Dexus Global REIT Fund - thinking private, investing public
Article10 mins31 October 2022
In less than three months, one of our investments within the Dexus Global REIT Income Fund more than doubled. While this is not a typical return in the staid but predictable real estate investment trust (REIT) sector, it is one we hope to repeat. Via special situations among North American REITs, I’m going to explain how we found this opportunity and why we expect to uncover more like it.
Each morning, our team's first priority is to review our global REIT dashboard which has been developed over many years. It tracks every listed REIT in the world, including North America, the deepest and most diverse REIT market of all. This morning ritual identifies anomalies worthy of further investigation and indicates fruitful opportunities to dig.
One such example is Bluerock Residential Growth REIT (Bluerock), a residential rental owner of a portfolio of 14,000 apartments in fast-growing cities including Atlanta, Phoenix, Orlando and Austin.
In January 2021, Bluerock’s stock was trading at around $10. Six months later, it reached $12.50. Bluerock still looked significantly undervalued no matter how we cut the numbers; from net asset value to implied capitalisation rate and earnings multiple. It was especially attractive when compared to similar privately-owned companies and REITs.
Upon further investigation, we found a well-managed REIT with great assets, but a complicated balance sheet that was scaring investors away. The company’s enterprise value (market value of debt, preferred and common equity) was US$3bn, but only 25% of that figure was in common equity. Bluerock was carrying US$1.5bn in debt and nearly US$1bn in preferred equity.
Further discussions with management confirmed a quality portfolio with strong underlying fundamentals. We examined the valuation and the impact of the unusual preferred equity component that promised a yield of 6.6%, and found that they were issued at a price several years earlier and were well above the current prevailing market.
To the common equity cashflow, these preferred securities were a burden. We reasoned that the capital cost would likely fall over time and unlock value. This was the upside in the potential income stream that probably didn’t make it into most investors' calculations.
But the real issue was leverage. Most investors weren't inclined to look further than the level of debt and the complicated preferred equity component. The lack of understanding of the REIT’s financial complexities was the reason Bluerock was cheap. In order to take a position, we needed to determine if and how the hidden value could be realised.
Bluerock’s share price implied that investors relying on conventional REIT metrics would never recognise its intrinsic value. More experienced, sophisticated investors, however, might. We were looking for a different type of investor who was prepared to approach the opportunity like a private investor while investing in public markets.
As it turned out, we were not alone. The pandemic changed priorities for many, including Bluerock management. On 15 September 2021, the company announced it was looking at “strategic alternatives”. Management was seeking to release the value we had identified that the public markets had ignored.
Our next step was to conduct a merger and acquisition (M&A) valuation which would lead to an inevitable conclusion; a private equity investor was likely to understand and realise the hidden value.
Our reasoning led us back to the balance sheet. Private equity could pay 50% more for Bluerock’s than traded common equity, but in doing so, would only increase the enterprise valuation by a mere 6%. That meant a private equity group could pay a substantial premium for Bluerock’s equity, take it private, and still make a handsome return in due course.
It was now time to act given our confidence in the business and Bluerock now ready to sell. Between October and December 2021, we built our stake at an average price of $13.43 per share.
The valuation recognition came quickly. On 20 December 2021, Blackstone Real Estate announced it was acquiring Bluerock Residential Growth REIT for US$3.6bn. Shareholders, including us, would receive US$24.25 per share in cash, plus shares in Bluerock Homes Trust, Blackstone’s single-family rental business spin-off. Each share in the Trust had an estimated net asset value of US$5.60. In just six months, we received a total of US$29.85 per share, more than twice our original purchase price.
From the intellectual property embedded in our dashboard valuations to the analytical firepower applied to a complex situation, this was a return several years in the making.
More importantly, this go-anywhere style of investing has been repeated many times since the Fund was established in April 2020 and we will continue to dig for opportunities like this in the future.
City Office REIT was another mispriced company we purchased in April 2021. It subsequently sold its life science portfolio to another private equity business for a price similar to that of the entire company’s market capitalisation. Our total return over a seven-month holding period was almost twice the initial investment. In fact, of the three largest M&A deals in 2021, the Dexus Global REIT Fund owned two of them.
We find ourselves seeking a new type of investor. The Dexus Global REIT Income Fund was envisioned in the manner of its predecessors - the Dexus AREIT Fund and the Dexus Asian REIT Fund - both focused on delivering a regular, reliable income.
That objective hasn’t changed. What has evolved though is a proven ability to uncover hidden value in situations like Bluerock and City Office REIT. These may not have a strict income focus, but they have helped deliver market-leading total returns. Such investment case studies also highlight the kinds of opportunities available to investors in the Dexus Global REIT Income Fund as our bottom-up research process and relative-value approach is applied to a global universe of real estate securities.
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