sir john templeton’s
TRANSCRIPT
Volume VI Issue 1 A Publication of Paramount Capital
Corporation Jan 15, 2014
Strategy and Insight for the Commercial Real Estate Industry
Inside This Issue:
Real Estate Focus:
2014 CRE Outlook
and Investment
Recommendations.
Summary of 2013
REIT Stock
Recommendations.
Economic Focus:
Sir John Templeton’s
Rules for Investment
Success.
Historical Graph of
10 Year US T-Bond
Yields.
REIT Focus:
Cedar Realty Trust,
Inc., a Retail REIT.
REAL ESTATE FOCUS
2014 CRE Outlook and Investment Recommendations
Summary
The CRE industry is starting to heat up with many of the non-core markets seeing
activity for the first time in six years. Our local city of Walnut Creek, CA, with a
population of only 65,000 and located about 25 miles east of San Francisco in the East
Bay, has more than 800 apartment units under construction and a major 300,000 sq. ft.
expansion/renovation of the Broadway Plaza regional mall in the city’s downtown. As
we look forward to 2014, we here at VOM are very optimistic on the CRE market and
believe that all major sectors; office, retail, apartment and industrial and transaction
volume of leasing, sales and financings will outperform this year. There should be plenty
of debt capital available with banks and other lenders increasing their 2014 funding
allocations. Equity capital should also be obtainable from HNW investors, private equity
funds, sovereign wealth funds, RIA’s and other investors.
Interest Rates
GDP growth, which was 4.1% for Q3 of 2013 should average 2.5%-3.5% in 2014. Even
though interest rates have increased with the 10 Year T-Bond at around 3% from a low of
1.6% in the summer of 2013, the demand for all property types should increase. We
expect the 10 Year T-Bond to increase to 3.25% in March 2014 and 3.5% by the summer
of 2014, with a yearly closing rate between 3.5% and 3.75%. A graph of the 10 Year T-
Bond and Swap rate is shown below and a longer term chart is featured in the Economic
Focus section.
Development
New development has been muted, except for apartments, and we expect demand to
outpace new construction in many markets. However, development of office and
residential properties in core markets like New York, Miami and San Francisco is
booming. There are more than 20 cranes up for construction in the Bay Area of CA,
primarily for office and residential developments. Investors need to be selective in new
construction opportunities and be aware of the risks associated with new development.
Stabilized cap rates on the cost of new developments for office and apartments are very
thin at 4%-7% in the core markets and these skimpy returns do not leave room for any
cost overruns, higher interest rates or slower absorption. A number of REITs are also
increasing their construction programs like Kilroy Realty Corporation for office buildings
and Mack-Cali Realty Corporation for apartments.
REITs
REITs had a difficult year in 2013, with the FTSE All Equity REIT Index up only 2.26%
through November 2013. This was primarily due to the rise in interest rates. However,
REITs have had a robust five year average annual return of 20.37% as shown in the table
below courtesy of NAREIT. Please note that the 20 year REIT return of 10.28% has
beaten the major stock indexes for that period. An allocation of 10%-20% of every
person’s investment portfolio should be in REIT stocks. This will not only increase
return but reduce risk as REITs have a low correlation with other asset classes.
Additionally, the average REIT dividend is 3.77% versus 2.02% for the S&P 500 which
adds stability and additional return to REIT stocks.
Cap Rates
Although cap rates have been compressed for apartments and institutional quality core
office and retail properties, we expect them to moderate somewhat due to new
construction and higher market interest rates. We are also recommending that investors
seek CRE investments in non-core and smaller real estate markets where the cap rates are
2% to 4% higher. Investors need to consider risk adjusted cap rates when investing in
different markets around the country. Investors in Class A properties should be
indifferent (assuming there are no liquidity issues upon sale), in acquiring a $50 million
property at a 5% cap rate in downtown San Francisco or New York and the same type of
property in Tucson, AZ or Oak Brook, IL at an 8.5% cap rate. Each investment is relative
to the respective market and is equalized by the risk adjusted cap rate. Acquiring CRE at
low cap rates is one of the main reasons for poor performance and equity losses by
investors. A low cap rate CRE investment is like buying a hot stock at a price earnings
ratio of 100. There is little room for error if the investment does not perform according to
over optimistic projections. A chart of Class A cap rates for 2013 and 2012 courtesy of
Integra Realty Resources, Inc., a valuation firm, is shown below.
