yoUR gUIdE To gloBAl REAl ESTATE InvESTIng
yoUR gUIdE To gloBAl REAl ESTATE InvESTIng
Strengthen portfolios with an investment in real estate making real estate a part of your portfolios offers a host of benefits, including a stable income stream and strong returns, capital preservation and diversification through non-correlation to the broader markets. But not all real estate is created equal, and an active approach to investing in this dynamic asset class can help increase returns and reduce portfolio volatility. This publication will tell you more about the benefits of real estate investing in today’s market, as well as the different investment options available when accessing this asset class.
TABLE OF CONTENTS Exploring the benefits of global real estate investing
3
A solution for high correlations and heightened volatility
5
REITs as a proxy for direct real estate investing
8
A 4-quadrant approach to real estate investing
10
About Timbercreek
12
Timbercreek Asset management is a global expert in private and publicly traded real estate investments, focused on delivering predictable, sustainable and growing returns to investors.
2
Exploring the benefits of global real estate investing Stability and performance in today’s challenging market environment Investors today face challenges that can only be overcome with innovative thinking. Real estate, whether in the form of private, direct investments or publicly traded companies via mutual funds, is particularly fertile ground for the out-of-the-box solutions investors need.
Done correctly, real estate investing can help dampen volatility and provide enhanced income streams for client portfolios.
A large proportion of investors have three main priorities when it comes to building a portfolio: 1) income, 2) diversification and 3) capital preservation through low volatility, but with meaningful growth. For decades, the standard approach to meeting these goals was the 60% equity, 40% fixed-income portfolio. There is increasing recognition that this approach is no longer adequate.
One of the reasons real estate is so attractive is that the income it generates is not fixed. With strong active management, real estate income can grow over time, typically at the pace of inflation – or slightly higher.
Today’s key challenges The inability of the old formula to deliver in today’s environment stems, in the first place, from structurally low yields offered by developed-country government bonds – once a reliable source of safe, robust fixed-income returns. Figure 1, below, shows just how much yield has been sapped from client portfolios in the past 20 years. Figure 1: The decline of government bond yields in Canada, the United States and Germany
Real estate advantage
Real estate income is predictable and transparent because it’s based on long-term leases. For instance, a large mall anchored by a high-end retailer in an affluent neighbourhood will generate high, consistently growing rents with a very low probability of delinquency. It’s a winning formula, which is why global real estate’s annualized performance of 9.8% over the past 15 years beats Canadian equities (7.4%), the S&P 500 (6.7%), global equities (6.5%) and global bonds (5.1%). Figure 2: 15-Year Annualized Performance 9.8%
10% 8% 6%
7.4% GCAN10YR Index USGG10YR Index GDBR10 Index
6.7%
6.5% 5.1%
4% 2% 0%
94 996 998 000 002 004 006 008 010 012 014 016 19 1 2 1 2 2 2 2 2 2 2 2
Source: Bloomberg, as at December 31, 2016.
Exacerbating the new normal of low yields is increasing volatility in equity markets. For example, Bloomberg data shows that between 1985 and 1999, there were almost 800 days where the S&P 500 Index saw market fluctuations of greater than 1%. For the years 2000 through 2015, that number jumps to over 1,200.
Global Real Estate
Canadian Equities
S&P 500
Global Equities
Global Bonds
Source: Bloomberg. Data as of December 31, 2016. Performance data in local currency. Indices include FTSE EPRA NAREIT Developed Global Real Estate Index, S&P/TSX Composite Index, JP Morgan Global Aggregate Bond Index, S&P 500 and MSCI World Index.
But security selection is key. While global real estate as a whole should currently be expected to generate income of about 4%, strong active management can yield 6% to 7%. One of the ways this is accomplished is by stripping out securities that are known to detract from income.
3
your guide to global real estate investing
For example, real estate developer stocks and emerging market real estate stocks tend not to pay strong dividends; an effective active manager will screen them out. Strong active management is also a guard against what’s commonly viewed as real estate’s Achilles heel: rising interest rates. To offset this potential headwind, an experienced real estate fund manager will take a number of steps, including buying companies with attractive cash-flow growth. Additionally, from a historical perspective, interest rates tend to rise when economies strengthen, which drives increased cash flow for real estate companies. This growth effectively trumps the effect of rising rates.
Diversification and low volatility Building a diversified portfolio through low- or noncorrelated assets has long been the cornerstone of security selection. For decades, this was accomplished with a simple stock and bond allocation. But recent years have seen a tightening of correlations between equities and fixed income, leading investors to search for other ways of achieving the diversification they need to weather turbulent markets. Real estate – both private and publicly traded – delivers diversification through low correlations to traditional asset classes. For instance, Canadian real estate has only a 0.52 correlation to Canadian equities, and a 0.50 correlation to U.S. equities.1
1
Complementing real estate’s diversification benefits is the low-volatility return path that’s so important to investors focused on capital preservation. Long-term leases have a major smoothing effect on cash flows, whereas general equities’ cash flows go up and down with the economy.
Meeting investor needs Strong, reliable income. Diversification. Capital preservation through low volatility, plus meaningful growth. Global real estate delivers on each of these investor priorities at a time when traditional assets fail to pull the weight they once did. And when paired with experienced active management, real estate can go well beyond replacing the income streams lost in today’s low-yield environment.
IN THE NEXT CHAPTER
A solution for high correlations and heightened volatility explains how making real estate a part of a portfolio can help counter the negative impact of market volatility and the rising correlation between equities and fixed income. It also explains how active management allows real estate investors to achieve reliable income streams and consistent long-term growth.
Source: Bloomberg. Data as at December 31, 1992 to December 31, 2016.
