Neuberger Fund Best on Prime Real Estate: Riskless ReturnCharles Stein
Neuberger Berman Group, an investment unit of Lehman Brothers Holdings Inc. until that firm succumbed to the U.S. subprime crisis, produced the best real-estate returns of the past five years by betting on less-indebted companies that could survive tough times.
The $843 million Neuberger Berman Real Estate Fund, run by Steve Shigekawa and Brian Jones, posted the best risk-adjusted returns among U.S. real estate funds over the past five years, according to the BLOOMBERG RISKLESS RETURN RANKING. Shigekawa and Jones bought companies such as Boston Properties Inc. and Public Storage, allowing them to outperform in 2008 and then keep pace with rivals during the economic recovery that followed.
“We’re most comfortable owning companies with high-quality assets and lower leverage,” Jones said in a telephone interview. “They may trail a bit when markets are improving rapidly, but they will hold up better at times of financial distress.”
Boston Properties and Public Storage, which fit the managers’ definition of high-quality companies, were among the biggest contributors over the past five years to the fund’s returns. Real estate investment trusts have more than tripled since the market bottomed in March 2009, driven by low interest rates, rising rents and an improving economy. Shigekawa and Jones say those trends will continue in 2013 and that investors in REITs could see returns of 10 percent to 13 percent.
Neuberger, which is majority-owned by its employees, is in the process of buying out the remaining stake in the firm held by Lehman Brothers, which acquired the money manager in 2003. Neuberger, based in New York, managed $205 billion as of Dec. 31. Lehman Brothers, one of the biggest casualties of the financial crisis fueled by slumping real estate prices and bad mortgage debt, filed for bankruptcy in September 2008.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
While real-estate companies in the Standard & Poor’s 500 Index have performed twice as well as the broader stock market since March 9, 2009, their volatility is the third-highest among the 24 industry groups in the U.S. market benchmark. The emphasis of the Neuberger Berman managers on companies with well-maintained properties in markets where supply is constrained and rents have the potential to climb has helped them curb price swings.
The Neuberger Berman fund gained 1.3 percent, adjusted for price swings in the five years ended Feb. 19, according to data compiled by Bloomberg. That was the best performance of 28 U.S. equity real estate funds with more than $250 million in assets. The fund had the greatest total return with lower-than-average volatility.
The $4.4 billion Nuveen Real Estate Securities Fund returned 1.25 percent and ranked second on a risk-adjusted basis, with the second-best absolute return and less volatility than peers. The $1.1 billion Cohen & Steers Realty Income Fund returned 1.1 percent over the five years, ranking third.
Public Storage and Boston Properties made the second-and fourth-biggest contributions to the Neuberger Berman fund’s returns in the past five years, according to data compiled by Bloomberg.
Boston Properties is the biggest U.S. office REIT by market value. The management team of the Boston-based company has been able to expand in cities with significant barriers to adding supply, Shigekawa said.
“They own buildings at great locations in what are arguably the best four markets in the country, New York, Washington, Boston and San Francisco,” said Shigekawa.
In October, Boston Properties and Hines formed a joint venture to develop San Francisco’s tallest office building, a 61-story tower. San Francisco’s office market has the best rental growth forecast of any U.S. city, according to Green Street Advisors, a research firm in Newport Beach, California.
Boston Properties’ shares have returned 42 percent over the past five years, including reinvested dividends.
Public Storage is the largest owner of self-storage facilities in the U.S. As Americans have chosen to rent apartments rather than buy homes over the past few years, their need for self-storage has grown, said Jones.
Public Storage has done better than rivals by exploiting its size to attract customers via the Internet, Jones said. In an August conference call with investors, Chief Executive Officer Ronald Havner said the Glendale, California-based firm gets most of its leads from Internet inquiries, “which means we don’t have to pay for them, and that’s certainly attributable to the brand name.”
Public Storage has something else the managers look for: a low level of debt, which allows a company to ride out difficult times and make acquisitions when competitors may not have the resources.
The Neuberger Berman fund’s ratio of total debt to total assets is 48 percent compared with 50 percent for its benchmark index composed of REITs. Public Storage’s ratio is just 3.75 percent, according to data compiled by Bloomberg.
Its shares returned 137 percent over the past five years, more than triple the gains of the FTSE NAREIT All Equity REITs Index.
