowdfunding attorney at Flaster/Greenberg PC in Cherry Hill, N.J., says the general response from crowdfunding proponents was that Title III as proposed was unworkable. “The government protecting folks means a lot of regulation, a lot of information, a lot of pieces of paper getting filed before and after the investment, and those all add up to compliance costs,” Roderick says. “People have estimated that maybe
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it costs $200,000 to do a Title III deal, and for a small company, that’s a lot of money as compared to maybe $5,000 or $10,000 to do a Title II deal.” The new Republican majority in the Senate may pave the way for more lenient Title III rules from the SEC, however, according to Richard Swart, director of crowdfunding research at the University of California, Berkeley. The researcher believes the Jumpstart Our Business Startups Act of 2012 didn’t give the SEC many options to come up with less prohibitive Title III rules, but Republicans may use their majority in both houses to legislate a better crowdfunding framework. “The consensus of opinion of people I know, and people on the Hill, is that they were waiting to see how the election goes and if Republicans take the Senate and control congress, we will probably see some change to Title III and some lightening of restrictions,” Swart says. “The people really pushing equity crowdfunding within the Republican party are total free-market people.”
good way to reach a whole younger community of accredited investors.” Real estate crowdfunding has mushroomed since September 2013, the effective date for Title II rules created under the Jumpstart Our Business Startups (JOBS) Act of 2012. Title II changed crowdfunding rules by allowing private companies to advertise investment opportunities to any accredited investors. Previously, companies were limited to presenting investment opportunities to accredited investors who had already established a relationship with the issuer. Crowdfunding raised about $40 million for real estate deals in the first six months of 2014, according to Richard Swart, director of crowdfunding research at the University of California, Berkeley. About 80 percent of that volume has been in the commercial sector. In all, issuers have posted some $10 billion in crowdfunding investment opportunities under Title II rules over the past year, of which only about 10 percent have been funded, said Swart, who is also research director at Crowdfunding Capital Advisors, which advises government agencies and financial institutions. “It’s not really revolutionary — it’s still private placement — but I would expect [equity crowdfunding volume] to grow 200 percent to 300 percent annually for the next couple of years,” Swart predicts. Not a technology play Crowdfunding took hold among charities and entrepreneurs, chiefly in the major U.S. technology markets, when conventional capital sources dried up during the Great Recession. Those early adopters used online platforms such as Kickstarter and Indiegogo to collect donations, sometimes in exchange for a reward, such as a product that the startup would manufacture. In real estate, however, crowdfunding investors buy equity ownership in the deal or provide capital in the form of a loan. The early association of crowdfunding with tech startups created a common misconception that crowdfunding requires advanced technological skills, observed Philip Racusin, CEO and co-founder of EnergyFunders LLC, a Houston-based realAssets Adviser | december 2014
crowdfunding platform that enables accredited investors to buy into oil and gas wells. In practice, platforms like EnergyFunders use technology to help investors find and compare investment opportunities, and to reduce the time and cost required to comply with government regulations and close deals. That’s a technological challenge for crowdfunding platforms, but the end product is intended to provide a streamlined, user-friendly experience for the investor. “It’s a misconception that it’s simply a technology play,” Racusin says. “It stands at the intersection of law, industry and, to some extent, technology.” That means the critical skills required to evaluate equity crowdfunding opportunities are the same as those used in conventional real estate deals, explains attorney Tony Zeoli, a senior transactional associate at Ginsberg Jacobs LLC in Chicago. “The Internet is being used as a tool to facilitate the type of equity and debt investments that were already being done,” says Zeoli, who runs an informational website about crowdfunding called crowdfundinglegalhub.com. “It’s simply a private placement; it’s just over the Internet, which is opening the doors to a bunch of people.” The online edge The chief advantages for an investor investing through a crowdfunding portal, in Zeoli’s view, are access to a large selection of specific projects, smaller fees, and a low threshold for investment, making it easy to build a diverse portfolio. “It’s a fantastic opportunity because it allows people to invest who would otherwise not have access to invest in these types of deals,” Zeoli says. “Plus it allows those who invest on a routine basis to diversify on a geographic level and a property-type level. You don’t have to put all your eggs in one basket, but you have to do due diligence.” But that due diligence could be decidedly easier than it was under the old-school approach, because the major real estate crowdfunding platforms assemble relevant financial statements, appraisals and other research materials for the investor’s perusal online. realAssets Adviser | december 2014
And because deals are screened by the portal operators and exposed to a crowd of potential investors, there are more eyes on each opportunity and less opportunity for fraud, according to Mark Roderick, a crowdfunding attorney at Flaster/Greenberg PC in Cherry Hill, N.J., and the author of a crowdfunding blog at crowdfundattorney.com. “The portals live and die on their reputation and are by and large owned by real estate guys, so they look very carefully at the deals they are offered and only accept a small percentage of the deals,” Roderick says. “So the portals do the heavy lifting of the due diligence. If you invest through one of the top portals, that is sort of your assurance you’re not being bilked, although you can still lose your money.” Roderick compares investing through a real estate crowdfunding portal to buying a book online rather than in a bookstore, where the selection may be limited. “If you were an investor before, to find a good deal, you relied on your private network,” Roderick says. “You called your broker, lawyer or accountant and tried to find good deals that they happened to know about, just as back in the old days if you wanted to get a book, you could only get one that your local bricks-and-mortar bookstore sold. “Now I can get any book in the world
