All the REIT Answers with David Kruth
Article9 Minutes14 April 2023
Can you tell us a bit about your background?
I was born and bred in New York City. My dad worked in advertising and marketing and my mum in telecommunications. I wouldn’t call it a privileged upbringing, maybe classically middle-class, but with a quirk. I was one of those kids that read the Wall Street Journal and invested in stocks in my teens.
I would go to a local brokerage company related to Bear Stearns for the prospectuses of upcoming IPOs. I had a pile of them next to my bed, which is what I would read at night. I was just fascinated by businesses and how they worked.
You could say I got the investing bug early but when I arrived at Ithaca College, a New York state private liberal arts college. The lecturer was an archetypal econ teacher with a pipe, dirty glasses, a plaid shirt and a beard. His first words to the class were “guns and butter”.
After speaking about scarce resources, he drew a supply and demand curve. My head almost exploded. I couldn’t believe a simple chart could explain so much. That night I called my father and told him I was changing to an economics major. A lot of analysts start with the numbers, but I like to start with the business. My economics training has a lot to do with that.
How did you end up in commercial real estate?
In 1981, my freshman year, I began working for a real estate developer during term breaks. He took me to job sites where I worked with contractors and foremen. Eventually, I sat in on meetings with banks and clients, seeing the industry from every perspective. I was 19 and smitten. There’s something about the substance of real estate, the complexity of the build and the financing that I still enjoy.
Tell me about a few of your key roles:
After college, I worked at Schroders as an acquisition analyst and then went to Richard Ellis, a UK commercial real estate company that had opened a US office. That eventually became the Yarmouth Group, which was sold to Lend Lease in 1993, which is how I became familiar with the Australian market.
That period was foundational for me. I worked with some of the smartest British valuers and senior commercial real estate (CRE) people, including investment experts that had studied at Wharton. For eight years I was doing acquisitions and special projects with some of the biggest dealmakers in America. At age 31, they put me on the investment committee and I became the main valuation person in the company.
About that time in the early ‘90s, I had another epiphany. The REIT sector was growing rapidly. There was at least one listing per week. I was like, “wait a minute. I know how to value commercial property and I know the sector inside out. Now I can assess balance sheets, management teams and business models and buy stock in the company if I like it without having to run real estate deals. Why wouldn’t I do that?”
I approached my partners at Yarmouth and made the case to get into REITs. We tried to buy a few companies but it didn’t work out. I made use of that period by becoming a CFA charterholder. In 1996, AllianceBernstein (then known as Alliance Capital) hired me and a colleague to start a REIT fund from scratch.
Alliance seeded the fund with US$1 million and we travelled the country marketing the new fund to brokers. It was a crazy, intense time but by 2005 we had almost US$3 billion under management and, performance wise, we were in the top 10% of all funds during that period and expanded the business internationally. I couldn’t have been happier.
And then you went to Goldman Sachs Asset Management (GSAM) and did it all again?
They had seen what we had achieved at Alliance and asked me to co-lead their efforts in the sector. With the Goldman halo and a big marketing budget, we launched multiple real estate securities funds, including two in the US and one in Japan. We took that business from under US$1 billion to over US$6 billion in about four years.
Any parallels between that situation and your current position with Dexus?
Yes. Dexus is a well-established, respected property company with a burgeoning funds management operation. With platform scale, we’re getting more marketing opportunities to institutional and high-net-worth investors. And because Dexus employs lots of industry experts, we have access to deep insights from asset management personnel right through to senior management. That’s really useful.
How would you describe your investing style now?
I wouldn’t use the term "value investing" because I think deep value investing is a dead science. There’s much more value embedded in brands and business models than in traditional assets like old machinery. I prefer to focus on businesses with strong balance sheets, benefitting from growing demand, rather than traditional value investing strategies. Across the Dexus GREIT Fund, we have a value plus growth perspective, which I think is well suited to the times. We like to call it “growth at a reasonable price” or “GARP”.
How have the recent bank failures affected your thinking?
Whilst these have a different origin to those of the 2008/9 global financial crisis, for commercial real estate investors I think they lead to the age-old conclusion, which is that debt matters. Because of what I lived through during the GFC, I constantly focus on the balance sheet and the ability of a business to endure and even grow in troubled times.
We have stayed well away from REITs with any combination of elevated gearing, high levels of floating rate debt or the imminent need for material refinancing. When businesses have too much leverage and values fall but leverage doesn’t, your equity is clearly at significant risk of becoming impaired. We're really, really focused on creating an exposure to listed portfolios where the underlying real estate demand is reliable and predictable and balance sheets are strong.