4
A solution for high correlations and heightened volatility Publicly traded and private real estate offer diversification and stability Tighter correlations between traditional asset classes and increasingly volatile equity markets have left investors searching for solutions that add meaningful diversification and stability to their portfolios. Real estate, whether private or public, stands out among the available options that can deliver what investors are looking for.
Low correlations Global real estate has an attractive 0.36 correlation to global bonds, and a 0.77 correlation to global equities.1 The latter figure appears high, but it doesn’t tell the whole story. Consider the more nuanced picture presented in Figure 1 below.
Correlations to equity markets Figure 1: Real Estate / Equity Regional Correlations Region
U.S.
Canada
Europe
Hong Kong
Japan
Singapore Australia
U.S.
0.55
0.43
0.45
0.36
0.32
0.47
0.5
Canada
0.50
0.52
0.39
0.36
0.28
0.48
0.44
Europe
0.53
0.43
0.57
0.39
0.41
0.52
0.54
Hong Kong
0.61
0.55
0.43
0.89
0.3
0.72
0.52
Japan
0.34
0.27
0.34
0.25
0.76
0.31
0.4
Singapore
0.53
0.52
0.44
0.70
0.32
0.84
0.49
Australia
0.43
0.38
0.41
0.34
0.28
0.37
0.26
Source: Bloomberg. Data as of December 31, 1992 to December 31, 2016.
Overall, correlations between global real estate and equities are low; there are only a handful of areas – focused in Asia – where correlations spike. For example, Hong Kong real estate is highly correlated to its local equity market. The same is true of Japan and Singapore. Conversely, Canadian real estate has a low correlation to its local equity market, with the same being true of the U.S., Europe and Australia. In addition, correlations between specific real estate markets and foreign equity markets are, with few exceptions, markedly low. Skilled active management can counteract the few instances of elevated correlations. Underweighting those markets, and overweighting markets that have low correlations to equity markets, will tend to bring down the overall correlation to equities. Low correlations are also observed within global real estate. Canada’s real estate market has a 0.55 correlation to U.S. real estate, 0.53 to Europe, 0.34 to Hong Kong, 0.28 to Japan, 0.39 to Singapore and 0.53 to Australia.
5
Your guide to global real estate investing
Low correlations across borders Figure 2: Global Real Estate Regional Correlations Region
U.S.
Canada
Europe
Hong Kong
Japan
U.S.
1.00
0.55
0.60
0.31
0.32
0.33
0.52
1.00
0.53
0.34
0.28
0.39
0.53
1.00
0.32
0.33
0.30
0.48
1.00
0.20
0.75
0.25
1.00
0.26
0.26
1.00
0.27
Canada Europe Hong Kong Japan
Singapore Australia
Singapore Australia
1.00
Source: Bloomberg. Data as of December 31, 1992 to December 31, 2016.
The reason for this is that real estate, unlike other asset classes, is entirely local. If you need an office in Tokyo, for example, you can’t substitute one in Toronto. This stands in stark contrast to the extremely high correlations we observe across equity markets.
Low volatility Many investors are gravitating towards strategies that lower the overall volatility of their portfolios. One reason is to avoid the psychological discomfort that can result from increasingly volatile equity markets. Another reason is based on an important investment rationale: exposure to significant market downturns makes future gains less beneficial. Lowering volatility is effectively a “win more by losing less” strategy. If an investor’s portfolio loses half of its value, it needs a 100% return just to get back to its pre-downturn level. By reducing volatility, the investor boosts long-term returns by making future gains add to portfolio growth, rather than simply make up for previous losses. Unlike equities, real estate investments – whether private or publicly traded – can create this low-volatility cushion for portfolios. If you look at equities, sector by sector, what you find is that most companies’ earnings are immediately responsive to economic events. For example, if China devalues the yuan and cuts its resource intake, global economic growth is reduced and stocks’ earnings per share see an almost-immediate negative impact.
Because they’re based on long-term leases, real estate investments are more insulated from such events. If you have an average lease term of seven years, and the average economic cycle is seven years, you won’t hit the bottom of the cycle. By the time the leases roll over, the economy will be coming out of the trough. By smoothing out the low points, long-term leases create more even cash flows, lowering volatility.
Smart leverage Some worry that the leverage used in real estate investing introduces risks that could increase volatility. A comprehensive risk-management process, which includes a local presence in key markets, can alleviate these concerns. Matching the amount of leverage to the characteristics of the property – location, tenant quality, lease terms – allows the fund manager to effectively dampen risk. For example, a mall in an affluent neighbourhood with long lease terms and the highest credit-quality tenants could safely take 70% to 75% leverage. A property that does not have these attributes to the highest degree should involve less leverage. A conservative average for a portfolio of real estate holdings will typically fall in the range of 60% to 65% leverage.
6
your guide to global real estate investing
Solving problems for today’s investor Real estate – both private and publicly traded – is a proven solution for investors seeking greater diversification and lower volatility. Guided by experienced active management, real estate investors can also achieve reliable income streams and consistent long-term growth.
1
IN THE NEXT CHAPTER
If investing in commercial real estate directly is too complicated and cost-prohibitive, a portfolio built with REITs may be the solution. Read more in REITs as a proxy for direct real estate investing.
Source: Bloomberg. Data as at December 31, 1992 to December 31, 2016. Indices include FTSE EPRA NAREIT Developed Global Real Estate Index, S&P/TSX Composite Index, and the JP Morgan Global Aggregate Bond Index.