crowdfunding investment to accredited investors, who are responsible for evaluating their own risks. “The working assumption of the SEC for the last 80 years has been that if you are dealing with an accredited investor, they can take care of themselves. It’s a completely laissez-faire, let the buyer beware, hands-off approach,” he notes. “From an investor’s perspective, that approach does come with some risk because the government really is not looking at these deals to see if they’re any good.” But that is a familiar risk for most commercial real estate investors. There are also a few unique hazards to avoid in crowdfunding, according to Swart, the UC Berkeley researcher. Some data suggests that when a crowdfunding deal gains rapid momentum, it attracts some contributors that are simply following the herd, relying on the crowd to evaluate the opportunity. “Social signals should only be used on deals where you’ve already done due diligence,” he says. Investors should also research a developer’s track record before assuming that company has the wherewithal to complete a proposed project. Experienced commercial real estate investors may be familiar with the major players in a market, but the new investors attracted to crowdfunding may be more susceptible to marketing claims by inexperienced firms, without knowing how to evalu-
Don’t assume that there’s anything special about a property because it’s on a crowdfunding platform, versus any other offering.
on my tablet, and crowdfunding is just like that,” Roderick says. “Now as an investor, I’m not limited to just the deals my broker is selling. I can see every deal across the country, so I get a much greater variety and quality of deals.” Familiar risks, new packaging Roderick cautions that Title II rules limit
ate developer capabilities, Swart warns. “This is still a regulated securities transaction and all the documentation is still there,” Swart says. “But don’t assume that there’s anything special about a property because it’s on a crowdfunding platform, versus any other offering.” Zeoli cautions crowdfunding investors to thoroughly research and understand the structure of investments they
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may make in real estate debt through a crowdfunding portal. In some cases, the investor may believe that their investment is secured by the real estate, when in fact the investor has loaned their capital to the portal operator or another entity that in turn pools invested funds and makes a single, separate loan to the borrower. When that is the case, the real estate is collateral on the larger loan and not on the individual sums contributed by crowdfunding investors. That said, debt investments provide a return over the life of the loan, which may
afford to do that because we’re looking at this as a technology platform and we’re not building a real estate company,” Hooper says. “We don’t have to charge exorbitant fees because we don’t have that huge operational cost to support, and that ultimately is a benefit of what these platforms can provide. This is a hyperefficient way to do what has traditionally been an analog business model.” Crowdfunding is gaining acceptance among real estate investors and will accelerate in volume over the next 24 months, predicts Ben Miller, CEO of Fundrise. A
Now I can get any book in the world on my tablet, and crowdfunding is just like that. be easier for new investors to embrace than an equity investment that won’t generate a return until the developer refinances or sells the project, Zeoli said. Portal progress RealCrowd CEO Adam Hooper echoes Zeoli’s recommendation that investors research the deal structure that a crowdfunding portal offers before deciding to invest. RealCrowd prides itself on its fee structure, which is free to investors and instead charges real estate companies a flat fee per deal to use its software. Hooper declines to disclose RealCrowd’s fees, but says it is a fraction of the 7 percent to 8 percent that a typical broker-dealer might charge. “We can
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pioneering crowdfunding portal based in Washington, D.C., Fundrise charges investors 30 basis points annually on investments made through its platform, and charges real estate companies origination fees of 1 to 2 basis points for crowdfunded loans. “The Internet is great at transparency, convenience and choice, so it will become a multibillion-dollar part of real estate,” he said. “There’s clear social accountability here, and a much lower fee structure.” Disruptions ahead Miller and other crowdfunding advocates expect an upheaval in the commercial real estate capital markets as investors grow familiar with the concept and grow dissatisfied with less-efficient investment
vehicles, such as nontraded real estate investment trusts (REITs). While crowdfunding is an illiquid platform compared with publicly traded REITs, it can offer a faster turnaround from investment to liquidity event than a nontraded REIT, Miller notes. And it provides investors greater control in selecting specific properties for investment than would an investment fund or REIT, without incurring the double-digit fees that those models can incur. “The whole private REIT industry has incredible fee load, at 10 percent to 15 percent just on the front end,” Miller says. “Those types of traditional feeloaded systems don’t fare well under competition from the Internet.” Crowdfunding will be “hugely disruptive to real estate within the next two years,” says Roderick, who moderated a panel on real estate crowdfunding at the Commercial Real Estate Development Association’s national conference Oct. 28 in Denver. He sees the practice as an increasing threat to non-traded REITs, brokers and other entities that have traditionally earned fees connecting investors with commercial real estate opportunities. “The power of the Internet is that it directly connects buyers and sellers,” he explains. “Middlemen do not fare well with the Internet; it just bypasses them. In this case, entrepreneurs and investors meet online and don’t require any intermediary to meet.” Matt Hudgins is a freelance writer based in Austin, Texas. realAssets Adviser | december 2014
Family Office Winter Forum A Private Wealth Series Event
March 10, 2015 / New York Marriott Marquis, New York, NY
As part of the Private Wealth Series, Opal's Family Office Winter Forum is designed to cover the ever-changing trust, tax, estate planning, family governance and investment issues that are timely and relevant to family offices and those who support their day to day operations. Experts and industry professionals from across the globe will travel to New York to speak on the important issues facing family offices and high-net worth individuals. Come and join us for a highly intense day of engaging discussions on the latest investment trends and soft issues with some of the most well established and senior Family offices, Private investors, money managers, and private wealth service providers from around the globe.
