Third Avenue Real Estate Value Fund – April 2020
Current market uncertainty is a timely reminder of how to invest prudently in this well-established asset class.
Amidst the onset of the Covid-19 pandemic, the most recent quarter was undoubtedly one of the most volatile periods for global real estate securities in the past decade. Yet investors can also view this positively.
Why is that? Firstly, we believe a focus on very well-capitalized property companies leaves portfolio holdings well-placed in turbulent times like today. Secondly, periods of market dislocation have historically provided opportunities to establish positions in high quality real estate franchises at below-market value prices.
Where next for investors from here? We expect to see four trends accelerating in the real estate space over the medium-term:
- Access to capital will be paramount
- A further bifurcation between property types – pressure is unlikely to abate for retail real estate that doesn’t offer a value or convenience proposition. This will likely work to the benefit of logistic facilities that support e-commerce activities.
- Cap Rates (or initial yields) for institutional-quality real estate are likely to decline further – the implied cap rates for highly-leased and generally very-stable cash flow property types (such as class-A office, self-storage, and multi-family properties) have increased in the public markets to levels that represent 6-11% cap rates—or nearly 5-10% premiums to “risk free” rates. This is a historically wide level and one that is unlikely to persist in duration for well-located assets with inherent inflation protection.
- There will be an even greater emphasis on one’s home
How have we responded? With these views in mind, Fund Management has actively recycled capital from issuers where the wealth-creation potential seems more uncertain to the common stock of enterprises that seem to have a more favorable risk-adjusted return profile over the long-term. As a result, the current positioning for the Third Avenue Real Estate Value Fund includes an allocation to:
52% Commercial Real Estate
31% Residential Real Estate
13% Real Estate Services
4% Cash & Debt Securities
Further, entering the second quarter of 2020, the Fund is largely comprised of common stocks representing ownership positions in some of the most well-capitalized and strategic real estate enterprises globally. It is also nearly “fully-invested” for the first time since the beginning of 2016.
What is driving our real estate positioning? Similar to early 2016, the near term outlook is undoubtedly bleak, but the securities of these high-quality issuers can be purchased at material discounts to what a control-buyer would likely pay for these hard-to replicate portfolios and franchises in a negotiated transaction. In fact, as of March 31, 2020, the Fund’s holdings traded at more than a 30% discount to our conservative estimates of Net-Asset Value (when viewed in the aggregate). This disconnect seems substantial and has only been exceeded in one other period in recent time: the Global Financial Crisis of 2008-2009.
At Third Avenue, we have long believed that it is nearly impossible to “pick a bottom” but that a well-financed, well-managed company can withstand a difficult environment—and that the price of its securities will eventually reflect its intrinsic value (either through public market recognition or a private market transaction). Moreover, the larger the discount at which a security can be purchased from its Net-Asset Value, the more compelling is one’s basis, and the greater the capital appreciation potential. For this reason, Fund Management has recently added to its personal investment in the Fund and believes other like-minded and long-term investors should also consider the opportunity.
Stay Safe and have a relaxing week…..
Ryan Dobratz
Portfolio Manager
Third Avenue Real Estate Value Fund