7
REITs as a proxy for direct real estate investing Actively managed portfolios of global REITs can deliver the key benefits of direct real estate investing An allocation to real estate offers a host of benefits for investors of all types: a stable income stream and strong returns, inflation protection, capital preservation and diversification through non-correlation to the broader markets. But retail clients may not have the financial capacity to invest in commercial real estate directly. For these investors, real estate investment trusts (REITs) are an effective alternative – with some added advantages. Unlike direct investing, which has high barriers to entry, REITs are easily accessible by investors of all types. REITs also have a highly liquid and transparent structure. Plus, they offer a diversification advantage by providing access to a wider range of real estate exposures than direct investing. But not all REITs are created equal. Passively managed vehicles tend to lose some of the advantages that lead investors to real estate in the first place. For example, these REITs have a tendency to move in lock-step with the broader equity market, and this high correlation diminishes their diversification benefits.
Active management is the solution Through careful screening and selection, active management is able to create a portfolio of pure-play REITs that retain all the advantages of listed vehicles while at the same time capturing the benefits of direct real estate investments. Figure 1 below compares the performance of Canadian direct real estate, the S&P/ TSX Capped REIT Total Return Index and Timbercreek’s actively managed portfolio of publicly listed real estate. Figure 1: Direct and Listed Property 200
Actively Managed
Canadian Direct Property Canadian Listed Property Pure-Play REIT Portfolio – Timbercreek
180 160
120
Passively Managed
Sep 16
Dec 16
Jun 16
Mar 16
Sep 15
Dec 15
Jun 15
Mar 15
Sep 14
Dec 14
Jun 14
Mar 14
Sep 13
Dec 13
Jun 13
Mar 13
Sep 12
Dec 12
Jun 12
Mar 12
100 Sep 11
Importantly, the active solution of publicly listed investments is more tightly correlated to direct investing than the passive option (97.0% versus 88.7%, respectively).1 This is clear evidence that active solutions are a more effective proxy for direct investing than passive REIT investment vehicles.
The power of process
140
Dec 11
Returns for the actively managed, pure-play portfolio of publicly listed real estate exceed both direct real estate investment and the passive, indirect investment option. While volatility for direct real estate will always be lower than publicly listed investments (3.4%), the actively managed pure-play portfolio bests the passive option (9.4% versus 10.0%, respectively).1
Canadian Direct Property: Canada REALpac/IPD Total Return All Property Index Canadian Listed Property: S&P/TSX Capped REIT Total Return Index Pure-Play REIT Portfolio – Timbercreek: Publicly traded common equities and preferred stock holdings from the Timbercreek Global Real Estate Fund (TSX:TGF). The stated return is presented in CAD, net of all fees, expenses and taxes.
A strong process is the key to achieving the advantages of active management described above. It should include two key phases: 1. Filtering out companies that undercut the benefits of real estate investing 2. Comprehensive company and market analysis of remaining candidates to identify stocks for inclusion in the portfolio
8
your guide to global real estate investing
FIlTERIng oUT dETRACToRS Out of the approximately 500 companies that make up the universe of listed global real estate securities, about one-third tend to detract meaningfully from performance and should be screened out. Think of this initial screening step as a removal of impurities. Common detractors include: • real estate developers; • brokers; • construction companies; • poorly located assets; • highly levered assets; and • emerging markets-based names, particularly developers and home builders. Developers typically don’t pay dividends. They usually redirect capital gains into the next project. Builders and brokers often pay very low dividends. Emerging markets names also pay weak dividends and tend to have unstable businesses. By stripping those away you see your income rise tremendously. Poor-quality real estate, financially engineered cash-flow streams and highly levered assets are other hallmarks of the group of names that a strong active manager screens out immediately. Those are the things that tend to give you more volatility and diminish the positives of exposure to real estate. Removing them can help you get closer to the experience of direct real estate investing, but through a liquid vehicle. ACTIvE SElECTIon At this point in the process, it’s all about the underlying assets. A wide range of variables are parsed and analysed, and while quantitative tools help crunch the numbers, final calls on which names make it into the fund should be shaped by the portfolio manager’s real estate experience and expertise. One group of variables measures internal growth prospects. They include occupancy rates, lease rollover relative to comparable local-market units, operating margins, and contractual rent increases. The goal of the analysis is to develop forecasts for a number of key metrics, including net operating income, cash flows and dividend sustainability, as we would with direct real estate investments.
1
It’s also critical to examine companies’ track records and prospects for external growth. This involves assessing acquisition and sale activity. Is management making smart choices when they buy and sell properties? Have they shown good judgement in the way they’ve financed acquisitions? Another important variable is capital improvements. Things like renovating an apartment building’s lobby or adding high-end amenities can generate higher rents over the long term. Strong, sustainable income is the goal, but only at an acceptable level of risk. An elaborate risk management regime will examine a host of variables, including: • Real estate risk – Considers asset quality and location (in part through property tours), as well as lease structure • Corporate risk – Assesses management quality (partly through in-person meetings) and company business model • Balance sheet risk – Examines key metrics such as leverage, interest rate sensitivity and fi xed charge ratio • Stock price risk – Analyzes liquidity (30-day average volume) and volatility (one-year standard deviation) The result: A high-active-share portfolio of quality global names that offers a liquid proxy for direct real estate investing. Such a portfolio will have exceptional prospects for income generation and growth because its constituents are purchased at a discount to intrinsic value.
A real alternative With the right process and management expertise, an actively managed global REIT portfolio can deliver the key benefits of direct real estate investing. Even though they’re liquid portfolios of stocks, they behave much more like a bricks-and-mortar real estate portfolio.
IN THE NEXT CHAPTER
A 4-quadrant approach to real estate investing describes Timbercreek Asset management’s unique approach to lowering risk and enhancing returns in a real estate portfolio.
Source: Bloomberg. Data as at October 1, 2011 to December 31, 2016.