Financing
Financing for CRE is expanding and there should be ample funds available in 2014. The
CMBS market has come back with approximately $50 billion in new issuance n 2013 and
more than $60 billion projected for 2014. Other lenders including banks, the GSE’s, life
companies and REITs will be very active in 2014. Below is a table of commercial real
estate loans outstanding by lender courtesy of the Mortgage Bankers Association Third
Quarter 2013 CRE Report. Even though commercial lending is increasing, the mortgage
debt outstanding of $2.4 trillion is down 37% from the 2007 Q4 MBA Report amount of
$3.3 trillion
Property Types
Apartments are still the favored property type but there are more than 346,000 units
projected to come to market in 2014 from 221,000 units completed in 2013. Hefty rent
increases of 3%-8%+ as seen in the last few years in constrained markets like San Jose,
San Francisco, Miami and New York may be coming to an end. One of the hottest
apartment markets in the country a few years ago was Washington D.C., however, it is
now one of the softest. There have been thousands of new units built in D.C. during the
last few years, primarily by the apartment REITs, and it will take four years to absorb all
the new construction. Existing projects are offering one to two months free rent on a one
year lease and average occupancy has fallen to 96%. Investors should focus on the rehab
and renovation of Class B&C properties and acquisitions in non-core markets where risk
and return are more favorable.
Office markets in the core cities of New York, Miami, Boston, San Francisco and Seattle
have seen brisk activity and low cap rate during the last few years, while suburban
markets have been very difficult. Many of the REITs that own suburban office buildings
like Highwoods Properties, Inc. and Mack-Cali Realty Corporation are trading at
attractive net asset values with 5%+ dividend yields. We think suburban office should
begin to outperform urban properties and they can be purchased at attractive cap rates of
8%-10%. Investors need to underwrite and buy these properties based on less than 95%
stabilized occupancy as many of these buildings may never achieve full occupancy. A
negative trend that seems to be accelerating is the reduction in office space per worker.
Currently, the average space per worker is about 190 sq. ft., however, many new
buildings are being developed with reduced space per worker at 160 sq. ft. or less.
The retail sector has continued to recover and should see increased development and
investment activity in 2014. One of the hottest sectors in 2013 was the net lease retail
sector with billions of investment transactions, primarily by the public and private REITs.
Most of this robust investment activity was spurned by the drop in interest rates and the
flood of money provide by the Fed’s ZIRP and quantitative easing. Shopping trends such
as show rooming, bricks and online, mobile and seamless experience over all platforms
will continue to change the industry. There were also many retailer bankruptcies and
store closings in 2013 including Fresh & Easy, Loehmans, Blockbuster and Fashion Bug.
Retailers with shaky financials, poor management and business models that may
negatively affect the retail investment business in 2014 include JC Penney, Sears/Kmart
and the office supply companies. Many retailers are reducing their real estate footprint to
reduce space costs and counter online sales as they create a seamless brick and online
retailing experience. For example, Wal-Mart and Target have reduced their store sizes
from 180K sq. ft. to 150K sq. ft, Lowes is going from 160K sq. ft. to 150K sq. ft and Best
Buy from 50K sq. ft. to 41K sq. ft.
Industrial real estate is also building momentum into 2014 with the increase in global
trade and investment especially in the major port areas of Los Angeles, New Jersey,
Oakland and Houston. Average cap rates and vacancy rates are 7.5% and 10%,
respectively. The most vibrant activity is in large 1million sq. ft. regional
distribution/fulfillment centers that are being built around the country. Amazon for
example is building 90 million sq. ft. of these large distribution facilities across the
country by 2016.