UBS Investment Research last week cut Public Storage to sell from neutral, saying stock prices in the self-storage business are too high given prospects for revenue and profit growth.
Shigekawa and Jones will relax their standards when they spot a real-estate company they consider undervalued.
In late 2009, the fund invested in General Growth Properties Inc., the second-largest U.S. shopping mall owner, as the Chicago-based firm was working its way through the bankruptcy process. The company filed for Chapter 11 protection in April 2009 after saddling itself with $27 billion in debt.
“We were able to see that the assets weren’t deteriorating,” said Jones.
The managers concluded that General Growth would emerge from bankruptcy as a strong competitor. General Growth gained 73 percent in 2010.
Shigekawa, 42, has worked at Neuberger since 2002 and has been a manager on the fund since 2005. Jones, 41, joined the firm in 1999 and the fund in 2008.
Shigekawa and Jones arrive at their selections by studying both individual companies and economic indicators such as housing starts and the volume of containers entering U.S. ports. Their analysis of regional markets often drives their picks.
The managers in the fourth quarter of 2010 began adding to shares of EastGroup Properties Inc., a Jackson, Mississippi-based owner of warehouses in Sun Belt states, because the area’s population growth is increasing demand for distribution facilities. The shares have returned 70 percent since then, including reinvested dividends.
Shigekawa and Jones also like Essex Property Trust Inc., which owns apartments in Northern California, where a growing technology industry and high home prices have created “the strongest apartment market in the country,” Shigekawa wrote in an e-mail.
The economic analysis doesn’t always translate into good stock picks. In a letter to shareholders for the year ended Aug. 31, 2011, the managers said they invested in Bethesda, Maryland-based hotel chain Marriott International Inc. on the expectation the firm would benefit from an improving economy. The stock had fallen 7.4 percent during the period, including reinvested dividends, when the U.S. economy grew more slowly than anticipated.
Still, the emphasis on stronger companies helped the Neuberger Berman managers as the real-estate market started deteriorating five years ago. In 2008, concerned that the economy and the real estate market were slowing, the managers positioned the fund for hard times.
“We bought companies we thought would protect the portfolio in a period of heightened volatility,” said Shigekawa.
The pair bought health-care REITs and firms that owned real estate in Washington, D.C., on the belief that both markets were relatively well-insulated from the impact of a recession. The fund lost 32 percent in 2008, better than 99 percent of peers, according to data compiled by Bloomberg.
The fund trailed a majority of rivals in 2009 and 2012 when the benchmark index rose 28 percent and 20 percent respectively.
“This past year, you were paid more handsomely to invest in lower quality real estate with higher leverage,” Jim Sullivan, managing director at research-firm Green Street Advisors, said in a telephone interview.
The Neuberger Berman fund did about as well as its benchmark index in periods of rising markets over the past five years, while suffering only 94 percent of the losses in falling markets, according to data from Chicago-based Morningstar Inc.
The fund would keep pace with its benchmark even if the S&P 500 were to rise, according to data compiled by Bloomberg. The Neuberger Berman fund would gain 7.44 percent if the S&P 500 were to surge by 10 percent, compared with a 7.46 percent gain for the FTSE NAREIT All Equity REITS Index, according to the data.
Shigekawa and Jones expect the REIT market to do well in 2013, in part, because the supply of property is being added slowly. Developers are still having trouble getting financing for construction projects, a plus for existing real estate, said Shigekawa.
Others share their optimism. UBS AG analyst Ross Nussbaum predicted a 9 percent total return for REITs in 2013 in an outlook note published in December. Nussbaum described supply as “constrained,” across most property types.
Economic conditions this year should also be favorable. The U.S. is expected to expand 1.8 percent in 2013, according to economists surveyed by Bloomberg. The yield on the 10-year Treasury note will average 2.32 percent, according to the same survey.
Low rates allow REITs to refinance maturing debt on more favorable terms. They also make the dividends that REITs pay attractive on a relative basis. The dividend yield on the benchmark FTSE REIT index is 3.3 percent, according to data compiled by Bloomberg. Were interest rates to rise by 0.25 percent, the fund would lose 0.76 percent, compared with a 0.75 percent decline for the benchmark REIT index, according to data compiled by Bloomberg.
“We think REITs are still early in the recovery period,” said Jones. “This should be an attractive investor story for years.”