Sponsorship and Exhibiting Opportunities are Available If you are interested in attending, sponsoring, speaking or exhibiting at this event, please call 212-532-9898 or email info@opalgroup.net To register, visit us online at www.opalgroup.net or email us at marketing@opalgroup.net ref code: FOWFA1503
Opal Financial Group Your Link to Investment Education
Momentum Deal flow for P3 infrastructure projects has slowly increased in the past few years. So what can investors expect?
By Mard Naman
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D
uring the past couple of years, public sector–sponsored entities have been established in the United States to attract private capital to infrastructure projects, and
with public funds often lacking to do the necessary work, the private sector is expected to play a much larger role in upgrading U.S. bridges, roads, water systems and other infrastructure. Yet despite the realAssets Adviser | december 2014
huge needs, deal flow for so-called P3 infrastructure projects has only slowly and incrementally increased in the past few years. However, 2014 has become the year that the federal government has dramatically stepped up its efforts to get public and private sides together on P3 infrastructure deals. So what can investors expect from these developments? How do exchanges rate? Among the public-sponsored groups that are coming online, there are the West Coast Infrastructure Exchange, The Chicago Infrastructure Trust and the New York Works Task Force — with more on the way. For example, in June 2014 groundwork was laid to create the Mid-Atlantic Infrastructure Exchange to serve the area around the nation’s capital. “These entities can serve an important role in developing case studies, standardizing documents and defining best practices in the solicitation, evaluation and execurealAssets Adviser | december 2014
tion of P3s,” says Thad Wilson, vice president of M3 Capital Partners. “They can help private investors identify projects by publicizing specifications and connecting investors to public-sector project sponsors. Private investors will require dedicated personnel who are fully aligned with investor objectives to manage the structuring, implementation and long-term oversight of P3 projects.” With 50 states and seemingly countless city, state and political jurisdictions, Michael Likosky, a P3 expert who extensively advises public officials and institutional investors on infrastructure issues, believes the exchanges present a great opportunity to organize and create project standards in the United States, so deals not only get done but can be replicated from one jurisdiction to another. Yet for all the publicity and promise the new exchanges have generated, they have accomplished very little so far in terms of tangible deals. The Chicago Infrastructure Trust, for example, after much fanfare, including public support from former president Bill Clinton, has managed only one small energy efficiency project with $12 million in private investor money. The West Coast Infrastructure Exchange has yet to close a deal. According to Likosky, however, these slow starts are to be expected. “If you want to do something ambitious, you have to lay a lot of groundwork,” Likosky says. “They hadn’t been working on these institutions before they were created, so you can expect there’s going to be some lag time before they start doing things.” Part of that groundwork is developing project standards to help provide guidance to both the public and private sides, letting
that proposed projects are consistent with those standards. According to Chris Taylor, executive director of the West Coast Infrastructure Exchange, the idea is to raise the profile of well-conceived projects and help investors identify them. The exchange has not yet initiated this certification process. “There are some important questions — such as what stage of the project the certification should occur — that we need to address before launching this process,” Taylor says. Federal support coming The creation of regional exchanges provides hope for better deal flow in the future, even if they are off to slow starts. In Washington, D.C., meanwhile, the federal government is finally stepping up as well. Likosky believes the U.S. infrastructure market has been difficult for investors partially because it is so fractured, with seemingly countless cities and states, and countless political jurisdictions. The challenge has been to get the federal government to act with stronger force in support of these projects, and Likosky thinks the United States may finally be turning the corner on that issue. “The Obama administration has been talking about P3s since day one,” Likosky says. “Now they’re actually doing something about it.” He sees the impact already on the cities and states that he advises. First, the Water Resources Reform and Development Act became law in June 2014, which addresses the financing needs for upgrades to drinking and waste water systems, dams, ports and other water infrastructure. Included in this law is a new low-cost loan program for water infrastructure called WIFIA, short for the Water Infrastructure Finance and Innovation
The challenge has been to get the federal government to act with stronger force in support of these projects. them know what has and has not worked before. The next step for such organizations will be the ability to vet and certify
Act. WIFIA is modeled after the successful TIFIA (Transportation Infrastructure Finance and Innovation Act) loan program
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for transportation projects. Many think WIFIA could be a catalyst for a large number of P3 water infrastructure deals. Second, over the course of one week in July, President Obama signed an executive order launching the Build America Investment Initiative to increase infrastructure investment, and then announced a $10 billion rural infrastructure bank to help jump-start infrastructure projects in farm states and rural areas. Likosky says the Build America Investment Initiative will do two big things: first, provide technical assistance to cities and states that are not doing many, or any, P3s because they do not know how to do them. It will start with a pilot program for transportation and then add water and communications. Second, it will free up credit within agencies to make sure that
