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Episode #96: Craig Leupold & Jim Sullivan, “From a Commercial Property Standpoint, We See Values Drifting Sideways Over the Next 12 Months”

Episode #96: “From a Commercial Property Standpoint, We See Values Drifting Sideways Over the Next 12 Months”


Guest: Craig Leupold and Jim Sullivan. Craig is Chief Executive Officer of Green Street Advisors, a preeminent independent research and advisory firm concentrating on the commercial real estate industry in North America and Europe. The company is a leading provider of real estate analytics, research, and data on both the listed and private markets. As CEO, Craig explores strategic opportunities to support the firm’s growth and brings best practices to all business lines. Prior to his role as CEO, Craig was President of Green Street for nine years, when he served as the primary liaison to the investment community and oversaw the firm’s client relationships and interactions.

Jim is President of Green Street’s Advisory Group, which provides strategic advice to commercial real estate owners and investors located in the U.S. and around the globe. He has managed the Group since 2014. Jim joined Green Street in 1994. During the subsequent 20 years, he was Green Street’s lead research analyst covering REITs in a variety of property sectors including office, industrial, malls, strip centers, self-storage, health care and manufactured housing.

Date Recorded: 2/27/18

Run-Time: 49:45

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Summary: In Episode 96, we welcome two of the brightest guys in real estate, Craig Leupold and Jim Sullivan of Green Street.

After touching on Craig’s and Jim’s backgrounds, the guys jump into real estate, with Meb asking about Green Street’s approach to the real estate markets (public and private) and how they think about valuation.

Craig gives us an overview, referencing Green Street’s REIT research (focusing on the public markets), their real estate analytics (focusing on private markets), and their advisory consulting group. Craig touches upon lots of ideas – understanding the value of the properties owned by the various companies… identifying the associated premiums or discounts at which the companies might be trading… a deeper dive into their real estate analytics lineup… looking at how to allocate capital…

Meb asks how the real estate world looks today, and what’s the outlook for 2018. Craig tells us that with the exception of retail real estate, most sectors are seeing increases in rents and occupancies. But fundamentals have moved from “great,” to “good,” to now, “okay.” He goes on to give us his growth forecast over the next four years, as well as what he expects for commercial pricing over the next 12 months.

When Meb brings up “returns,” the guys make the distinction between public and private markets and how there’s a divergence. Private real estate is generally fairly valued today, yet in the public market, REITs are trading at an 11% discount to their unleveraged asset value.

Jim dives into greater detail on this topic, telling us how the average REIT should trade at a modest premium to NAV. The reason for this is that an investor should be willing to pay the fair market value for the property owned by the REIT, but then there’s the added benefit of the management team and the liquidity of the REIT structure; both deserve a premium. But again, today, we’re not seeing this premium today – quite the opposite, in fact.

Meb brings up valuation, asking about how to distinguish between buying opportunities and value traps. Jim tells us it’s situational, and depends on the property type. This dovetails into a discussion about pessimism in the mall sector.

Soon, the conversation turns toward rising rates. The common opinion is that rising rates are bad for real estate, but Jim tells us it’s more complicated than that. If rates are rising due to our economy accelerating, then that could be positive for commercial real estate, leading to higher occupancies and rising rents.

There’s far more in this episode: activism in the real estate space… how the real estate market looks around the world… the challenge of figuring out what risk-adjusted returns should be in different global locations… which geographies look particularly attractive today… farmland REITs… and Craig’s and Jim’s one piece of advice to investors looking to allocate to the REIT space.

All this, as well and Craig’s and Jim’s most memorable trades, in Episode 96.

Special Announcement for Meb Faber Show listeners: Green Street just launched Atlas, an interactive mapping and analytics platform to help investors easily compare and underwrite commercial real estate investments across geographies and property sectors. To learn more, watch a 2-min. video, or schedule a demo, click here.

Links from the Episode:

  • 00:50 (First question) – Introduction and how both got involved with Green Street
  • 5:21 – The Green Street approach to Real Estate investment and valuation
  • 9:06 – The 2018 outlook for the real estate world
  • 9:15 – “REITs on the Rebound: Where to Shop Now” – Barron’s
  • 13:18 – Closing the gap between public and private market pricing
  • 18:44 – Are the premiums in REIT subsectors warranted or does it create an opportunity
  • 21:53 – Their thoughts on highly leveraged companies
  • 23:48 – Real estate trends that should be on everyone’s radar
  • 25:28 – Activism in the REIT space
  • 28:22 – How is the global real estate market looking
  • 31:35 – Any countries that are particularly attractive
  • 34:50 – Why haven’t we seen more farmland REITs in the US?
  • 37:03 – Twitter Questions – Has indexing had a major impact on the REIT market
  • 40:17 – Advice for average investors to help avoid mistakes in the REIT market
  • 43:33 – Most memorable investment
  • 48:40 – How do people connect with Craig and Jim – Green Street’s website
  • For more information, sign up for email alerts, or follow Green Street on Twitter, and LinkedIn

Transcript of Episode 96:

Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the Co-Founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: Welcome, podcast listeners. Today, we have a special show with you with not one but two guests. They’re coming to us from one of the most respected real estate research shops in the world founded in 1985 with over 40 analysts covering over 100 real estate companies. Their buy REX have done over 20% annually since 1993, which is double all the companies in our universe and 1% for their sells. If you’re real estate REIT investor, this episode is for you. So we are thrilled to welcome both the CEO and the President of Green Street Advisors, Craig Leupold and Jim Sullivan. Guys, thanks for joining us.