9
A 4-quadrant approach to real estate investing Boost portfolios with a balance of public and private exposure to real estate equity and debt Investors have long turned to real estate for income, inflation protection and diversification. There are a variety of ways to access this asset class, including private, direct investments in bricks-and-mortar properties, debt investments backed by real estate, publicly traded real estate investment trusts (REITs) and publicly traded debt-like instruments. Each of the four main types of real estate exposure – private equity, private debt, public equity and public debt – has its own set of advantages. Arguably the best approach is to combine their complementary benefits.
Combining strengths Having all four types of real estate exposure allows investors to offset the limitations of one type with the benefits of another. Figure 1 illustrates the primary features of each type of exposure. Figure 1: The Four Quadrants of Real Estate Exposure
STABILITY
GROWTH
YIELD
Private Equity
Private Debt
LIQUIDITY
REAL ESTATE
Public Equity
Private equity: high returns with low volatility A private equity allocation consists of direct investments in real estate (bricks-and-mortar investments) and privately held companies that primarily own real estate. As an active investor, Timbercreek's focus is on investments where value can be created by improving net operating income (e.g., through renovations or recapitalization) or the overall quality and competitiveness of the property. Private debt: stable income A private debt exposure involves direct investments in debt that’s secured by real estate or issued to companies that focus on real estate. The aim of the portfolio manager should be to identify opportunities that generate more yield than would normally be expected for the level of risk undertaken. Timbercreek’s focus is on shorter-duration mortgage loans to protect invested capital in a rising interest rate environment. Public equity: strong returns with high liquidity This is the most liquid form of real estate investing, targeting common equities of publicly traded issuers backed by real estate, such as REITs. Investing in REITs provides a diversified exposure to real estate assets. Timbercreek targets both income and opportunistic growth with the aim of generating substantial returns. Public debt: stable income and liquidity
Public Debt
A public debt exposure includes investments in publicly traded preferred stock, unsecured debt, convertible debentures, preferred equity of REITs and mortgage REITs. Timbercreek targets undervalued securities to generate outsized returns. As with private debt, Timbercreek is looking for securities with yields that are greater than would be expected given their risk levels.
10
Your guide to global real estate investing
Where one of these four types of exposure shows limitations, another steps in to offset it. For example, private equity’s stability comes at the expense of liquidity. This disadvantage is overcome when the investor has an allocation to public real estate equity and debt. Conversely, while strong active management will dramatically reduce the volatility of a public real estate portfolio, an allocation to private equity and debt can provide a degree of stability that exchange-listed investments cannot match.
By the numbers A portfolio that includes a real estate allocation combining all four exposure types has substantial benefits over the typical 60% equity, 40% bond portfolio. In addition, Figure 2 illustrates the benefits of achieving the optimal combination of global direct and global listed property (based on 25 years of performance, ending December 2015). Figure 2: Combining Global Direct and Global Listed Real Estate 8.5%
0% Global Direct Property/ 100% Global Listed Property
8.0%
RETURN (p.a.)
7.5% 7.0% 6.5%
70% Global Direct Property/ 30% Global Listed Property
6.0%
100% Global Direct Property/ 0% Global Listed Property
5.5% 5.0% 6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
VOLATILITY (p.a.)
A 30% allocation to global listed property and a 70% allocation to global direct property provides the highest potential return with the lowest volatility of returns in a global property portfolio.
Best of all worlds Innovative new solutions now enable clients to harness the full range of benefits real estate offers. With a multi-strategy approach, investors no longer have to make compromises to achieve liquidity, stability, income and growth. In today’s investing environment, it’s important to look at asset classes that can help enhance portfolio returns and lower volatility. The real estate asset class can do just that, with an active approach enhancing these benefits.
11
About Timbercreek
LIQUIDITY
Less
Founded in 1999, Timbercreek Asset Management is an active investor, owner and manager of global real estate and related assets focused on delivering sustainable and growing returns to our investors. We maximize value by employing a value-oriented investment philosophy combined with an active, hands-on asset management platform, to identify opportunities that will generate predictable and sustainable Timbercreek long-term cash flow. Our global team is located in key Four Quadrant Global Real Estate Partners markets around the world and takes a hands-on approach to Timbercreek managing investments. Global Real Estate Fund Timbercreek Global Real Estate Income Fund
Timbercreek provides a range of globally diversified real estate investment solutions designed to suit a variety of investment objectives.
More
Timbercreek Offerings Less
PRIVATE
More
Timbercreek Global Real Estate Income Fund1
Timbercreek Global Real Estate Fund1
Timbercreek Four Quadrant Global Real Estate Partners2
Up to 10%
Up to 20%
Up to 70%
Liquidity
Daily
Daily
Quarterly
Target Yield
5-6%
6-7%
4-5%
Quarterly
Quarterly
Monthly
1.00%
1.25%
1.50%
Accredited Investor
No
No
Yes
RRSP Eligible
Yes
Yes
Yes
$500
n/a
$25,000
Characteristics Private
Distribution Frequency Management Fee
Minimum Investment Fund Code
Ticker Symbol
Series A
TBR201
TGF.UN
TBR600
Series F
TBR203
—
TBR601
For more information on Timbercreek’s offerings, please contact: Timbercreek Asset Management 25 Price Street Toronto, ON, Canada M4W 1Z1 1.866.898.8868 [email protected]
George Ganas, MBA, CFA Senior Vice President, Business Development & Client Services [email protected]
timbercreek.com/advisors lease refer to prospectus and most recently filed public disclosure for further information, including risk factors that could cause actual results P to differ materially from those expressed or implied by any statement herein. Such disclosure is also available upon request to Timbercreek. This document is not to be reproduced or distributed to third parties, and is for use only by qualified investors. 2 Offered for sale and sold only to accredited investors or by another available prospectus exemption. 1
12
Strengthen portfolios with an investment in real estate making real estate a part of your portfolios offers a host of benefits, including a stable income stream and strong returns, capital preservation and diversification through non-correlation to the broader markets. But not all real estate is created equal, and an active approach to investing in this dynamic asset class can help increase returns and reduce portfolio volatility. This publication will tell you more about the benefits of real estate investing in today’s market, as well as the different investment options available when accessing this asset class.