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credit reaches more intended recipients of P3 support from the federal government. As it stands, TIFIA funds have only gone to seven or eight states. “It has not been used universally,” Likosky notes. He is working with new entrants on building the capacity to go after those funds. Of the USDA infrastructure initiative, Likosky says, “the Obama administration is committed to looking for and identifying projects for that $10 billion.” Likosky is actively working on packaging these rural projects together for investors. “The challenges are there,” he says, but we’re readying for conservative-minded investors looking for a solid return.” Likosky believes the federal government, much more so than in the past, will now actively facilitate and help get projects financed, which he thinks will be very helpful for investors. “The federal government is going to act like a federal government and create one-stop shops for investors and onestop shops for cities and states,” Likosky says. As part of this initiative, the administration created the Build America Transportation Investment Center, housed within the Department of Transportation. The center’s mission is to help both private investors and public entities find innovative ways to fund transportation P3 infrastructure projects. This center will serve as the one-stop shop for all P3 participants — state and local governments, public and private developers and investors — seeking to use public-private financing strategies.
The administration clearly sees this as only the first step, and intends to take the “onestop shop” idea to other infrastructure sectors as well. At the same time the Build America Investment Initiative was created, President Obama also created the Build America Interagency Working Group. This group’s job is “to expand and increase private investment and collaboration in infrastructure beyond the transportation sector,” according to a White House news release. Chaired by two cabinet secretaries, the group will work with state and local governments, project developers, investors and others to bring down barriers to private investments and partnerships in municipal water, ports, harbors, broadband, the electrical grid and other areas. Rare bipartisan support These federal developments would be less significant without rare bipartisan support. Government gridlock and infighting is arguably among the worst it has ever been in the United States, but furthering infrastructure and P3 projects appears to be one of the very few areas of consensus between the political parties in Congress. “Today, politicians from both sides of the aisle are utilizing infrastructure as a platform to showcase their support for economic revitalization,” says Frank Rapoport, senior partner at Peckar & Abramson and leader of the law firm’s P3 practice group. More and more, Rapoport says, politicians are referring to newly constructed infrastructure projects, the number of jobs created and the stimulus to the economy generated by modernized schools and courthouses, and improved roads, bridges and tunnels. “Rebuilding America’s infrastructure creates jobs,” is how Rapoport summarizes this new political enthusiasm. Likosky agrees, and points to a bill awaiting passage right now known as the Delaney Bill. Officially called the Partnership to Build America Act, if passed it will create the American Infrastructure Fund. The AIF will be funded by the sale of $50 billion of infrastructure bonds to provide loans or guarantees to help finance the rebuilding of transportation, energy, communications, water and education infrastructure, using P3s as one of its primary methods. realAssets Adviser | december 2014
The Delaney Bill is co-sponsored by 39 Republicans and 36 Democrats. “That’s unheard of for any other bill,” Likosky says. “The one thing Republicans and Democrats agree on is public-private partnerships. If you survey the country from sea to shining sea, as I do for clients, you see a lot of investible infrastructure opportunities. It’s no longer a question of whether projects are out there, it’s about knowing where to look, and I think we’re going to see a lot more money for infrastructure P3s, from a federal perspective, than we have in the past,” he predicts. Likosky believes this extends beyond transportation and water to social infrastructure. There has been controversy around social infrastructure P3 projects, which has made it hard to develop in the United States. “But there is starting to be consensus, both in Congress and in the states, to do social infrastructure. I think we’re going to see a lot more social infrastructure projects,” Likosky explains. “There’s no reason that the same processes and ideas that have been used for transportation P3 projects couldn’t be expanded to other areas such as water, schools and courthouses,” says Steve Park, an attorney with Ballard Spahr in Philadelphia and an expert on public-private infrastructure financing and legalities. Park says social infrastructure projects are becoming more prevalent. “After the success of the Long Beach Courthouse project, more and more state and local governments are open to using the P3 model as a tool in financing much needed infrastructure,” Park says. Fred Kessler, an attorney specializing in P3 infrastructure deals for Nossaman LLP in Los Angeles, adds, “Most recently, the City of Indianapolis is pursuing a new justice complex using an availability payment P3 model, and the University of California is pursuing a $1 billion expansion of its Merced campus via a P3 procurement.” Despite the encouraging signs that the markets for private investment in water and social infrastructure in the United States are poised for growth, to date there remains only a relative trickle of activity, and until more deals are closed, many in the market advise cautious optimism. realAssets Adviser | december 2014