Summary of 2013 REIT Stock Recommendations
The table below shows our REIT investment recommendations for the year.
REIT Date of
Valuation
Cap Rate
Used in
Valuation
VOM Stock
Recommendation
VOM
NAV
Per
Share
Price Per
Share at
Valuation
Price On
1/15/14
Camden Property
Trust
1/15/13 7.5% Sell $40 $69 $59
Hudson Pacific
Properties, Inc.
2/15/13 7.50% Sell $10 $22 $22
CBL &
Associates
Properties, Inc.
3/15/13 7.5% Buy $20 $23 $18
Essex Property
Trust, Inc.
4/15/13 6% Sell $101 $155 $152
Commonwealth
REIT
5/15/13 8% Buy $22 $20 $23
Douglas Emmett,
Inc.
6/15/13 7% Sell $14 $25 $24
UDR, Inc. 7/15/13 7% Sell $16 $25 $23
Inland Real
Estate
Corporation
8/15/13 7.5% Buy $9 $10 $10
Highwoods
Property, Inc.
9/15/13 7.75% Buy $29 $35 $36
Mack-Cali Realty
Corporation
10/15/13 8% Buy $27 $21 $20
Home Properties,
Inc.
11/15/13 7% Buy $53 $54 $55
Kilroy Realty
Corporation
12/15/13 7% Sell $37 $48 $51
ECONOMIC FOCUS
Sir John Templeton’s 16 Rules of Investment Success
The great investor, Sir John Templeton, was a global pioneer in investment management
and founded the Templeton Mutual Funds, a successful mutual fund company. As a
pioneer in both financial investments and philanthropy, Sir John, who passed away in
2008, but spent a lifetime encouraging open-mindedness. If he hadn’t sought new paths,
he once said, “he would have been unable to attain so many goals.” We here at VOM
thought it would be educational to list Sir Johns 16 rules for investment success. Even
though Sir John was in the investment management business, these rules apply to
commercial real estate investment as well.
16 Rules for Investment Success:
1. Invest for total maximum “real” return.
2. Invest-don’t trade or speculate.
3. Remain flexible and open minded about types of investment.
4. Buy low.
5. When buying stocks, search for bargains among quality stocks.
6. Buy value, not market trends or the economic outlook.
7. Diversify in stocks and bonds, as in much else, there is safety in numbers.
8. Do your homework or hire wise experts to help you.
9. Aggressively monitor your investments.
10. Don’t panic.
11. Learn from your mistakes.
12. Begin with a prayer.
13. Outperforming the market is a difficult task.
14. An investor who has all the answers doesn’t even understand all the questions.
15. There’s no free lunch.
16. Don’t be fearful or to negative too often.
Historical Look at 10 Year T-Bonds
An interesting chart on the 10 Year T-Bond from 1790 through 2013 is shown below and
courtesy of www.csinvesting.org. The chart reveals the bull market in bonds beginning in
1981 that may be set for a reversal and reversion to the mean with many bond gurus
projecting a 10 Year T-Bond yield of 6%-6.5% in the next few years.
REIT FOCUS
Summary
This month’s REIT Focus is on Cedar Realty Trust, Inc. (“CDR”), a publicly traded
REIT engaged in the ownership and operation of primarily grocery-anchored shopping
centers in the Boston, MA to Washington, DC corridor. CDR owns 67 properties
containing 9.8 million square feet of space and the average occupancy and lease renewal
revenue growth as of 9/30/13 was 92% and 7.3% , respectively. CDR’s properties are
located in PA, MA, CT, MD, VA, NY and NJ. CDR owns a 99.7% economic interest and
is the sole general partner in its UpReit general partnership, Cedar Realty Trust
Partnership, L.P.
CDR completed a secondary common stock offering in January 2014 for 6.9 million
shares and net proceeds of $41.3 million. The proceeds will be used for general corporate
purposes, acquisitions and repayment of debt.
CDR was organized in 1984, is incorporated in Maryland, is traded on the NYSE, is
based in Port Washington, NY and its debt is not rated. CDR has 68.8 million common
shares outstanding and a market capitalization of approximately $447 million.