Speaking of offices, what are your views on the sector?
For three years, we’ve been underweight office due to pandemic impacts. That’s unlikely to change for the foreseeable future. Many loans on CBD and suburban office properties, written at low-interest rates, will be maturing in the next five years or so. In the US, the problem is that the sector has experienced lower demand, occupation erosion and higher capital concession costs to attract tenants. The result is lower rents and net operating income, a risk that is now being reflected in higher cap rates and corresponding lower valuations. There’s still a lot of pain to go around.
Some asset owners have already figured this out, flicking the keys to lenders. Others will try and renegotiate terms. Equity markets have watched all this unfold, writing down the equity value of most office REITs. Some have more than halved in the past year and most are well down.
The band-aid has been ripped off the sector, leading to a flight to quality. Premier assets are gaining market share while older commodity assets are suffering. The issue is that most REITs own a mix of both, which makes them hard to decipher. That’s why we’ve have minimal exposure to the sector.
Are you investing in any office assets?
Our only substantial exposure is in life sciences and medical offices. Both are highly specialised with more attractive metrics than traditional offices. There are select office markets we like in Asia, Europe and Toronto but our portfolio allocations there are minimal. Like I say, we saw this coming, got out early and aren’t keen on getting back in until the dynamics are more attractive.
Can you give me an example of an office REIT you think is well-placed?
Sure, Alexandria Real Estate Equities is in the fund and is a stock I’m really excited about. Alexandria is the world’s largest owner/operator of high-quality life science real estate, providing wet and dry labs and office space to major science innovators like Pfizer and Moderna. If you’re a lab technician in one of these companies, working from home simply isn’t an option. That removes some obvious risks, and funding for medical research is available from public and private sources so that helps, too.
The company operates a cluster model, where talent, capital and the physical environment combine to form a local ecosystem in places like the Research Triangle in North Carolina, San Diego and Greater Boston. The buildings tend to feature heavy-duty HVAC, air filtering, load bearing and specialised electrical requirements so they’re unique environments, often close to universities, hotels and auditoriums. Tenants spend millions to set them up and they simply can’t pack up a few boxes and move down the road. That removes even more risk. As real estate investors, we like landlords with tenants that have a high barrier to exit.
Alexandria has a US$22 billion market capitalisation, offers a yield of about 4% and has excellent growth prospects. It’s also a great example of the kind of real estate sector exposure that’s simply unavailable to REIT investors in Australia right now.
What areas of the CRE market are you excited by?
We're largely weighted to logistics, for-rent residential, technology (data centres and mobile towers), self-storage, life science properties and daily needs retail like grocery, discount and DIY centres. These are very sticky businesses that make the world go around. We think of them almost like infrastructure.
There are some headwinds right now, but these sectors offer reasonable yields, excellent inflation protection and good growth prospects. Right now, some are trading below replacement costs and private asset valuations so it’s an attractive place to be positioned in the current market.
Lastly, let’s hear the elevator pitch for the Dexus GREIT Fund:
Okay. Well, first, REIT values usually rebound strongly after a terrible year and last year was truly terrible. Many of the stocks in our portfolio are trading below asset value and buying cheaply is the best indicator of selling at a handsome profit. Because of the current uncertainty, this is a great time to get in with a 2–3 year+ time horizon.
Second, our metrics are good. The portfolio’s current yield is over 4%2 - not crazy high but above treasuries. Where I think we’ll excel is in the growth, thanks to higher rents and growing occupancy. Demand for the assets we own is solid and the supply outlook is manageable. We’re simply not in sectors that face structural challenges.
Third, the companies in our portfolio generally have CPI-linked leases or currently benefit from market dynamics which allow a level of immediate access to growing rents. This is especially important in periods of inflation and underpins the real asset qualities accessible by REIT investors.
Fourth, we have a first-rate investment team with decades of commercial real estate investing experience, backed by a company of Dexus’s stature. We’ve invested through many market cycles and are well-positioned to ensure our investors capitalise on the opportunities in the sector that lay ahead.
And finally, the Dexus Global REIT Fund is a simple and effective way to diversify your CRE portfolio with international exposure to the kind of REITs you simply can’t get access to in Australia. I think it’s unique in that regard, unlike anything else on the Australian market which is backed up by the Fund’s performance. Naturally, I’m a big fan.
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