TABLE OF CONTENTS Exploring the benefits of global real estate investing
3
A solution for high correlations and heightened volatility
5
REITs as a proxy for direct real estate investing
8
A 4-quadrant approach to real estate investing
10
About Timbercreek
12
Timbercreek Asset management is a global expert in private and publicly traded real estate investments, focused on delivering predictable, sustainable and growing returns to investors.
2
Exploring the benefits of global real estate investing Stability and performance in today’s challenging market environment Investors today face challenges that can only be overcome with innovative thinking. Real estate, whether in the form of private, direct investments or publicly traded companies via mutual funds, is particularly fertile ground for the out-of-the-box solutions investors need.
Done correctly, real estate investing can help dampen volatility and provide enhanced income streams for client portfolios.
A large proportion of investors have three main priorities when it comes to building a portfolio: 1) income, 2) diversification and 3) capital preservation through low volatility, but with meaningful growth. For decades, the standard approach to meeting these goals was the 60% equity, 40% fixed-income portfolio. There is increasing recognition that this approach is no longer adequate.
One of the reasons real estate is so attractive is that the income it generates is not fixed. With strong active management, real estate income can grow over time, typically at the pace of inflation – or slightly higher.
Today’s key challenges The inability of the old formula to deliver in today’s environment stems, in the first place, from structurally low yields offered by developed-country government bonds – once a reliable source of safe, robust fixed-income returns. Figure 1, below, shows just how much yield has been sapped from client portfolios in the past 20 years. Figure 1: The decline of government bond yields in Canada, the United States and Germany
Real estate advantage
Real estate income is predictable and transparent because it’s based on long-term leases. For instance, a large mall anchored by a high-end retailer in an affluent neighbourhood will generate high, consistently growing rents with a very low probability of delinquency. It’s a winning formula, which is why global real estate’s annualized performance of 9.8% over the past 15 years beats Canadian equities (7.4%), the S&P 500 (6.7%), global equities (6.5%) and global bonds (5.1%). Figure 2: 15-Year Annualized Performance 9.8%
10% 8% 6%
7.4% GCAN10YR Index USGG10YR Index GDBR10 Index
6.7%
6.5% 5.1%
4% 2% 0%
94 996 998 000 002 004 006 008 010 012 014 016 19 1 2 1 2 2 2 2 2 2 2 2
Source: Bloomberg, as at December 31, 2016.
Exacerbating the new normal of low yields is increasing volatility in equity markets. For example, Bloomberg data shows that between 1985 and 1999, there were almost 800 days where the S&P 500 Index saw market fluctuations of greater than 1%. For the years 2000 through 2015, that number jumps to over 1,200.
Global Real Estate
Canadian Equities
S&P 500
Global Equities
Global Bonds
Source: Bloomberg. Data as of December 31, 2016. Performance data in local currency. Indices include FTSE EPRA NAREIT Developed Global Real Estate Index, S&P/TSX Composite Index, JP Morgan Global Aggregate Bond Index, S&P 500 and MSCI World Index.
But security selection is key. While global real estate as a whole should currently be expected to generate income of about 4%, strong active management can yield 6% to 7%. One of the ways this is accomplished is by stripping out securities that are known to detract from income.
3
your guide to global real estate investing
For example, real estate developer stocks and emerging market real estate stocks tend not to pay strong dividends; an effective active manager will screen them out. Strong active management is also a guard against what’s commonly viewed as real estate’s Achilles heel: rising interest rates. To offset this potential headwind, an experienced real estate fund manager will take a number of steps, including buying companies with attractive cash-flow growth. Additionally, from a historical perspective, interest rates tend to rise when economies strengthen, which drives increased cash flow for real estate companies. This growth effectively trumps the effect of rising rates.
Diversification and low volatility Building a diversified portfolio through low- or noncorrelated assets has long been the cornerstone of security selection. For decades, this was accomplished with a simple stock and bond allocation. But recent years have seen a tightening of correlations between equities and fixed income, leading investors to search for other ways of achieving the diversification they need to weather turbulent markets. Real estate – both private and publicly traded – delivers diversification through low correlations to traditional asset classes. For instance, Canadian real estate has only a 0.52 correlation to Canadian equities, and a 0.50 correlation to U.S. equities.1
1
Complementing real estate’s diversification benefits is the low-volatility return path that’s so important to investors focused on capital preservation. Long-term leases have a major smoothing effect on cash flows, whereas general equities’ cash flows go up and down with the economy.
Meeting investor needs Strong, reliable income. Diversification. Capital preservation through low volatility, plus meaningful growth. Global real estate delivers on each of these investor priorities at a time when traditional assets fail to pull the weight they once did. And when paired with experienced active management, real estate can go well beyond replacing the income streams lost in today’s low-yield environment.
IN THE NEXT CHAPTER
A solution for high correlations and heightened volatility explains how making real estate a part of a portfolio can help counter the negative impact of market volatility and the rising correlation between equities and fixed income. It also explains how active management allows real estate investors to achieve reliable income streams and consistent long-term growth.
Source: Bloomberg. Data as at December 31, 1992 to December 31, 2016.
