Investors can use the benefit of hindsight to determine what have been the best performing REITs over a one-, five- and 10-year span, but just what are the attributes that set the best REITs apart from the rest? It’s a question a trio of REIT CEOs and one analyst tackled at this week’s RealREIT forum in Toronto.
Falling interest rates and lower cap rates have helped generate good to stellar returns for REITs which has also “masked a few sins,” said panel moderator Tom Rothfischer, a KPMG LLP partner and its GTA real estate industry leader.
With the end of ultra-low interest rates at least somewhere on the horizon, what will be the benchmarks for REIT success going forward? Some off-the-cuff answers included: long-term value creation, total return and net asset value.
“We have always been focused on total return,” said Rob Geremia, president of Boardwalk REIT (BEI.UN-T). “That is a bit of a challenge in Canada because our products lump into financials on the capital side as a result of that. The yield is a big driver in our particular industry.”
NAV is a critical measure for Boardwalk, he added. “One of the key metrics that we do look at is net asset value. When we add to our portfolio or sell from our portfolio, we look at that.”
That NAV focus hurt Boardwalk in its early development after becoming a REIT in 2004, he added. “In 2004 I couldn’t get a meeting in Toronto because I was competing against income trusts,” with distribution yields of 12 to 13 per cent versus the REIT’s five per cent yield.
That pushed the REIT to seek U.S. investors who generally were far more interested in trusts that could demonstrate sustainable asset growth rather than a steady stream of yield income.
Kevan Gorrie, president and co-CEO of Pure Industrial REIT (AAR.UN-T) takes a similar approach, describing quality of real estate as the REIT’s key performance indicator. “We spend a lot of time evaluating our real estate and that means having core product, modern distribution product in the right markets and those markets would be growth markets.”
Gorrie added that Pure REIT does stray a bit from the Canadian market’s yield focus “where we are more value-focused and yield-focused.”
Considering the Winnipeg-based REIT has grown from a single property to an asset base of $5 billion over nine years, the answer most years was likely yes.
Shrink or grow?
David Way, a research analyst with Pyramis Global Advisors, observed that the pressure on most REIT chief executives is to always display forward momentum, which can be challenging.
“The idea of looking at your portfolio every day and saying, ‘Should I be looking at selling assets to buy back my own stock?’ ‘Should I be using my stock, which is trading at a big premium to NAV to try to grow aggressively?’ I find that companies that try to have that capital discipline do better over the long run.
“It is really hard as a REIT to shrink, because I think it is in the DNA of real estate people to want to get bigger. And sometimes bigger is not always better.”
Pure Industrial’s Gorrie agreed, noting that his REIT actually shrank in terms of assets due to the sale of nine or 10 non-core assets over the past year that resulted in dilution in FFO and AFFO that can led to investor criticism.
“People don’t really report how that is impacting your FFO and AFFO; they just focus on the dilution itself. So you have to maintain that discipline and believe in what you are doing and hopefully in the long run people will see the benefit in that.”
Geremia noted that Boardwalk recently sold its B.C. portfolio because it could not buy any more. The REIT used the majority proceeds from the sale to buy back shares, which went over well with investors.
“My experience in that area is whatever you do, have a very good communication strategy to the market: ‘This is what we are doing, this is why we are doing it, this is how we are redeploying the capital into an implied 5.5(%) cap rate – I sold at 4(%) buying at a 5.5 cap rate,’ ” he said. “Even though there is dilution, we are finding that as long as you are there saying it properly, saying it over and over again and proving it, you will do well.
“We are one of the few REITs out there in the last five years, we have bought nothing, we have actually shrunk the last number of years,” Geremia added. “Not because we wanted to, we just felt the deals that were out there in our industry which is multi-family were way overpriced.”
Secrets of management success
The REIT CEOs observed that it is often the little things that make the difference between outstanding performance and so-so results.
In the case of Boardwalk, where the issue is filling buildings in wildly different markets (rent control, no rent control, high vacancy and low vacancy) the strategy is not defined by squeezing every dollar out of tenants. “People ask ‘what is your revenue strategy’ and we say we don’t have a revenue strategy. We have an NOI strategy. Our bottom line is NOI.” That means reducing tenant churn is of prime importance and is a measure it tracks daily though it is not likely top of mind with investors.
Pure REIT’s Gorrie said investors need to evaluate a REIT management team’s ability to grow and grow while improving the quality of its cash flows rather than simply grow for growth’s sake.
“One of the things we keep talking about is interest rates going up, cap rates going up, what that does for liquidity of assets and that is something from an asset-management perspective should always be on your mind with someone else’s money.”
Picking up on the Boardwalk chief’s theme, the ability to drive rents and drive net operating income is also a key measure. First a great REIT will pick the right markets to prosper in and secondly, it has to grow its cash flow.
Finally, Gorrie points to the ability to add value to the portfolio “whether it is through intensification, growing with tenants’ development . . . these are things that are critical for adding value for investors and I think when you are looking at a REIT, you have to look at the ability of a REIT to grow other than just through acquisitions.”