Craig: Thank you.

Jim: Thanks for having us.

Meb: So before we dive in to all things real estate related, let’s start with you two guys. Maybe give us a couple minute intro on your background, how you guys joined or started at Green Street, and we’d love to hear from both of you.

Craig: Sure, this is Craig Leupold. I’m the CEO of Green Street. I have been involved in the commercial real estate industry for over 30 years, starting out my career as a commercial real estate banker, funding development loans in Southern California primarily, as well as Arizona and Northern California. And from there, went back to business school at Columbia Business School. And when I was coming out looking for my next opportunity within commercial real estate, I landed at a advisory and consulting firm called Kenneth Leventhal and Company that was located at Newport Beach, California.

But as part of my business school training in real estate, I was exposed to a firm called Green Street Advisors and Green Street had work on an IPO engagement with Kimco Property Company. And Kimco was an IPO that came out in November of 1991, and it really set the stage for what we’ll call, sort of, the new wave of REITs. And from that moment on, we saw a tremendous number of companies come to the public market. And as part of a business school case, I was working on the Kimco offering, and because Green Street had done some work with Kimco that’s how I got to become familiar with Green Street. And when I relocated here to Newport Beach, California at the business school, I was first working with Kenneth Leventhal and Company, I was working on some REIT formation engagements.

And Mike Kirby, one of the Co-Founders of Green Street, reached out to me and asked me if I’d be interested in coming onboard and joining them and that’s what I did. So I joined Green Street in 1993. So coming up on my 25th year anniversary here. So my time here at Green Street is spent doing a variety of things. I was the first analyst to have sector coverage covering the residential sector here at Green Street which includes apartments and manufactured housing, and student housing companies. And then, in 2007, became the president of Green Street and now serving as the CEO. So I’ll pass it over to Jim and let him give you a little bit of his background.

Jim: Thanks, Craig. Jim Sullivan, and I’m the President of Advisory and Consultant Group at Green Street. I’ve been with Green Street now for 24 years. For 20 of my 24 years, I was onhe research side of our shop. So I was our analyst, leading our coverage of the REITs that specialize in malls and healthcare, and office, and industrial, self-storage, manufactured housing. You name it, I did that. Many years for four years, 2010 through 2014, I was the Head of our of our North American Research Group. So that was 30 analyst covering different markets around North America.

And then four years ago, took over the leadership of our Advisory and Consulting Group, which is a group that helps investors and owners of real estate answer challenging question. For example, “We’re private real estate company, should we go public?” Or a giant retailer that owns a lot of real estate, “What should we do with it? How do we monetize the value of that?” Macy’s and McDonalds are two examples of retailers that we’ve worked with trying to answer those questions.

“We work with foreign investors who are looking to invest their capital in the United States, where should we invest, New York or Los Angeles? If we’re gonna invest in Los Angeles, should we be buying apartment buildings or office buildings or warehouse properties today?” So that’s what we do in the advisory group. And for a few years prior to getting to Green Street, I learned the real estate business as a real estate construction lender and as an investment banker.

Meb: Very cool, guys. Thank you for that. Why don’t we get started with just, kind of, the general Green Street approach to real estate analysis and valuation, in general. I’m happy to kick that to Craig, maybe let you start, and, Jim, feel free to chime in as well. But why don’t you tell us a little bit about your framework for how you guys think about real estate in general and valuation, too?

Craig: Sure, happy to do so. I think, you know, first, I think it’s important to state that, you know, Green Street’s an independent firm ,so meaning we’re not affiliated with any investment banking or real estate brokerage activity. So I think that allows us to provide trusted insights and unbiased advice to our client. So, you know, simply state our goals to any of our clients to make the best capital allocation decisions possible, whether that be within the public real estate market or the private real estate market.

You know, we have three primary product offerings. Our research which covers the publicly traded real estate companies or real estate investment trust, and includes coverage over 80 companies as you stated in your intro, Meb. And then, our real estate analytics product line which provides insight and advice on navigating the private real estate markets, and, there, we cover over 50 markets throughout the U.S. across all the major property sectors. And just as Jim just hit on, we have our Advisory and Consulting Group which does more customized solutions, or provides more customized solutions to clients on the bespoke engagement basis.

So when Green Street was founded just over 30 years ago, our focus was on the public real estate market and covering the publicly-traded real estate investment trust. And Green Street’s approach at that point was very different from what was taking place in the market. Green Street’s approach was, “Let’s go out and understand the value of the properties that these companies own. Let’s do a valuation from a ground up standpoint and know what their portfolio are worth, and then, see what kind of premiums or discounts to that underlying real estate value the companies are trading at.”

So we built a model around understanding, or, you know, we’ll call it net asset value or NAV-based model where we have a valuation for the portfolios of every company in our coverage universe. And could understand how they were priced relative to that underlying real estate value to look for opportunities where a company was overpriced or underpriced relative to that real estate.