Educate both sides Even with stronger federal support and even with the creation of regional exchanges, there still remains a huge lack of awareness about what P3s are and when projects may be good candidates for them. “The one persistent, overarching obstacle to more successful use of P3s is the education of elected and nonelected officials,” Kessler says. The West Coast Infrastructure Exchange is taking steps to educate both public officials and private investors. “There’s a huge awareness gap,” Taylor says. “A lot of unsuccessful deals happened because people didn’t have a clear picture of what they were trying to do and how to get there.” Taylor is a proponent of the DesignBuild-Finance-Maintain (DBFM) approach to P3 deals. In these deals, the private sector is incentivized to design a project that will be lowest cost over its entire life cycle, not just the lowest cost to build. “That’s one of the criteria for a successful P3,” Taylor says. “If it’s all just a cost of capital game, you don’t really need a full DBFM to achieve efficiency. But if there are significant operational costs and risks that can be managed more effectively by private partners, that’s when the model can deliver the most value.” Taylor says it is wrong to just focus on the building costs. “We shouldn’t be building things we’re not prepared to main-
That is one of the key benefits of a longterm DBFM contract: You guarantee that maintenance gets done, because the private side has to meet detailed performance specifications during the operational period. Plus, at the back end of the contract, the private investor has to return the project to the public sector in a good state of repair. “They can’t just blow off the maintenance,” Taylor says. And if public agencies question how private equity investors can deliver enough value to justify the higher IRR they are seeking, Taylor answers that the private side has to take risks, has to be innovative and has to guarantee outcomes. “To me, that is what can justify paying a higher rate of return for the private capital invested,” Taylor says. Build a floor The other side of the equation is the public sector can also “de-risk” deals so that the rate of return demanded by private investors does not appear to be outsized. If investors are given a floor return, the investment takes on a fixed-income component, in contrast to a toll road deal based entirely on toll revenue projections that could prove completely wrong. Investors in such deals can, and indeed have, lost their entire investments. In that type of arrangement — a private equity deal — investors are going to want a traditional privateequity level of return.
… to date there remains only a relative trickle of activity, and until more deals are closed, many in the market advise cautious optimism. tain — that’s part of the reason we’re in the mess we’re in,” he says. “Elected officials decided to build stuff and then didn’t appropriate money to maintain it because it’s much more exciting to cut a ribbon on a new shiny project than do routine maintenance. Then we end up with a huge backlog of deferred maintenance which leads to decaying infrastructure.”
Taylor aims for a middle ground between the two extremes: The real opportunity in the U.S. is for deals that provide some assurance to the investor that they are not going to get wiped out due to circumstances beyond their control, but also assure the public that the investors aren’t going to end up earning a 30 percent IRR “on the back of Grandma Millie,” he says.
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Such an approach does commit future government money, whether public priorities 20 years from now have changed or not. But Taylor believes we shouldn’t be building things we’re not prepared to budget to maintain. Numerous studies have found that for every dollar we fail to spend on preventative maintenance, we create a future need for at least $2 of deferred maintenance. “The best analogy is not fixing a leak in the roof of your house”, says Taylor, “the ultimate cost to repair the damage that creates is a multiple of what it would have cost to simply repair the leak when it started.” “The whole point of this kind of procurement is to lock in costs and incentivize the private sector to minimize those costs because they’re only going to win the bid if their all-in 30 year price is lower,” Taylor says. You say TIFIA, I say WIFIA With new water legislation signed into law, the sector looks poised to become the next
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big area of P3 infrastructure investments, but that is by no means guaranteed. “The hope is that WIFIA becomes for water what TIFIA has been for transportation,” Ballard Spahr’s Park says. “That said, it’s unclear it will be.” The main reason for this uncertainty is that no one knows yet what types of projects the WIFIA loans will be used for. It is also unclear what types of borrowers will be lining up for WIFIA loans. “It’s possible that the only borrowers for the loans will be municipal water authorities borrowing money to fix their existing systems,” Park says. That would not be bad, but it would not be the big private investment catalyst that many want it to be. “At this point, we have to wait and see what the guidelines will look like, what the process will be, and who the first few applicants and projects are going to be,” Park concludes. Nossaman’s Kessler also is cautious. “A problem with WIFIA, unlike TIFIA, is that it bars use of tax-exempt financing, including private activity bonds, if the project uses WIFIA financing,” he says. “We’ll have to see whether projects pencil better using private investment and WIFIA financing or sticking with traditional tax-exempt financing mechanisms, but it would certainly help if Congress allowed both financing tools on the same project just like TIFIA does,” Kessler says. Others are more optimistic about WIFIA’s promise. According to M3 Capital Partners’ Wilson, because WIFIA is aimed at relatively large water projects, with support limited to 49 percent of the project cost — with the balance required to come from private/taxable sources — the legislation can serve as an important catalyst for private investment in the water sector. He notes that many water and wastewater infrastructure projects are generally carried out at the local level. Therefore, he believes, any effort to increase water infrastructure P3s should seek to enhance the ability of local officials and their staffs to effectively solicit, review and approve such projects.