Management
CDR’s management team includes Bruce J. Schanzer, President, Chief Executive Officer
and Director since June 2011 and prior thereto and since 2007, Mr. Schanzer was
employed by Goldman Sachs & Co and Philip R. Mays, Chief Financial Officer, who
joined CDR in June 2011 after six years with Federal Realty Investment Trust.
Financial Data
Select financial data for CDR as of the 9/30/13 10Q and supplemental data for the period
1/1-9/30/13 is as follows (in millions where applicable):
Real Estate Assets, Gross $1,468
Total Assets $1,336
Mortgages Payable and Credit Facility $741
Common Stockholders’ Equity $529
Revenue $107
Net Loss ($3)
Net Loss Per Share ($.06)
Cash Flow from Operations $34
Unsecured Line of Credit ($310 with $180 used) $130
Market Capitalization $447
Property Debt to:
Gross Real Estate Assets 50%
Market Capitalization 165%
Enterprise Value 62%
Dividend and Yield ($.20/sh.) 3.1%
Valuation Methodology:
First Nine Months Revenue Per Above Annualized $143
Less: Operating Expenses Annualized (excluding depreciation,
amortization & interest expense, plus G&A expenses and other
income)
56
Annualized Net Operating Income 2013 $87
Projected Inflation Rate at 3.5% x103.5%
Projected Forward NOI for Next Year $90
Projected Cap Rate 7.5%
Projected Value of Real Estate Assets $1,200
Add: Net Operating Working Capital 77
Total Projected Asset Value $1,277
Less: Total Debt Per Above (741)
Series B Preferred Stock (at book value) (191)
Minority Interests in Consolidated JV’s (at book value) (5)
Projected Net Asset Value $340
Common Shares Outstanding 69.63M (68.8M common stock
shares, 584K incentive plan shares and 248K operating partnership
shares)
Projected NAV Per Share $4.88
Closing Market Price Per Share on 1/15/14 $6.50
The gross real estate assets, property debt, revenues, net income (loss), funds from
operations and dividends per share for the years 2009 through Q3 2013 are shown in the
table below:
(millions except per
share amounts)
2009 2010 2011 2012 Q3 2013
Gross Real Estate
Assets
$1,555 $1,591 $1,364 $1,460 $1,468
Property Debt $1,053 $839 $878 $784 $741
Revenues $140 $131 $135 $140 $107
Net Income (Loss) ($25) ($51) ($118) $10 ($3)
Funds From
Operations
$52 $29 $26 $27 $27
Dividends Per Share $.20 $.36 $.36 $.20 $.05(1)
(1) Per quarter
As shown above, our net asset value per share for CDR is $4.88/sh. versus a market price
of $6.50 per share. Current average cap rates for retail properties per our experience and
CBRE are in the 6% to 9% range, depending on the location, tenancy and quality of the
property. We have used an average cap rate of 7.5% due to CDRHH’s portfolio being
primarily Class A food and drug neighborhood retail properties.
CDR’s strengths include; lease renewal rental growth of 7.3% in Q3 and stable
occupancy of 92%. Weaknesses include; low dividend yield of 3.1%, high stock price
which equates to about a 6.8% cap rate, a decline in asset growth of 5.5% from 2009, no
revenue growth from 2009 and poor investment and growth strategy.
We are not recommending the purchase of the stock at the current price of $6.50 and the
low dividend yield of 3.1%, especially with minimal growth in assets and revenue.
Food/drug retail centers are excellent investments as they are usually very stable and are
in high demand by institutional investors. However, they trade at low cap rates and the
income is fairly flat with minimal rental increases and are considered bond type
investments. CDR needs to be more aggressive in acquiring assets to grow the company
and should consider investments in other markets than the current Northeast corridor. If
cap rates are too low for food/drug centers, then CDR should consider other retail
properties to acquire at higher returns to grow the company. We think there are more
value oriented retail REITs for investment at values below NAV and 5%+ yields
including Inland Real Estate Corporation and CBL & Associates Properties, Inc.
