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Why Management Is The Most Important Thing When It Comes to REITs 

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I writing a topical email every week to my mailing list. Here’s our last email to subscribers which I thought I share.

You can sign up on our mailing list to get the latest updates when it goes out every week.


 

I’ve just finished a short two-week stint on an executive program at Cambridge for real estate.

I head back every couple of months to keep up to date with the latest happenings of the industry and to learn from the expertise of other real estate professionals.

Plenty of posts upcoming that will cover some of the key learning points which I think are relevant to investors are on the way.

I’ve been talking a lot about bonds and Hyflux over the last few months so I thought I talk about the REIT market. S-REITs in aggregate have delivered robust performance over the last year or so… and yet the long term performance of some REITs have significantly diverged.

That brings me to a key takeaway that a property manager shared – “The biggest risk is not in the asset, but the manager.”

I cannot agree more.

Examining the long term track record of the REITs will give you tremendous insight into managers that deliver value to shareholders over the long run by focusing on the right metrics and delivering superior long term returns to unitholders for both capital gains and distribution growth.

Let me dig deeper into this on multiple levels. Buffett once remarked that when looking to hire, he looks for three things:

1) Integrity
2) Intelligence
3) Energy

Integrity to me is a clear alignment of interest with unitholders.

There is plenty of leeway when valuing assets and justifying acquisitions (a post for another day) and you want management to be acting in a way that is consistent with your own interests.

Intelligence and energy are things that people think less about when it comes to REITs as there is a natural tendency to focus on the asset itself. To me, it is as essential for two major reasons.

Firstly, there have been real shifts in the real estate industry in the last few years, with much more on the way.   The way we live, shop and work are changing dramatically, and that is leading to considerable changes in the use of traditional properties.

Traditional leasing structures in offices have been up-ended by co-working spaces (WeWork, JustCo and more). Retail shopping has been altered dramatically with the rise in popularity of smartphones, online shopping and logistics.

I think the contrast between the old Holland Village Shopping Centre which is strata owned, and the new Raffles Medical  Centre Holland V provide a pretty good example.

On the one side, you have tenants like Virgin Gym and DBS driving foot traffic into the mall.

On the other side, you have a very lacklustre retail offering which looks incredibly dated and is unlikely to change soon given the problems with ownership.

Real estate is becoming far more management intensive and the quality of management matters. That being said, the best and brightest are naturally attracted to work for the best, and it is impossible to attract good talent if you work for a lacklustre organisation.

Secondly – the quality of management is essential in investing through the cycle.

There is a consensus among a large part of the industry that we are at the tail end of the property cycle. I don’t have a strong opinion on this but is what is exceedingly clear is that property moves in cycles and that all cycles must eventually end.

It is very easy to look like a genius on the way up when you’re highly leveraged… but the result of each bust is the same. Plenty of people go out of business, and vast amounts of capital are lost.

Being able to withstand the turning of the cycle and being able to exploit it as the market goes south is the key to delivering sustainable long term performance. My experience with investors in REITs is that in contrast to stocks, many are long term investors.

The last three years has already claimed many casualties both within the real estate industry and outside it as an era of hyper-low interest rates and easily moderated somewhat.

On the other hand, you can see the resilience of quality management who have been prudent in managing their exposure proactively.

Ending thoughts:

Many of the fundamental principles that apply to equities are equally important when it comes to analysing REITs.

While it may be attractive to look at simple metrics like price to book ratios, distribution yield and gearing ratios, the truth is far more complicated than reality. Assessing management over long periods is as important (if not more) when it comes to investing in REITs.

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