And whether or not that was justified based upon maybe some, you know, balance sheet issues or whether that was justified based on above or below market overhead and/or G&A cost, whether the company was overexposed to a variable rate debt, whether management did a good job in terms of capital allocation. Those types of things we would consider to think what company should trade a premium to net asset value, and what company should trade at a discount. That’s, basically, the basic Green Street model when it comes to evaluating real estate investment trust.

Over the years, because we had to understand how each of these company’s portfolios were valued, we had to really understand the private market. We had to understand how apartments in Atlanta were priced relative to, say, industrial buildings in Northern California. And so, over the years, we’ve collected a tremendous amount of data to understand these various markets and that was really the advent of our real estate analytics product line, which was repackaging much of these data and research that we’ve done over the years to better understand and help those active in the private market value their real estate portfolios to think about where they’d wanna allocate capital. And so, that’s the basic framework of Green Street.

Meb: And so, what’s, kind of, the way the world looks like right now? I mean, I leave it open ended for you, but as you kinda roll into 2018, I know Barren’s had a great interview as your founder, we can link to in the show notes as well. That was a lot of fun, but what’s the outlook for 2018 and beyond? What are your broad overview? What do you guys kinda seeing in the real estate world?

Craig: Taking a step back, I think, when we look at real estate fundamentals and what I mean by that is thinking about rents and occupancies and where they’re going, and then, as well as valuation. So, you know, with the exception of retail real estate, most property sectors are seeing increasing rents and occupancies, but fundamentals have slowly moved from what I’d call great down to good to, now, I would say are, sort of, okay.

If you look at our forecast for intermediate term net operating income growth meaning the cash flow that a portfolio is throwing off, over the next four years, we’re forecasting roughly 2.5% growth across the various property sectors with the industrial property sector leading away, and retail being the [inaudible 00:10:14]. You know, coming out of the global financial crisis, real estate saw limited editions to new supply which set the stage for strong rent and occupancy games.

Today, however, we’re seeing new supply coming into most markets across most of the property sectors which is really, sort of, at a level now where it’s meeting the demand of the marketplace and that’s why we see rent growth continuing to slow, positive rent growth, but rent growth slowing. From a property value standpoint, after several years of very heady property price appreciation, we’ve now more recently seen price appreciation stall out. And for the most part, see property prices as drifting sideways, if you will. So, and, again, we’re focused on commercial properties, not residential, You know, residential would be probably a different story, but from a commercial property standpoint, we see values drifting sideways, you know, over the next 12 months or so.

Meb: Okay, and when you say, kinda, the return expectations, is it sort of the mid single digits for expectations in general as far as total return on some of these investments? Is it higher? Is it lower? What’s, kind of, the ball park?

Craig: Sure. So we look at things on an unlevered return basis, you know, don’t think it’s appropriate to look at things on a levered basis, then you had to take a deeper dive into understanding the capital structure of a company or a particular asset. But across the sectors, we see real estate price today to deliver unlevered returns of about 6% or in the very low 6% range. When we think about that relative to other capital market alternatives, we’re fairly comfortable with where real estate is priced today. And, again, this is focused on the private market more so than the public market, and I’ll get into why I say that in a second.

But if you look at unlevered return in the low 6% range relative to BAA corporate bonds say, which we think is a reasonable benchmark to think about when understanding how real estate stacks up relative to other capital market alternatives,historically, REITs have been priced to deliver an unlevered return of about 150 basis points higher than the BAA corporate bond rate. Today, we see that spread at a little over 150 basis points. So that’s why we say we see private market real estate is, sort of, fairly priced today. You know, it’s right, kind of, in line with the historical average of REITs premium that’s been afforded real estate.

In the public market, there’s a large difference and that is in the public market, we are seeing the real estate investment trust in our coverage universe now trading it roughly in 11% discount to their unleveraged asset value. So there’s a difference going on here in the public market versus the private market and that being, you know, real estate is cheaper for anybody looking to invest in it by buying a REIT security versus buying the underlying asset that those REITs own.

Meb: And I think I saw, you know, I’ve read a lot of y’all’s else research, I think I saw in some place where you mentioned your belief, and correct me if I’m wrong, that the public tends to lead private. And so, is this a scenario where this sort of divergence resolves by, you know, in general ,you think private market values need to come down or what’s, kind of, your general thoughts there?

Craig: That’s a great question. I’m gonna let Jim touch on that in a second. But I say, you know, there’s two ways for that gap to change, right. One would be for REIT prices to rally and the gap get closed by real estate pricing and the public market increasing, or it could be closed by real estate pricing and the private market decreasing. The public market has, historically, been a pretty good predictor of future private market real estate returns, but it’s not a perfect predictor.