Indeed, the West Coast Infrastructure Exchange has recently selected water infrastructure to be its main area of focus. “We have been consulting with a work group of experts from the public and private sectors to develop screening criteria for identifying water and wastewater projects that have the potential for aggregation into larger investable structures, such as Design-BuildFinance-Maintain or concession agreements,” Taylor says. From P3 to P4 WIFIA also presents an opportunity for a “P4” structure — with both federal and local government entities included as public partners, Wilson points out, that such an approach offers the best of both worlds to municipalities, by combining low-cost federal debt financing with private equity investment that is ‘at risk’ for project performance, while still maintaining ownership at the local level. “With the efforts of these public sector– sponsored exchanges, combined with lowcost funding and federal support through the WIFIA program, the success of transportation projects should increasingly be expanded into the U.S. water sector,” Wilson concludes. Likosky concurs. “Water needs are much more spread across the country, so the WIFIA program may have a broader group of users, in terms of cities and states, than does TIFIA,” he says. It should not take long to find out. “I think WIFIA will blossom quickly because there are so many water projects that need to be done,” Likosky says. But whether those projects will include robust private investment has yet to be determined. Mard Naman is a freelance writer based in Santa Cruz, Calif.
realAssets Adviser | december 2014
Real Estate Investors Summit March 30-31, 2015 / Miami Beach, Florida
Network with the industry's leading experts as they analyze the opportunities and challenges in the real estate market! This real estate investors conference will focus on the latest developments in the marketplace. It will analyze the opportunities and challenges in the real estate market; examine best practices and explore new deal making strategies. Sponsorship and Exhibiting Opportunities are Available If you are interested in attending, sponsoring, speaking or exhibiting at this event, please call 212-532-9898 or email info@opalgroup.net
Register To register, visit us online at www.opalgroup.net or email us at marketing@opalgroup.net ref code: REISA1503
Opal Financial Group Your Link to Investment Education
By Doug Bartholomew
A somewhat bright outlook for the solar industry is clouded by few viable investment options.
F
or those unwilling to accept the risk associated with buying a single company’s shares, the primary selections on the menu are a couple of exchange-traded funds (ETFs) that track solar indexes, and a recently issued corporate bond. Nonetheless, even the ETFs — occasionally buffeted by energy prices as well as the price of photovoltaic (PV) cells — pose plenty of volatility. In recent decades, the chief means for consumers looking to invest in solar has been to install an array of solar photovoltaic collectors on the roof of their home. The cost, which easily can run into the tens of thousands of dollars, includes the associated electronic controls and metering equipment needed to store the energy and return any unused excess power to the grid for a rebate from the local utility.
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Although there are a number of “green” funds or “alternative energy” mutual funds, these tend to invest in companies that make a broad array of environmentally friendly, energy-saving technologies or other non-polluting products such as electric cars. Alternative energy mutual funds typically carry a limited weighting in solar stocks, sometimes 10 percent or less, with shares of energy efficiency, electric cars, windpower, hydroelectric and geothermal energy companies comprising the bulk of their assets. While these “green” funds may provide investors with greater diversification, since they invest in a variety of environmentally friendly technologies and solutions, at the same time investors lose the “pure solar” focus in the mix.
realAssets Adviser | december 2014
Why invest in solar power? The rationale for investing in solar energy generally includes at least three common tenets: • Clean solar promotes energy security, public health and a cleaner, safer environment; • Solar energy offers a long-term solution to the world’s energy needs, with zero pollution, free fuel and near-zero operational risk; and • Solar energy holds the promise of a distributed, as opposed to centrally generated, electricity source. The other alternative — stock-picking a solar energy producing company or solar product manufacturing stock — in the view of some, may be a riskier tack than stock-picking companies in other, more established industries. “For the average investor, shares of solar manufacturers are very volatile and risky,” says Morningstar senior equity analyst Stephen Simko. Adds Steve Schueth, president of First Affirmative Financial Network LLC, a registered investment adviser in Colorado Springs, Colo., “We would never recommend any client to just invest in any one company or one sector.” For proof of the volatility of the solar energy sector, just a quick look at the gyrations of the MAC Solar Index over the last couple of years should suffice. A leading solar energy sector barometer, the MAC Solar Index was down 5 percent for the year as of mid-October, having surrendered some of the 127 percent gain it posted in 2013. The index had staged a new seven-month high in September, but fell sharply the following month. Still, solar stocks remain up sharply from the lows they suffered in late 2012. One reason for the robust prices for solar shares overall is the strengthening of global demand for solar panels over the past year.