4
A solution for high correlations and heightened volatility Publicly traded and private real estate offer diversification and stability Tighter correlations between traditional asset classes and increasingly volatile equity markets have left investors searching for solutions that add meaningful diversification and stability to their portfolios. Real estate, whether private or public, stands out among the available options that can deliver what investors are looking for.
Low correlations Global real estate has an attractive 0.36 correlation to global bonds, and a 0.77 correlation to global equities.1 The latter figure appears high, but it doesn’t tell the whole story. Consider the more nuanced picture presented in Figure 1 below.
Correlations to equity markets Figure 1: Real Estate / Equity Regional Correlations Region
U.S.
Canada
Europe
Hong Kong
Japan
Singapore Australia
U.S.
0.55
0.43
0.45
0.36
0.32
0.47
0.5
Canada
0.50
0.52
0.39
0.36
0.28
0.48
0.44
Europe
0.53
0.43
0.57
0.39
0.41
0.52
0.54
Hong Kong
0.61
0.55
0.43
0.89
0.3
0.72
0.52
Japan
0.34
0.27
0.34
0.25
0.76
0.31
0.4
Singapore
0.53
0.52
0.44
0.70
0.32
0.84
0.49
Australia
0.43
0.38
0.41
0.34
0.28
0.37
0.26
Source: Bloomberg. Data as of December 31, 1992 to December 31, 2016.
Overall, correlations between global real estate and equities are low; there are only a handful of areas – focused in Asia – where correlations spike. For example, Hong Kong real estate is highly correlated to its local equity market. The same is true of Japan and Singapore. Conversely, Canadian real estate has a low correlation to its local equity market, with the same being true of the U.S., Europe and Australia. In addition, correlations between specific real estate markets and foreign equity markets are, with few exceptions, markedly low. Skilled active management can counteract the few instances of elevated correlations. Underweighting those markets, and overweighting markets that have low correlations to equity markets, will tend to bring down the overall correlation to equities. Low correlations are also observed within global real estate. Canada’s real estate market has a 0.55 correlation to U.S. real estate, 0.53 to Europe, 0.34 to Hong Kong, 0.28 to Japan, 0.39 to Singapore and 0.53 to Australia.
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Your guide to global real estate investing
Low correlations across borders Figure 2: Global Real Estate Regional Correlations Region
U.S.
Canada
Europe
Hong Kong
Japan
U.S.
1.00
0.55
0.60
0.31
0.32
0.33
0.52
1.00
0.53
0.34
0.28
0.39
0.53
1.00
0.32
0.33
0.30
0.48
1.00
0.20
0.75
0.25
1.00
0.26
0.26
1.00
0.27
Canada Europe Hong Kong Japan
Singapore Australia
Singapore Australia
1.00
Source: Bloomberg. Data as of December 31, 1992 to December 31, 2016.
The reason for this is that real estate, unlike other asset classes, is entirely local. If you need an office in Tokyo, for example, you can’t substitute one in Toronto. This stands in stark contrast to the extremely high correlations we observe across equity markets.
Low volatility Many investors are gravitating towards strategies that lower the overall volatility of their portfolios. One reason is to avoid the psychological discomfort that can result from increasingly volatile equity markets. Another reason is based on an important investment rationale: exposure to significant market downturns makes future gains less beneficial. Lowering volatility is effectively a “win more by losing less” strategy. If an investor’s portfolio loses half of its value, it needs a 100% return just to get back to its pre-downturn level. By reducing volatility, the investor boosts long-term returns by making future gains add to portfolio growth, rather than simply make up for previous losses. Unlike equities, real estate investments – whether private or publicly traded – can create this low-volatility cushion for portfolios. If you look at equities, sector by sector, what you find is that most companies’ earnings are immediately responsive to economic events. For example, if China devalues the yuan and cuts its resource intake, global economic growth is reduced and stocks’ earnings per share see an almost-immediate negative impact.
Because they’re based on long-term leases, real estate investments are more insulated from such events. If you have an average lease term of seven years, and the average economic cycle is seven years, you won’t hit the bottom of the cycle. By the time the leases roll over, the economy will be coming out of the trough. By smoothing out the low points, long-term leases create more even cash flows, lowering volatility.
Smart leverage Some worry that the leverage used in real estate investing introduces risks that could increase volatility. A comprehensive risk-management process, which includes a local presence in key markets, can alleviate these concerns. Matching the amount of leverage to the characteristics of the property – location, tenant quality, lease terms – allows the fund manager to effectively dampen risk. For example, a mall in an affluent neighbourhood with long lease terms and the highest credit-quality tenants could safely take 70% to 75% leverage. A property that does not have these attributes to the highest degree should involve less leverage. A conservative average for a portfolio of real estate holdings will typically fall in the range of 60% to 65% leverage.
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your guide to global real estate investing
Solving problems for today’s investor Real estate – both private and publicly traded – is a proven solution for investors seeking greater diversification and lower volatility. Guided by experienced active management, real estate investors can also achieve reliable income streams and consistent long-term growth.
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IN THE NEXT CHAPTER
If investing in commercial real estate directly is too complicated and cost-prohibitive, a portfolio built with REITs may be the solution. Read more in REITs as a proxy for direct real estate investing.
Source: Bloomberg. Data as at December 31, 1992 to December 31, 2016. Indices include FTSE EPRA NAREIT Developed Global Real Estate Index, S&P/TSX Composite Index, and the JP Morgan Global Aggregate Bond Index.