Meb: So, Jim, I’ll, kind of, let you chime in there, too, if you want as well is one of the things that as we’re talking about especially real estate investing and public REITs, and you guys have touched on this briefly already, is that it’s not, you know, a uniform space. You have everything from malls and office to lodging and storage and student and manufactured homes, which I think is a fancy way of saying trailer parks at this point, but maybe talk to me a little bit about, again, the signals from the public market anymore, kinda, uniformity in valuations, because a bunch of listeners are probably saying, “Okay, if they’re talking about this net asset value approach, why not just buy the cheapest stuff?” But in some cases, these sectors have a premium or discount for a reason. So I’ll let you…there’s a couple of things in there, but I’ll let you fire away when you’re ready.

Jim: Yeah, sure, this is Jim. Yeah, you make a very good point that REITs tend to specialize by property type which allows investors to then aggregate portfolios that consist of the property types that they’re most optimistic about and/or they think are priced most attractively. So you do have REITs that specialize on apartments, REITs that specialize on office, REITs that specialize on malls, and REITs that specialize on warehouse properties. And then you have a lot of niche property types that are represented in the REIT market as well, self-storage, student housing, senior housing are some examples.

When an investor invests in a REIT, basically, they should be willing to pay fair market value for the real estate that the REIT owns. So Craig talked earlier about the concept of net asset value which is calculated by marking to market, the value of the assets that the REIT owns, and then, subtracting the liabilities. And when a REIT investor decides, “What I should pay for this stock? What’s the right price for this REIT?” You start with, “Well, what’s the real estate worth? And then let’s work from there. ”

So I should be willing to pay fair market value for the real estate. These REITs are ran by management teams that range and quality from pretty good to best in class. So I should be willing to pay something for the management team. And then, an important distinction between the REIT market and the private real estate market is that with REITs, an investor gets liquidity. If you wanna exit your position, you could do it this morning by hitting a couple of buttons or calling your representative if you trade your REIT stocks. You can’t do that in the private market. It takes months to market a property, get it closed, and get the cash in your wallet. So fair market value plus something for great management teams plus something for liquidity means that the average REIT, over time, should trade at a modest premium to its NAV. And in fact, that’s what happened over long periods of time. REITs on average have traded at about 102%, 103% of NAV.

In the market today, as you alluded to, we’re seeing some very unusual signals. We are seeing sectors such apartments, and office, and malls, in particular, trading at very sizeable discounts to NAV. And by contrast, we’re seeing say in the industrial sector company, so then, warehouse properties, those companies are trading at sizeable premium to NAV. So what are the signals that we’re getting from the REIT market? Well, as concerned as a lot of people are about the mall business, REIT investors are saying, “It’s even worse than that. You’re gonna have to entice me with a very low share price to get me to deploy my capital into the mall sector at this very uncertain time for retail.”

Conversely, in the warehouse business, e-commerce has been a huge benefit to the warehouse business, a huge detriment to the mall business. So in the industrial business, we see REITs trading at a premium as REIT investors say, “Hey, as good as everybody knows market conditions to be for the owners of warehouse properties, we, the public market think things a year from now are gonna be even better than those expectations. So we’ll pay a premium for the REITs that specialize in warehouse ownerships.” So some very interesting signals. Things are not in alignment and I think that creates some real opportunity for nimble investors looking for cheap opportunities to buy real estate and to do it through REITs as opposed to through buying buildings or investing in funds, they go out and buy buildings right now.

Meb: And I think that’s a great jumping off point and maybe you can expand upon it. We had asked my Twitter follower for a few questions, and one of them was, kind of, a long those lines. He says, “Are strip retail REITs values or value traps?” And did those…they set for apartment REITs. Basically are some of these areas that you mentioned whether it’s mall or office, etc., you know, with the big discounts, is that an opportunity or is that more of like a value trap? And then, I know you’ve guys have written about some of the huge, kind of, macro forces at play whether it’s the Amazon-ing of everything or whether it’s we work, you know, playing out. Maybe talk a little bit about if you think some of these sector, subsector industry discounts and premium are warranted or whether that’s actually not opportunity as well.

Craig: Yeah, I think it’s very situational. It depends on the property type that you’re talking about, the influences on the apartment sector are gonna be different that they are in the office sector which will be different than they are in the mall sector, and I think there’s geographic considerations as well when you talk about real estate, real estate, and a lot of respect to the very local business. So what’s happening in Seattle might be different than what’s happening in Los Angeles versus Austin, Texas. So it does require a lot of consideration for the macro, a lot of consideration for the micro when it comes to the different geographies. So a lot of different considerations depending on the property type and where the properties are located.

But what I would say is that in the mall sector, the extraordinary pessimism as it relates to Amazon taking over the world of retailers, closing stores and department stores really struggling has caused the owners of high quality malls in the public space in the REIT arena to trade it unprecedented discount to what the private market value of their real estate is, and we’ve, at Green Street, been proponents of investing in high quality malls REIT owners, Simon property group, General Growth, Macerich, just to name a couple. Is it a value trap? It could be. I would say that in real estate, demand considerations are really important. What’s driving demand? Who’s occupying the space? What [inaudible 00:20:56] are they willing to pay are all important dynamics.

But in real estate, commercial real estate, excess new supply has always been the factor that has ended the commercial real estate party. And the good news there is that in most property types today, excess new supply, too much new construction is not much of a concern. We have certain packets where that’s the case, but, in general, the reluctance of banks to make construction loans, the careful nature of the developers have brought to this part of the cycle as opposed to previous real estate cycles has kept new supply in check in a way that is a bit comforting to those who are worried about these prices being in fact a value trap. If too much new construction was an issue, I would be more concerned about the value trap, sort of, view than is the case in the current market.