A five year price chart of CDR is shown below:
REIT Focus reviews in prior issues of VOM are as follows:
1. BRE Properties, Inc., June 15, 2011
2. Boston Properties, Inc., July 15, 2011
3. Simon Properties Group, Inc., August 15, 2011
4. First Industrial Realty Trust, September 15, 2011
5. Public Storage, October 15, 2011
6. Ashford Hospitality Trust, Inc., November 15, 2011
7. AvalonBay Communities, Inc., December 15, 2011
8. Alexandria Real Estate Equities, Inc., January 15, 2012
9. Federal Realty Investment Trust, Inc., February 15, 2012
10. Digital Realty Trust, Inc., March 15, 2012
11. Lasalle Hotel Properties, April 15, 2012
12. Apartment Investment and Management Company, May 15, 2012
13. Equity Residential Apartment Company, June 15, 2012
14. The Macerich Company, July 15, 2012
15. SL Green Realty Corp., August 15, 2012
16. Kimco Realty Corp., September 15, 2012
17. Cole Credit Property Trust II, Inc., October 15, 2012
18. Realty Income Corporation, November 15, 2012
19. Piedmont Office Realty Trust, Inc., December 15, 2012
20. Camden Property Trust, January 15, 2013
21. Hudson Pacific Properties, Inc., February 15, 2013
22. CBL & Associates Properties, Inc., March 15, 2013
23. Essex Property Trust, Inc., April 15, 2013
24. Commonwealth REIT, May 15, 2013
25. Douglas Emmett, Inc., June 15, 2013
26. UDR, Inc., July 15, 2013
27. Inland Real Estate Corporation, August 15, 2013
28. Highwoods Properties, Inc., September 15, 2013
29. Mack-Cali Realty Corporation, October 15, 2013
39. Home Properties, Inc., November 15, 2013
40. Kilroy Realty Corporation, December 15, 2013
General Publication Information and Terms of Use
View of the Market is published at www.paramountcapitalcorp.com/vom-newsletter by
Paramount Capital Corporation and edited by Joseph Ori, Executive Managing Director.
Use of this newsletter and its content is governed by the Terms of Use as described
herein. This newsletter is not an offer to sell or the solicitation of an offer to buy any
security in any jurisdiction where such an offer or solicitation would be illegal. This
newsletter is distributed for informational purposes only and should not be construed as
investment advice or a recommendation to sell or buy any security or other investment,
or undertake any investment strategy. It does not constitute a general or personal
recommendation or take into account the particular investment objectives, financial
situations, or needs of individual investors.
The price and value of securities referred to in this newsletter will fluctuate. Past
performance is not a guide to future performance, future returns are not guaranteed, and a
loss of all of the original capital invested in a security discussed in this newsletter may
occur. Certain transactions, including those involving futures, options, and other
derivatives, give rise to substantial risk and are not suitable for all investors. There are no
warranties, expressed or implied, as to the accuracy, completeness, or results obtained
from any information set forth in this newsletter. Paramount Capital Corporation will not
be liable to you or anyone else for any loss or injury resulting directly or indirectly from
the use of the information contained in this newsletter, caused in whole or in part by its
negligence in compiling, interpreting, reporting or delivering the content in this
newsletter. Paramount Capital Corporation receives compensation in connection with the
publication of this newsletter only in the form of subscription fees charged to subscribers
and reproduction or re-dissemination fees charged to subscribers or others interested in
the newsletter content.
THE VIEW OF THE MARKET NEWSLETTER ARCHIVES
For a Subscription to this letter see http://paramountcapitalcorp.com/vom-newsletter
Copyright © Paramount Capital Corporation 2014
Disclaimer: The information, strategies and material presented in the newsletter are for information purposes only
and not to be considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for
securities, investment products or other financial instruments. This newsletter is available only by paid subscription
and should not be reproduced, copied, emailed or disseminated in whole or in part without the express written
consent of Paramount Capital Corporation.