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REITs as a proxy for direct real estate investing Actively managed portfolios of global REITs can deliver the key benefits of direct real estate investing An allocation to real estate offers a host of benefits for investors of all types: a stable income stream and strong returns, inflation protection, capital preservation and diversification through non-correlation to the broader markets. But retail clients may not have the financial capacity to invest in commercial real estate directly. For these investors, real estate investment trusts (REITs) are an effective alternative – with some added advantages. Unlike direct investing, which has high barriers to entry, REITs are easily accessible by investors of all types. REITs also have a highly liquid and transparent structure. Plus, they offer a diversification advantage by providing access to a wider range of real estate exposures than direct investing. But not all REITs are created equal. Passively managed vehicles tend to lose some of the advantages that lead investors to real estate in the first place. For example, these REITs have a tendency to move in lock-step with the broader equity market, and this high correlation diminishes their diversification benefits.
Active management is the solution Through careful screening and selection, active management is able to create a portfolio of pure-play REITs that retain all the advantages of listed vehicles while at the same time capturing the benefits of direct real estate investments. Figure 1 below compares the performance of Canadian direct real estate, the S&P/ TSX Capped REIT Total Return Index and Timbercreek’s actively managed portfolio of publicly listed real estate. Figure 1: Direct and Listed Property 200
Actively Managed
Canadian Direct Property Canadian Listed Property Pure-Play REIT Portfolio – Timbercreek
180 160
120
Passively Managed
Sep 16
Dec 16
Jun 16
Mar 16
Sep 15
Dec 15
Jun 15
Mar 15
Sep 14
Dec 14
Jun 14
Mar 14
Sep 13
Dec 13
Jun 13
Mar 13
Sep 12
Dec 12
Jun 12
Mar 12
100 Sep 11
Importantly, the active solution of publicly listed investments is more tightly correlated to direct investing than the passive option (97.0% versus 88.7%, respectively).1 This is clear evidence that active solutions are a more effective proxy for direct investing than passive REIT investment vehicles.
The power of process
140
Dec 11
Returns for the actively managed, pure-play portfolio of publicly listed real estate exceed both direct real estate investment and the passive, indirect investment option. While volatility for direct real estate will always be lower than publicly listed investments (3.4%), the actively managed pure-play portfolio bests the passive option (9.4% versus 10.0%, respectively).1
Canadian Direct Property: Canada REALpac/IPD Total Return All Property Index Canadian Listed Property: S&P/TSX Capped REIT Total Return Index Pure-Play REIT Portfolio – Timbercreek: Publicly traded common equities and preferred stock holdings from the Timbercreek Global Real Estate Fund (TSX:TGF). The stated return is presented in CAD, net of all fees, expenses and taxes.
A strong process is the key to achieving the advantages of active management described above. It should include two key phases: 1. Filtering out companies that undercut the benefits of real estate investing 2. Comprehensive company and market analysis of remaining candidates to identify stocks for inclusion in the portfolio
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your guide to global real estate investing
FIlTERIng oUT dETRACToRS Out of the approximately 500 companies that make up the universe of listed global real estate securities, about one-third tend to detract meaningfully from performance and should be screened out. Think of this initial screening step as a removal of impurities. Common detractors include: • real estate developers; • brokers; • construction companies; • poorly located assets; • highly levered assets; and • emerging markets-based names, particularly developers and home builders. Developers typically don’t pay dividends. They usually redirect capital gains into the next project. Builders and brokers often pay very low dividends. Emerging markets names also pay weak dividends and tend to have unstable businesses. By stripping those away you see your income rise tremendously. Poor-quality real estate, financially engineered cash-flow streams and highly levered assets are other hallmarks of the group of names that a strong active manager screens out immediately. Those are the things that tend to give you more volatility and diminish the positives of exposure to real estate. Removing them can help you get closer to the experience of direct real estate investing, but through a liquid vehicle. ACTIvE SElECTIon At this point in the process, it’s all about the underlying assets. A wide range of variables are parsed and analysed, and while quantitative tools help crunch the numbers, final calls on which names make it into the fund should be shaped by the portfolio manager’s real estate experience and expertise. One group of variables measures internal growth prospects. They include occupancy rates, lease rollover relative to comparable local-market units, operating margins, and contractual rent increases. The goal of the analysis is to develop forecasts for a number of key metrics, including net operating income, cash flows and dividend sustainability, as we would with direct real estate investments.
1
It’s also critical to examine companies’ track records and prospects for external growth. This involves assessing acquisition and sale activity. Is management making smart choices when they buy and sell properties? Have they shown good judgement in the way they’ve financed acquisitions? Another important variable is capital improvements. Things like renovating an apartment building’s lobby or adding high-end amenities can generate higher rents over the long term. Strong, sustainable income is the goal, but only at an acceptable level of risk. An elaborate risk management regime will examine a host of variables, including: • Real estate risk – Considers asset quality and location (in part through property tours), as well as lease structure • Corporate risk – Assesses management quality (partly through in-person meetings) and company business model • Balance sheet risk – Examines key metrics such as leverage, interest rate sensitivity and fi xed charge ratio • Stock price risk – Analyzes liquidity (30-day average volume) and volatility (one-year standard deviation) The result: A high-active-share portfolio of quality global names that offers a liquid proxy for direct real estate investing. Such a portfolio will have exceptional prospects for income generation and growth because its constituents are purchased at a discount to intrinsic value.
A real alternative With the right process and management expertise, an actively managed global REIT portfolio can deliver the key benefits of direct real estate investing. Even though they’re liquid portfolios of stocks, they behave much more like a bricks-and-mortar real estate portfolio.
IN THE NEXT CHAPTER
A 4-quadrant approach to real estate investing describes Timbercreek Asset management’s unique approach to lowering risk and enhancing returns in a real estate portfolio.
Source: Bloomberg. Data as at October 1, 2011 to December 31, 2016.