Meb: And by the way, you know, one of the interesting things that you mentioned earlier briefly, but I thought you could touch upon, too, is you guys talked about on the public REIT space, you know, in general, you say NAV is the starting point, there’s other areas like franchise value. So, obviously, the management, corporate governance overhead, but one thing that. kind of, surprised was that you said, historically, actually, you wanted to avoid companies that are highly levered and have, kind of, what you would call balance sheet risk. And to me, it was almost a little bit surprising where, you know, sometimes in romping, stomping bull markets, leverage ends up being tailwind, but maybe that’s something you guys found not to be the case?

Jim: Craig, you wanna take a shot at that?

Craig: Yeah, certainly, if you had the perfect crystal ball, then by all means, if you knew the market we’re gonna see appreciating asset values, you’d wanna be more levered. Unfortunately, we don’t have perfect crystal balls, and we have seen real estate like many asset classes can be a cyclical business, and you have periods where asset values are increasing, you have periods where asset values decline. At that time when real estate values are declining, you don’t wanna be the over-levered company, or you don’t want to be the more highly levered company because, you know, what goes up does come down.

And so, what we have found is that, you know, if you look at those companies that employ higher degrees of leverage and those companies that deploy lower degrees of leverage that over extended periods of time, that those more lowly levered companies have absolutely outperformed the more highly-levered companies, which really says you’re not being compensated as an equity investor for the incremental risk that you’re taking with having a higher leveraged capital structure.

Meb: And so, kind of, as we’re talking about crystal balls in general, what are some other market dynamics today that should be on that podcast listener investor radar?

Jim: The question we get most commonly is, “Hey, interest rates are on the rise and real estate’s a capital intensive business, so rising interest rates has to be bad for real estate, correct?” And the answer to that is complicated and it’s a bit more challenging than, “Hey, rates are going up, that’s bad for real estate.” It really comes down to, “Hey, let’s think about why rates are going up. And if rates are going up because the economy is accelerating and we have robust economic conditions and that’s why rates are going up, that’s actually a pretty decent scenario for commercial real estate. Because in a robust economy, you have a lot of demand for real estate, the owners of real estate can achieve high occupancy levels and they can push their rents aggressively.” And that’s what we’re seeing in a lot of property types right now especially in industrial.

So if interest rates are going up because the economy is doing a really well, that can be a pretty good scenario for real estate. And it’s one of the reasons why commercial real estate is often describe as a bit of an inflation hatch. So, if you’re gonna ask a question, “Hey, interest rates and what’s their effect on real estate going to be?” I think you need to take a stab at, “Well, why are interest rates going up?” And the evidence right now is that rates are rising because the economic growth of the economy is accelerating and that’s a pretty decent scenario for most types of commercial real estate.

Meb: And as your talking about that macro environment and talking about REITs in general, whether…and thinking about rising rates potentially, there’s also seems to be an increase in activism. And so, maybe you could a little bit about the capital markets. Jim, what’s going on maybe with, sort of, anything going on with IPOs, MNA, privatization, all that good stuff. And whether you’ve seen a big influence or footprint on activism, in general, in the REITs space.

Jim: Yeah, the starting point for that is we have a lot of REITs. So we have nearly 200 REITs in a business that has an aggregate market capital of about a trillion dollars. So there’s a pretty good argument that we have more REITs than we should which always stokes the discussion of MNA consolidation. And as we talked about earlier with the number of high quality companies that are great real estate trading at discounts to their private market value that raises the spectra of privatization. Let’s take these public companies private. So the underpinning for this and your question on activism is when something trades at 80 cents on the dollar in the stock market, that is a mall company trading at a 20% discount to the private market value of real estate, that’s gonna attract all sorts of interested capital sources including activist investors.

Now, the term “activism,” I think, in other industries in some respects has dual meaning. I mean, some investors look at activist as the saviours, the guys that wake sleepy companies and extracts shareholder value. And plenty of others in other industries than real estate would say, “No, those guys are short-term opportunists and just trying to make a quick buck on the backs of the people who built the company, and the long term employees and the long term shareholders.” I can’t speak to activism in other parts of the stock market, but I can speak to it when it comes to real estate. And we have seen enough taken activism. The activists have been attracted to stocks trading cheaply and companies that arguably have not done the right things for shareholders for long periods of time.

So we’ve seen activist show up. We’ve seen them, I think, in general, go after companies whose boards and management teams perhaps weren’t executing as well as they could. And I think we’ve seen some outcomes involving sales of companies and the privatization of companies that have been beneficial to shareholders. So, again, activism might be a dirty word in other industries, but I would say in the REIT business, the activist have by and large picked the appropriate targets, and have in some cases effectuated change that has been very beneficial to the shareholders of those companies.