Exchange-traded funds The MAC Solar Index is tracked by the Guggenheim Solar ETF, an exchange-traded fund listed on NYSE Arca with the symbol TAN. As of late October, the ETF had assets of about $344 million. A competing solar energy exchange-traded fund, the Market Vectors Solar Energy ETF (NYSE Arca: KWT), distributed by Van Eck Securities, tracks another index, the Ardour Solar Energy Index (SOLRS). “We were first to market with the launch of the Guggenheim Solar ETF in April 2008,” says Bill Belden, managing director at Guggenheim Investments. “Why there are not other solar-specific investment products available in the market, we can only speculate, but one reason may be that it’s a volatile market. Maybe other firms are challenged by the volatility of that space.” Most investors in the Guggenheim Solar ETF access the fund through financial advisers, although investors can purchase it through any brokerage account. In general, most solar ETF investors already understand what they are getting into, and aren’t fazed by solar’s volatility. Adds Belden, “Given the volatility of the product, we certainly attract more of the tactical investors.” Regardless of the sector’s volatility, solar energy ETFs offer investors certain advantages. “The advantage of the ETF is that you get diversification and global coverage,” says Richard Asplund, research director of the MAC Solar Index in Chicago. Commitment to change Investors in solar generally are totally committed to doing something to bring about a positive
Given the volatility of the product, we certainly attract more of the tactical investors.
realAssets Adviser | december 2014
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change in the environment and who believe solar energy is the future. “These are investors who are willing to put their money to work to create a truly sustainable future,” notes Schueth. “They want to make a difference while, at the same time, making some money through their investment.” Part of the reason for the volatility is the fund’s concentration of assets in a few big solar enterprises. As Belden points out, the top five company names in the MAC Solar Index — First Solar Inc., Sun Edison, GCL-Poly Energy Holdings Ltd., Hanergy Solar Group Ltd., and Solarcity Corp. — make up more than 40 percent of the index. Among other criteria, to be eligible for inclusion in the index, companies must derive at least one-third of their revenues from solar energy–related sales. Not surprisingly, with an industry that is still maturing, the company names that comprise an index may be in flux depending on market shifts as well as other factors. For example, the MAC Solar Index in September added a pair of “YieldCos” to the index, embracing a trend in the industry toward capitalizing on guaranteed revenue streams, similar to infrastructure investments. “The revenue stream for solar power plants is fixed, so the only variables would be weather conditions and the reliability of the installed solar devices,” says Simko. “It’s a pretty low-risk investment, a decent way to get a fixed income.” YieldCos generally own solar electric generating facilities and receive a relatively stable revenue stream from a larger utility in their area. The revenue stream often is backed by long-term agreements to purchase power. Once the solar infrastructure is built and in place, the YieldCo typically has minimal operating costs and distributes the bulk of its cash flow to shareholders. YieldCos can benefit from clean energy tax credits and accelerated depreciation, making them attractive to investors seeking low risk and steady, reliable yields.
There is so much more money that is finding its way into solar projects. The MAC Solar Index added TerraForm Power (TERP), a spinoff from SunEdison (SUNE), and Abengoa Yield (ABY). By incorporating these com-
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panies in its composition, the MAC Solar Index may be able to dampen volatility somewhat. According to a report on the Mac Solar Index site www.macsolarindex.com, “YieldCos add a lower beta yield component to a stock index, thus dampening the volatility of the index while boosting its overall dividend yield.” For investors with less appetite for volatility, the green or alternative energy funds may offer greater diversification. Of course, this comes at the expense of losing the “pure solar” refinement of the fund. “If a green fund has solar, wind and water companies, it will offer a more diverse set of energy sources,” Belden observes. “You can see how these companies would move at different paces or rhythms relative to each other. There could be the opportunity for less volatility if you invest in something that was green versus pure solar.” A pure play Perhaps the most interesting “pure play” solar investment to come to market recently was Solarcity’s Solar Bonds offering launched in midOctober. These registered corporate bonds issued by Solarcity carry interest payments paid from income derived from the company’s thousands of solar customers around the U.S. who have Solarcity’s systems on their roofs at residential, commercial and government buildings. The company has a huge installed base of customers representing one-third of all U.S. solar power installations. “We specifically designed the bonds so it would be easy for anyone to invest in,” says Tim Newell, Solarcity vice president for financial products. In keeping with that goal, the company priced the bonds with a minimum investment of $1,000 and makes them available online. “People can purchase the bonds online and we do not charge any investment fee,” Newell adds. The bonds have varying maturities and interest rates ranging from a sevenyear bond paying 4 percent to a one-year bond at 2 percent. Nor is Solarcity necessarily done flexing its solar financing muscle. The company needs capital to fund its rapid growth, Newell says, indicating that more financial products may be on the way. “Many investors depend upon their financial advisers, and we are working on some additional investment products that respond to the needs of wealth and investment managers.” Those in the industry view Solarcity’s initial bond offering as a bullish step. “I think Solarcity’s Solar realAssets Adviser | december 2014