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A 4-quadrant approach to real estate investing Boost portfolios with a balance of public and private exposure to real estate equity and debt Investors have long turned to real estate for income, inflation protection and diversification. There are a variety of ways to access this asset class, including private, direct investments in bricks-and-mortar properties, debt investments backed by real estate, publicly traded real estate investment trusts (REITs) and publicly traded debt-like instruments. Each of the four main types of real estate exposure – private equity, private debt, public equity and public debt – has its own set of advantages. Arguably the best approach is to combine their complementary benefits.
Combining strengths Having all four types of real estate exposure allows investors to offset the limitations of one type with the benefits of another. Figure 1 illustrates the primary features of each type of exposure. Figure 1: The Four Quadrants of Real Estate Exposure
STABILITY
GROWTH
YIELD
Private Equity
Private Debt
LIQUIDITY
REAL ESTATE
Public Equity
Private equity: high returns with low volatility A private equity allocation consists of direct investments in real estate (bricks-and-mortar investments) and privately held companies that primarily own real estate. As an active investor, Timbercreek's focus is on investments where value can be created by improving net operating income (e.g., through renovations or recapitalization) or the overall quality and competitiveness of the property. Private debt: stable income A private debt exposure involves direct investments in debt that’s secured by real estate or issued to companies that focus on real estate. The aim of the portfolio manager should be to identify opportunities that generate more yield than would normally be expected for the level of risk undertaken. Timbercreek’s focus is on shorter-duration mortgage loans to protect invested capital in a rising interest rate environment. Public equity: strong returns with high liquidity This is the most liquid form of real estate investing, targeting common equities of publicly traded issuers backed by real estate, such as REITs. Investing in REITs provides a diversified exposure to real estate assets. Timbercreek targets both income and opportunistic growth with the aim of generating substantial returns. Public debt: stable income and liquidity
Public Debt
A public debt exposure includes investments in publicly traded preferred stock, unsecured debt, convertible debentures, preferred equity of REITs and mortgage REITs. Timbercreek targets undervalued securities to generate outsized returns. As with private debt, Timbercreek is looking for securities with yields that are greater than would be expected given their risk levels.
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Your guide to global real estate investing
Where one of these four types of exposure shows limitations, another steps in to offset it. For example, private equity’s stability comes at the expense of liquidity. This disadvantage is overcome when the investor has an allocation to public real estate equity and debt. Conversely, while strong active management will dramatically reduce the volatility of a public real estate portfolio, an allocation to private equity and debt can provide a degree of stability that exchange-listed investments cannot match.
By the numbers A portfolio that includes a real estate allocation combining all four exposure types has substantial benefits over the typical 60% equity, 40% bond portfolio. In addition, Figure 2 illustrates the benefits of achieving the optimal combination of global direct and global listed property (based on 25 years of performance, ending December 2015). Figure 2: Combining Global Direct and Global Listed Real Estate 8.5%
0% Global Direct Property/ 100% Global Listed Property
8.0%
RETURN (p.a.)
7.5% 7.0% 6.5%
70% Global Direct Property/ 30% Global Listed Property
6.0%
100% Global Direct Property/ 0% Global Listed Property
5.5% 5.0% 6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
VOLATILITY (p.a.)
A 30% allocation to global listed property and a 70% allocation to global direct property provides the highest potential return with the lowest volatility of returns in a global property portfolio.
Best of all worlds Innovative new solutions now enable clients to harness the full range of benefits real estate offers. With a multi-strategy approach, investors no longer have to make compromises to achieve liquidity, stability, income and growth. In today’s investing environment, it’s important to look at asset classes that can help enhance portfolio returns and lower volatility. The real estate asset class can do just that, with an active approach enhancing these benefits.
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About Timbercreek
LIQUIDITY
Less
Founded in 1999, Timbercreek Asset Management is an active investor, owner and manager of global real estate and related assets focused on delivering sustainable and growing returns to our investors. We maximize value by employing a value-oriented investment philosophy combined with an active, hands-on asset management platform, to identify opportunities that will generate predictable and sustainable Timbercreek long-term cash flow. Our global team is located in key Four Quadrant Global Real Estate Partners markets around the world and takes a hands-on approach to Timbercreek managing investments. Global Real Estate Fund Timbercreek Global Real Estate Income Fund
Timbercreek provides a range of globally diversified real estate investment solutions designed to suit a variety of investment objectives.
More
Timbercreek Offerings Less
PRIVATE
More
Timbercreek Global Real Estate Income Fund1
Timbercreek Global Real Estate Fund1
Timbercreek Four Quadrant Global Real Estate Partners2
Up to 10%
Up to 20%
Up to 70%
Liquidity
Daily
Daily
Quarterly
Target Yield
5-6%
6-7%
4-5%
Quarterly
Quarterly
Monthly
1.00%
1.25%
1.50%
Accredited Investor
No
No
Yes
RRSP Eligible
Yes
Yes
Yes
$500
n/a
$25,000
Characteristics Private
Distribution Frequency Management Fee
Minimum Investment Fund Code
Ticker Symbol
Series A
TBR201
TGF.UN
TBR600
Series F
TBR203
—
TBR601
For more information on Timbercreek’s offerings, please contact: Timbercreek Asset Management 25 Price Street Toronto, ON, Canada M4W 1Z1 1.866.898.8868 [email protected]
George Ganas, MBA, CFA Senior Vice President, Business Development & Client Services [email protected]
timbercreek.com/advisors lease refer to prospectus and most recently filed public disclosure for further information, including risk factors that could cause actual results P to differ materially from those expressed or implied by any statement herein. Such disclosure is also available upon request to Timbercreek. This document is not to be reproduced or distributed to third parties, and is for use only by qualified investors. 2 Offered for sale and sold only to accredited investors or by another available prospectus exemption. 1
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