Meb: Interesting, you know, we talked a lot about asset allocation and everything at Cambria on this podcast and in the equity space, in general, you know, we talked a lot about global investing as well. And maybe talk a little bit about, you know, you mentioned that there’s quite a bit of difference between Seattle and Los Angeles, but, you know, what do you, kind of, guys seen globally, what markets do you look at? What markets do you stay away, but, you know, instead of Seattle, Los Angeles, what’s, kind of, difference between say Los Angeles and London? Or what’s going on in some of the developed or emerging markets REITs globally as well?

Jim: It’s fascinating to see over the last 20 to 30 years how global real estate capital has become and how quickly capital moves around the world, trying to find the best risk-adjusted return. And one of the challenges to that is figuring out what risk-adjusted returns should be when you look at an office building in London versus an office building in New York when you look at a major mall in Paris versus a major mall in Los Angeles. And so, part of the challenge for global capital is just getting your hands around how do I even make those comparisons on a risk-adjusted basis.

And I think one of the strengths that Green Street has is we have a London office with 20 professionals covering the real estate market in the UK and across Continental Europe, and it’s really helped us hone in our ability to help investors answer that challenging question, where can I deploy my capital today and get the best risk-adjusted returns? I think Green Street has a model for that that helps equate markets and help investors understand where they should be considering putting new capital.

When we talked about the investors, we work with investors from the Middle East. We work with investors across the world, but the Middle East, Europe, Canada, Asia and Australia that are trying to find the best places to put their money. And in some cases, that money and the redeployment of it is motivated by net worth preservation, “I wanna get my capital out of somewhere where the political situation might be uncertain and get my capital into a real estate investment in a place that is more certain over time, a New York City office building, for example.”

Some of the capital is travelling around the world, trying to find the highest yield and with a fixed income market being a place where yields are low, “How can I deploy capital around the world that’s a real estate and get better yield?” So we work with a lot of investors that are more focused on yield than they are in net worth preservation. But the capital is moving around the world quickly. It, kind of, comes and goes. Money coming out of China two years ago had a very big influence on gateway cities in U.S. Today, that capital flow has shrunk inconsiderably. So it’s a dynamic market. The money comes and goes, but the common denominator is help me find the place where I can get the best risk-adjusted return when I deploy my capital from wherever it comes into real estate around the world.

Meb: And not to put you on the spot, but are there any particular countries you think are particularly attractive right now or not attractive or are they pretty similar to, kinda, where the U.S. market is today?

Jim: Yeah, I think it depends on what your motivation is. Is your motivation total return? Is your motivation net worth preservation? Is your motivation to replace income that you use to get when oil was $100 a barrel versus $50 a barrel today? It really depends on your motivation. And then, a huge consideration is foreign exchange consideration and tax considerations.

So if I take my money from point A and put it into point B, what, sort of, real estate dynamic and what, sort of, real estate consideration should I make? But then, very importantly can I get my money back? Can I get it back tax efficiently? That has a big motivation as well. So it’s a complicated process, but you got to start with, “Hey, why are you considering taking your capital from this country and considering that country?” And then you layer on all those questions and the answers to which will lead you to the right place.

Meb: Let’s say that we have one of my friends in Los Angeles, he sold all of his Bitcoin Etherium. He wants to put a little money to work and his goal is total return, you know. And he can take a little risk. He can take a little volatility. Would you say most of the opportunity would be in some of these, kinda, other countries or is it U.S.? Or it would be balanced? Or is it also too, kind of, personalized question that it’s even too hard to drill down to that, kinda, generic example?

Craig: First off, hopefully he sold his Bitcoin maybe a couple of months ago so he has more dollars to invest. But when we look at things, sort of, broadly. And I’m gonna, sort of, give you three larger regions, Continental Europe, the United Kingdom, and the United States. We see in the private market, Continental Europe is being, sort of, the most attractively priced today. Again, in the private market. The issue is when you look through it in the public market, you see that the REITs that invest in Continental Europe are actually trading at smaller discounts to net asset value.

And so, from a public market perspective, we, kind of, see Continental Europe, the United Kingdom, and the United States all priced about evenly today. That’s not always been the case, but just coincidentally today, it seems like the public market in terms of the premium or the discount that they’re ascribing to net asset value are accounting for the fact that in the private market, Continental Europe offers better returns relative to their underlying government bonds.

Meb: That’s interesting. It’s so interesting and the depth of it on the private versus public side is we’ve had a handful of people from the private equity business on here and talking about ideas on private equity versus public equities in traditional stocks base. And it’s fascinating to me because it waxes and wanes over time on which area tends to be, where the money is sloshing around.

So I would love to hold you guys here forever, but I got a couple of other quick hits. And some of these questions are stuff that you guys may or may not have a strong opinion on and that’s totally okay. And so, I’ll just, kinda, volleyball them up and either Craig or Jim can take them. So I have a family farm that we’ve…My father grew up on a farm in Kansas in Nebraska, and so, we have a wheat farm. So farming has always been area that’s been particularly close to my heart. I know a lot of institutions do it on the private side.

I’m curious to your guys opinion as to why we haven’t seen more farmland REITs in the United States. I mean, to my knowledge, I think there is only one. There might have been two. And I think one bought the other one. But what’s your, kind of, thoughts there? Is it a bad structure for REIT? Is it interesting, but there’s just not that much development. What’s the general overview of that tiny, tiny corner of the REIT space?