Bonds are evidence of an increasing sophistication in the market,” Belden says. “Solarcity’s new product is attracting attention and a lot of investor capital,” adds Schueth of First Affirmative Financial. “There is so much more money that is now finding its way into solar projects. And these aren’t only the companies that produce solar energy and make solar collectors, but also those companies that make and sell the metering that counts the kilowatts and sells the energy back to the utility.” Separately managed account To be sure, there are other pure solar plays, but they tend to be few and far between, and may require a steep ante to get in the game. For instance, Green Alpha Advisors, an investment firm in Boulder, Colo., offers well-heeled individual investors the opportunity to invest in its separately managed account called the Green Alpha Select Solar Portfolio. With a $50,000 minimum investment, investors can participate in this fund containing Green Alpha Advisors LLC’s 25 solar company picks. “We’ve got our best 25 ideas in solar in there,” says Garvin Jabusch, co-founder and chief investment officer at Green Alpha. “We’d like to convert it to a mutual fund, and if there is enough interest we may do that,” he adds. The company currently has a listed mutual fund, the Shelton Green Alpha Fund (NEXTX) that includes a basket of both solar and other companies active in renewable energy or other sustainable economy enterprises. “I agree that solar is the next energy source for civilization, and we believe realAssets Adviser | december 2014
in renewable energy. We keep a pretty decent weight of what we believe in the fund.” Industry size a hindrance Relative to other industries, the small size of the solar energy sector may be the biggest factor limiting the number of investment vehicles for individuals seeking to make a pure play with an investment in solar. “It’s still a really small industry,” says Simko of Morningstar. He points out that the largest U.S.-traded solar company names have a total market capitalization of $25 billion to $30 billion, while some individual oil and gas companies have a bigger market cap. Despite this limitation, the outlook for solar investing appears bright over the long term. More investment options are expected to become available as the industry further matures. “Certainly the solar energy industry is maturing,” says Belden of Guggenheim. “As the industry matures, we will tend to see a broader set of investors. In the future, it’s not unreasonable to expect more solar investments.” Similarly, prospects for solar energy over the long haul also appear bullish, judging from the findings of the International Energy Agency. In September, the agency released a roadmap delineating solar’s future, projecting that the capture of the sun’s energy for power will become the world’s largest power source by 2050. Maybe by then, solar energy won’t be considered a young industry anymore. Doug Bartholomew is a freelance writer based in San Francisco.
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The new Salesforce Tower, now under construction in downtown San Francisco, will dramatically change the shape of the city’s already iconic skyline. (photo courtesy of Boston Properties)
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Optimizing a PE Real Assets Program Why experienced pros are needed for private equity real assets portfolios.
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private equity investment program in real assets can help investors diversify their portfolios, generate yield, provide inflation protection and offer the opportunity to earn above-average returns. But investing in real assets is a significant undertaking. Many investors lack the resources to identify the most attractive opportunities, adequately conduct due diligence and manage complex portfolios. To meet their investment objectives, investors must construct and manage high-quality portfolios, yet the risk of picking bad investments is significant. According to The Burgiss Group LLC, the median net return for private real estate and natural resources funds from 1987 to 2010 was a low 5.6 percent and 7.7 percent, respectively (as of Dec.
Real assets investing is not just about putting capital to work. 31, 2013). Investors must find managers who can consistently perform above the median simply to justify an investment in the asset class. Real assets investing is not just about putting capital to work; it is about finding the most attractive opportunities and spreading potential risk and return among different vintage years, product
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types, commodities and geographies. To do so effectively, investors must determine the best strategy for successful implementation. IN-HOUSE STAFF Investors who want to keep full control may choose to self-implement their program. It is challenging and expensive to hire and retain talented investment professionals who are current on trends, managers and markets. Valuable context is frequently lost when a member of the team departs, leaving the program in the lurch and forcing an investor to start over in terms of sourcing opportunities and monitoring current investments. Investors may try to get around the staffing problem by investing in a limited number of large, diversified funds. Such a program provides fewer managers to monitor, but also introduces idiosyncratic manager risk to the portfolio. In a concentrated portfolio, poorly performing funds could be the difference between hitting a return target and missing it entirely. GENERALIST CONSULTANT Some investors choose to work with a generalist consultant. Consultants can provide broad investment advice, but often are not able to fully dedicate sufficient time and resources to real assets. Consultants with multiple clients often present managers for consideration in which the consultant
By Jennifer Garrison
can get access for all of their clients — not necessarily the best-performing capacity constrained managers. REAL ASSETS SPECIALIST With limited resources, many investors are turning to a real assets specialist with a deep knowledge of real assets markets, managers and macroeconomic trends. Specialists bring experience in helping investors develop complex private real assets portfolios while simplifying the implementation and management of the program. Specialist investors have the context to determine how each manager compares to hundreds of others, as well as how different strategies, geographies and/or markets perform during different economic environments. Specialists provide due diligence experts who understand each sub-asset class and can thoroughly and thoughtfully evaluate managers. By employing both dedicated real assets investment professionals and back-office personnel with experience in administering private investments, the burden of managing real assets investments is removed, providing investors with more time to focus on other areas of the portfolio. One thing is clear, deep expertise is needed to generate expected returns. Jennifer Garrison is partner, investor relations and marketing of Verdis Investment Management, a privately held investment management firm. realAssets Adviser | december December 2014
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