As Hedge Funds Struggle, REIT Shares Become Their Victimsby and
NorthStar stock among worst-performing in mortgage-REIT index
Senvest Partners, Orange Capital and SAB among investors
Hedge funds that piled into real estate investment trusts are hurting the companies on their way out.
REITs that have had a relatively large portion of hedge fund owners are struggling with declining stock prices. NorthStar Realty Finance Corp. is one of the two worst performers this year in a Bloomberg index of 41 mortgage REITs, with a 39 percent decline. IStar Inc. has dropped 25 percent, Colony Capital Inc. has fallen 19 percent and New Residential Investment Corp. has slumped 10 percent.
Hedge funds are reducing their stakes in the REITs as market turmoil has caused some of the funds to struggle with liquidity issues. Stocks with a heavy concentration of hedge fund ownership get high valuations when things are going well, and shares are sold rapidly when the funds hit tough times, said Trevor Cranston, a REIT analyst at JMP Securities LLC.
“The selloff is quick,” Cranston said. “So it takes some time for a transition in ownership to happen and for the valuation to stabilize.”
The portion of hedge fund ownership of REITs including NorthStar and New Residential fell in the fourth quarter, according to filings with the U.S. Securities and Exchange Commission. Steadfast Capital Management and Maverick Capital, NorthStar’s two biggest hedge fund stockholders in the third quarter, reduced their stakes by 90 percent and 33 percent respectively in the three months ended Dec. 31.
Gem Realty Capital Management, previously one of IStar’s largest shareholders, sold its entire stake in the REIT from March 31 to Dec. 31. SAB Capital Management, which planned on returning most client money by mid-January, sold all its Colony shares, according to an SEC filing. The firm was one of Colony’s largest shareholders as of Sept. 30. New Residential saw EJF Capital reduce its stake by 83 percent, while SAB sold all of its shares in the REIT.
A smaller concentration of hedge funds will mean that shareholders will stick around longer, said New Residential Chief Executive Officer Michael Nierenberg.
“For us, the underlying fundamentals of our business continue to be very good,” Nierenberg said in a telephone interview. “We are more cautious now, as we should be. However, markets like this create great investing environments.”
New York-based NorthStar didn’t respond to requests for comment on its stock price and hedge fund shareholders. Jason Fooks, a spokesman for IStar, declined to comment, as did Jennifer Hurson, a Colony spokeswoman.
NorthStar, which has among the highest concentration of hedge fund owners among REITs, at 28 percent, acquires loans, bonds and commercial properties such as hotels, office buildings and manufactured housing.
Jade Rahmani, a Keefe Bruyette & Woods Inc. analyst, cut his recommendation on the company’s stock last week to market perform from outperform and said in a report that he expects a successful repositioning of the firm to be a “tall and likely lengthy order.” He had previously recommended the REIT based on its discounted valuation and a belief that strategic actions such as asset sales might help turn the share price around.
Senvest Partners, which boosted its stake in NorthStar to 4.2 million shares in the fourth quarter, saw its main fund lose 12.5 percent in January, according to a person with knowledge of its returns who asked not to be identified because the information is private. A spokesman for the firm declined to comment.
Orange Capital, which owned 3 million shares of the REIT at the end of December, is closing and returning about $1 billion to investors, the Wall Street Journal reported on Feb. 3.
Hedge funds are having the worst start to a year since 2008, falling an average of 1.7 percent in January, according to analysis firm Hedge Fund Research Inc. Returns have been depressed by slowing global growth, falling prices for oil and other commodities, and a strengthening U.S. dollar.
“A lot of hedge funds focus on similar types of companies,” Nierenberg said. “As volatility in the markets picks up and redemptions take place, it creates a domino effect which drives selling in the sector. I think there is a little bit of herd mentality, and that affects everyone.”
REITs aren’t the only firms trading at discounts to their book value, or the amount that would theoretically be left for shareholders were a company liquidated. Some of the large banks are seeing their shares at similar discounts, Nierenberg said.
For NorthStar, the decline is exacerbated by its corporate structure and management contract. The firm is externally managed, which shrinks its base of potential investors because of perceived conflicts of interest associated with that structure, said Jason Weaver, an analyst with Sterne Agee Group Inc. NorthStar’s managers get a flat fee regardless of the company’s performance. New Residential is managed by an affiliate of Fortress Investment Group LLC. Colony and IStar are internally managed.
NorthStar, which was once internally managed, spun off NorthStar Asset Management Group Inc. in mid-2014. Now the two have a 20-year contract that could limit upside given that it calls for a fixed fee that’s not tied to performance and that the agreement is non-terminable, Rahmani wrote in his note.
The REIT has recently gained the attention of activist investor Jonathan Litt, who announced plans to force changes at NorthStar’s management company. Litt’s Land & Buildings Investment Management LLC nominated six directors for election to NorthStar Asset Management and expressed an interest in the firm selling assets and returning to an internally managed structure.
Hedge funds are drawn to REITs that are growing quickly or aggressively raising money, according to Cranston. That was the case for many of the real estate firms last year.
More typical REIT investors, he said, will wait a while “before they are willing to step in, especially given how volatile the market has been this year.”