Craig: So yeah, we had two farm REITs. We now have one farm REIT. And farmland REITs make a tremendous sense when I think about the supply and demand dynamics of farmlands versus other types of real estate. It’s very appealing. The challenge to being a public company is that you have a couple of million dollar a year of expenses related to just being a public company. Your filings with the SEC, your board of directors, etc. And so, to be a public company, you need to get to a decent size pretty quickly or those public company cost become a real burden.

And the challenge in the farm business is it’s hard to consolidate properties. It’s hard to acquire aggressively. When you go to a lot of the places like the scenario you described, you see a bit of resistance from sellers to selling to big public companies as opposed to selling to maybe the family next door. So a farm REIT needs to get big quickly, that’s challenging to do. And I think the concept makes tremendous sense, but the execution has proven to be a bit challenging at least so far.

Meb: All right. Great business opportunity listeners. When you all want to start bunch of farmland REITs, I would certainly be an investor. One of the Twitter question that you guys may or may not have an opinion, but was asking about ETF ownership of REITs, and, you know, as you’ve seen all these money flow into passive market cap weighted indexes which, in general, I think, is a pretty great thing because their lower cost. It also, kind of, blindly funnels money into the market cap weighted indexes. And ETF ownership of REITs, in general, is about three times that of other stocks and I don’t know if that’s just because of the vanguardization of, kinda, sector or the way that REITs have recently sprung out to a new sector.

Have you guys seen distortion maybe the indexing, or ETFs, or mutual funds maybe playing a role? Does that create opportunities? Is this something that’s not that big of an influence? Any general thoughts there?

Craig: Well, s you highlighted clearly passive investment strategies have one out in the REIT market in terms of where the flow of capital has been. You know, historically, you had, you know, a large ownership within REIT that was comprised of REIT-dedicated mutual funds, and they had significant influence in the marketplace. Today, that influence rest more in the hands of the, you know, passive investment strategies, which we think actually has created some opportunities.

As you highlighted at the beginning, you know, in introducing Green Street, we have found that, historically, higher quality companies with lower leverage in owning what our lower yielding properties at least initially have generated outsized returns, meaning that the growth from those companies has been more than sufficient to offset the lower initial yield. So that model has stood the test of time, generating returns where the spread between our buy bucket of stocks and our sell bucket of stock is averaged about 24 percentage points per year.

You couldn’t necessary replicate that in the real world because of the trading cost and other things, but the fact is the model has proven out that higher quality companies, lower leverage companies, you know, lower initial yield properties have tended to outperform those companies that own something different than that.

And I think what has happened now with passive investment strategies is that rising tide has, sort of, risen all boats, and now we’re actually seeing the tide going out. And I think as we see the tide go out and, you know, as I said earlier, we now see properties more likely to drift sideways, you know, to the extent property prices were to decline, you know, those companies with lower leverage now have dry powder and have an opportunity to go out and acquire good real estate at discounted pricing. We’re not calling for that at this point, but if and when that does happen, you know, those companies are well positioned to take advantage of it.

Meb: And is that, not to put words in your mouth, but we always say near the end, we say, “Look, for the individual investors, financial advisors, even institutions really, endowments real money, family offices.” And you’re to, say, give one piece of advice for investing in real estate and REITs with the head nod to the most common way people make stupid mistakes when they’re investing in REITs. Is that, kind of, the general advice to be thoughtful about purchasing high quality, you know, real estate and with lower leverage? Or is there a, kind of, different slant as well?

Craig: I think maybe first piece of advice which would be, you know, as any investment manager would hopefully say which is to first have a diversified portfolio. I certainly wouldn’t advocate putting all your eggs in one basket. Yes, the mall REITs are trading at large discounts, but I wouldn’t load up on mall REITs to the exclusion of other property sectors. So, you know, our approach at Green Street has to be sector neutral.

And what I mean by that, within the REIT space, being property sector neutral, so being exposed to the various property sectors, but then picking the best companies that are most attractively priced within each of those sectors. And we think it’s more times than not, behooves to own high quality companies well-ran, well-managed companies that generally have good, strong capital structures that will enable them to prosper and whether real estate prices are going up or real estate prices are going down.

Jim: And to add to that on private versus public REITs or investing directly in real estate or investing funds by real estate, just a couple of consideration. Number one, you need to understand alignment of interest. So are those who are managing your money, the executives at the REIT or the private equity firm that’s managing your money on the direct side, you need to make sure you have alignment of interest that those parties go to work every day trying to make you richer. And in some structures, you have tha. In the REIT structure, you definitely get that. And some private structures, you get that, too, which is be weary there.

And then, the second point would be in a capital intensive industry like real estate that’s attached to the cyclicality of our broader economy, liquidity matters. And so, you really wanna understand that, “Hey, when a condition is changed and I wanna get my capital back, can I? Can I do it efficiently? And can I do it in a way that gives me the capital back that I need to redeploy perhaps somewhere else?” So alignment of interest and liquidity are two important considerations when you think about investing in REITs or investing in real estate through different structures.

