This commentary is part of our September Special Report on Real Estate in Canada and around the world. To see all the articles so far, click here.
Real estate is a key pillar in most alternatives portfolios, and at the Foster Family Office Group, we’re no different. At any given time, we will have exposure to real estate lending funds, private real estate, private real estate investment trusts and sometimes public REITs.
Considering these are hardly normal times in real estate, let me share with you a few things we’re thinking about right now that may help guide your own real estate decision-making.
Think about whom you are in bed with
Usually, when evaluating an allocation, one tends to focus on the target investment. That makes sense. But in today’s real estate market—especially in private real estate investment trusts—it’s worth thinking about whom you are investing alongside. Who they are, how they were sold to, and what their risk appetite is will all impact their behaviour during times of trouble.
One thing to watch out for is a REIT that’s largely reliant on the Exempt Market Dealer (EMD) channel for subscriptions. This channel tends to provide a large number of small-ticket purchases, driven by hefty sales commissions and trailer fees, and sold to sometimes less-sophisticated investors. It’s true that having a diversified investor base is a good thing, but maintaining this sales funnel isn’t cheap, and it speaks volumes that bigger institutional and family office investors may have given the REIT a pass.
Focus on valuation policies
The way private REITs assess the value of their buildings varies widely from REIT to REIT. Frequent is better than infrequent, external valuations are better than internal, having both is better than one, and even better is a rotating regime of internal and external valuators. Do not underestimate the pressure that must be felt by internal valuation teams at these private REITs, in the absence of the regulatory oversight of a publicly listed REIT.
The street is littered with the corpses of funds that had the audacity to mark down their NAV, only to see the floodgates of redemptions open.
Christopher Foster
One private REIT we looked at claims to have never had a down year (even in 2020) since they started up over 15 years ago, and their performance chart is an almost-straight diagonal line across the page. Perhaps they’re gifted.
The spoiled investor
If you notice that the REIT or the real estate lending fund you’re invested in never marks down their net asset value (NAV), be nervous. It’s not necessarily that there is any fraud going on, but their investors could have become enraptured by the apparent stability in the NAV and could react badly to any small markdown.
The street is littered with the corpses of funds that had the audacity to mark down their NAV, only to see the floodgates of redemptions open. What can happen then is all bad. They may lose assets quickly, hurting the viability of their business. Then, unless they can quickly liquidate assets or dip into a credit line, they may also have to gate the fund or curtail redemption privileges, which can prompt even more investors to head to the exits.
Love the losses
Nobody likes to lose money, but seeing downticks in your NAV can be a good thing. One real estate lender we have some money with has a fierce valuation policy. Is the interest payment late? If yes, the loan gets marked down. Right away. Often, it gets marked right back up again the next month, after the loan gets current, but this can be happening over multiple loans in the fund at the same time, creating a choppy monthly NAV.
Of course, all this drama may be more excitement than you’re looking for. But if you want something that reflects reality, you should get used to a messy NAV. If, on the other hand, you’re looking for a guaranteed yield and perfect price stability, you may want to consider GICs.
Christopher Foster is the Chief Executive Officer and Portfolio Manager at Foster & Associates and the founding client of the firm’s Family Office Group.
The Canadian Family Offices newsletter comes out on Sundays and Wednesdays. If you are interested in stories about Canadian enterprising families, family offices and the professionals who work with them, but like your content aggregated, you can sign up for our free newsletter here.
Please visit here to see information about our standards of journalistic excellence.