Meb: That alignment of interest is something we talked a lot about on the podcast, and the concept is skin in the game. There’s a morning star stat on mutual fund managers, for example, and it’s something, like, 50% to 90% depending on the style of mutual fund have, the managers has zero dollars invested in the fund. So I think that is one of the most important things in all of investing not just real estate, but, you know, having some who’s the fiduciary and/or incentivized to win along with you.

Guys, we’re gonna start winding this down. Our final question that we always ask anyone in 2018, and we’ll let Craig go first and then Jim is, we say, and this doesn’t necessarily apply to Green Street. This is more of a personal question and a fun one. And you can conjure both good or bad, but think about what is the most memorable investment you’ve made in, kind of, your career. It could be Mickey Mantle baseball card. It could be buying a terrible stock that went down 100% CMGI in ’99, or whatever is the first thing that, kinda, pops into your head. Craig, we’ll go with you first. What’s been your most memorable investment or trade?

Craig: Not to be too hokie, I guess, my most memorable investment would be the investment of time and attention to my children. So I have four children and so that would be my most memorable investment. But if I’m thinking about from a financial standpoint, I would say my most memorable investment was buying Apple stock probably 15 years ago. I’m not normally one to speculate into individual stock. I tend to have a very broad base approach to investing and I tend to seek out low-cost index funds more so than the most, despite the fact I run an investment advisory firm. You having said that, I did make a little four A in Apple stock at one point, like I said, about 15 years ago and that actually proved to be pretty fruitful.

Meb: Was that motivated by, like, the Peter Lynch style of investing in what you know? Or did you just like the company? Was that, kind of, the origin of the purchase?

Craig: Yeah, it was as, you know, the iPhone was first being introduced and I just, and it just seem so revolutionary to me. I remember sitting in a friend’s backyard and they had just bought this first iPhone and just flipping through it, and, you know, just the totally different approach to things, and thinking, “Boy, beyond just the technology advancements, just the style and design of the phone and how different it was thinking what other areas could this be expanded into and could Apple take advantage of.” So it was a flyer. It was a small investment, but it was one that served me quite well.

Meb: You know, it’s funny you say that because I can remember the exact moment I first saw one was sitting with a friend by the pool in Las Vegas and he showed me his. And I was like, “You know what, that’s just…I don’t really get it. I’m totally fine with clam shell Motorola Razr.” I’m like, “This is way better.” It goes to show… that why I’m a quant. What little do I know when it comes to that.

But it just reminded me. I don’t think I’ve talked about this in the podcast because…but one of my most memorable just thinking about was the same, sort of, thing, as a kid, I always loved reading comic books and I remember buying Marvel stock. I think it was when they came out of bankruptcy. Again, knew nothing literally knew nothing. And I remember it being one of the better multi-baggers I’d ever had mainly because I like Wolverine and the X-men. All right. Jim, you’ve had a little time to think about it, what do you got for us?

Jim: Yeah, I’ll stick to real estate and when I was a young analyst at Green Street, we had a couple of companies come public in the self-storage industry. Public storage was one of them and Shurguard was another. And being the new guy at Green Street, I was tasked with figuring out the self-storage business. And I tried to do that the best I could. The challenge in self-storage is, there wasn’t any information out there. It was hard to get. It was inconsistent.

But as I dug deeper and deeper into the self-storage industry, I thought this is a fascinating business. And at the time, in the mid-90s, about 2% of Americans were using self-storage. Today, that number is approaching 10%. And for many, many years Green Street had a point of view that self-storage is a very interesting real estate business that very few people pay attention to, but they should because the assets are fundamentally mispriced favourably to investors. And if you buy-and-hold these stocks, we think the outcome was gonna pretty good.

So we were bulls on self-storage for a long period of time and it was probably a period of close to 15 years where self-storage prices were just too low relative to what investors had to pay in more traditional real estate like office or apartments. And the world has come around to that point of view. Today, self-storage which just had an extraordinarily great outcome for those that got in early. It’s priced fairly.

There’s a lot of capital in the market, the information in the industry is better known. But I just remember, going back a long way and it’s applicable to other places, too, that if you can dig a little deeper and get an informational edge and translate that into a pricing conclusion that says, “Hey, this looks cheap all things considered. What an interesting way to find great investment opportunities.”

Meb: I love it. I love it. Craig, Jim, this has been so much fun. Where do people go if they wanna follow y’all’s research, sign up to be a client, you know, all that good stuff, where is the best place to follow you guys?

Craig: Best places to go would be to our website which green, and then ST, short for street, dot.com. So there’s a longer version of the website title as well, but that’s the quickest and easiest one, greenst.com.

Meb: Awesome. Craig, Jim, thanks so much for taking the time today.

Craig: Thanks, man. We appreciate it.

Jim: Thank you.

Meb: Listeners, we’ll post all the links we talked about in the show notes. Any of the publication that Green Street has publicly, that they’ll let us share, we’ll toss up there. A lot of the other things we talked about today you can always find at mebfaber.com/podcast. If you’re loving the podcast, hating it, you can always leave us a review and sign-up to subscribe on iTunes, Stitcher, Castro, Overcast, all those good apps. Thanks for listening, friends, and good investing.

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