Asia, BIW, catalyst, China, commercial property, de-leveraging, emerging markets, Germany, Joel Greenblatt, KWG Kommunale Wohnen, NAV, Net LTV, Price/Book, residential property, Russia, Sirius Real Estate, special situations, SRE, Stockopedia, Ukraine
Continued from here.
As with Agri, some of my recent posts will overlap. I should obviously point you to my series on German Residential Property, Post I to Post V – it offers an in-depth look at my allocation & stock selection approach to Property. This culminated in a recent stock-pick I’m v pleased with: KWG Kommunale Wohnen (BIW:GR), a 5.1% portfolio holding.
At EUR 5.475, it’s up +6% since my write-up a month ago (and +9% from my actual avg. entry price). It’s clearly left resistance at EUR 5.25-32 trailing in the dust, and the next EUR 5.60-80 resistance now beckons. A possible break of EUR 6.10-20 in due course may suggest the share’s ready to muscle its way far higher. It’s fascinating to note that price level corresponds to a KWG market cap of about EUR 100 mio: Which is precisely the level I highlighted as a possible sweet spot for the market to award KWG a significantly higher price/book valuation!
You know, I’m not much of a stock screener – I mean why ruin a day of reading annual reports instead?! 😉 But I do think property stocks lend themselves v nicely to a stock screening approach (Stockopedia, of course!) – there’s only a couple of key variables on which you really need to focus. In fact, let me suggest a stock selection strategy, a la Joel Greenblatt:
Select all property stocks (or a subset, to reflect a Great Story). Let’s say the total no. of stocks is 40. Rank them from cheapest Price/Book (scoring 40) to the most expensive (scoring 1). Now rank them again from best negative Net LTV (i.e. Net Cash, scoring 40) to the highest Net LTV (scoring 1). [OK, I haven’t checked, but Net LTV probably doesn’t exist on most/all screeners – a quick download of key B/S figures & some number-crunching gets you there. Debt/Equity, or a similar ratio, is an acceptable proxy also.] Now sum those scores, and rank accordingly – I’m confident the highest scoring companies will offer a v interesting & rewarding property portfolio/allocation.
OK, that was a little simplistic, but it would probably get you most of the way there… With property companies, first you must focus exclusively on Leverage. This weeds out the lottery tickets/no-hopers – as far as I’m concerned, no property stock’s cheap enough to invest in if it has a Net LTV of, say, 85%!
Personally, I’ve no interest investing in stocks with, say, a Net LTV > 60-65%. And that only applies to a property investment company with exposure to a compelling geography/segment (like Germany). If a company’s exposure was less attractive, or riskier, I’d prefer to scale back that limit. And with property development companies I’d probably limit Net LTV to 40-45% (to offset higher risk). You’re probably wondering where does that leave you..?
Actually, pretty nicely! Even 4-5 full yrs after the financial crisis, it’s gratifying to see so many cash rich/low debt property companies trading at attractive prices. Actually, it’s mystifying why people even take on the challenge of analyzing & investing in distressed property companies. Sure, they’re a little cheaper, but why bother with the risk & aggravation when there’s plenty of perfectly good safe & cheap bargains on offer! Reminds me of investors who dive into retailers & old media stocks – not my cup of tea, I think there are far easier investments to make. But if you’re hell-bent on those sectors, at least invest in the cash-rich or low-debt companies – they’re bloody cheap too..!
This cheapness is particularly evident in the UK, which is pretty irrational… There’s nothing to suggest the UK’s a worse market, in relative terms, esp. if we’re talking about companies focused on foreign property! Plenty of other markets offer good value & discounts too. All except the US, really – which prefers to reward its listed property investors with often huge premiums, plus leverage, plus a woeful lack of ex-US diversification!
Property companies tend to understate their Net Loan-to-Value ratios. I like to calculate my own, using this formula:
(Borrowings + Financial Derivative Liabilities + (Convertible/Preference Liabilities + Pension/Employee Liabilities + Government Loans/Repayable Grants etc.) * 50% – Cash/Marketable Securities – Derivative Financial Assets) / (Current/Non-Current/Held-for-Sale Property)
This includes the net impact of derivatives (mostly interest rate swaps, a significant B/S item in recent yrs with the collapse in rates). I also include 50% of convertible/preference capital, pension deficits etc., which seems an appropriate balance – it recognizes these (long term) liabilities aren’t bank loans, but they still increase gearing & prior claims on capital. Finally, I don’t include joint ventures etc. as they generally have their own embedded leverage. See here also.
Next, I look at NAV & a company’s Price/Book ratio. Again, most companies like to trumpet the highest NAV possible – there are multiple plausible variations out there. I’ll admit there is a logic to all of them – rather than debate them all day long, I recommend a simple but effective solution: Use an average of the highest & lowest NAVs as your (adjusted) NAV. For the lowest NAV, I use:
(Net Equity (exc. Minorities/NCI) – Goodwill/Intangibles) / Net Outstanding Shares
Goodwill/intangibles is relatively rare for property companies, but does pop up on occasion. I can’t think of an instance where its value has ever been justified, so the formula above provides a rock-bottom assessment of NAV. For the highest NAV, I use EPRA NAV/NNNAV, which basically boils down to:
(Net Equity (exc. Minorities/NCI) + Net Deferred Tax Liabilities + Net Derivative Liabilities) / Net Outstanding Shares
Note Deferred Taxes & Derivatives could possibly turn out to be Net Assets, but when have you ever seen that happen, eh..?!
Next, I try my best to ignore the P&L – for property companies, I find it uninformative, and sometimes downright misleading. Most P&L based ratios, including P/E, are fairly irrelevant when it comes to analyzing property. This is not to suggest a cavalier attitude – instead, focus on the Cashflow statement. This nicely excludes (un-)realized property gains, and gives you a far clearer picture of underlying profitability. If you limit yourself to companies with a Net LTV of 60-65% or lower, this normally implies underlying cashflow will be neutral to positive. If not, a more detailed analysis, an adjustment in potential fair value, or simply a pass on the stock is obviously required. Also, look for companies which are unable to actually fund their dividends. This is mostly a US/REIT phenomenon – and usually implies these companies are incorrectly valued, increasing leverage, and/or risking an eventual dividend cut.
So, what kind of of property exposure actually looks interesting to me? Well, there’s far too many to ever think about highlighting individual companies..! Let’s stick to some macro observations:
I’m not that hopeful for near-medium term property price appreciation in most of the developed world. This doesn’t necessarily imply I believe they’re over-valued – substantial price falls in many major markets has taken care of that problem. But as long as banks, in aggregate, are de-leveraging – which may continue for quite some years yet – both inflation & property appreciation will, by default, remain quite subdued… We might even see another lurch lower in property prices as Europe & the US both still teeter perilously close to recession. This suggests a more defensive strategy:
i) A focus on cash rich/low debt, more opportunistic, and/or special situation property companies would be my preferred strategy in most developed markets. These will have the firepower to pick up distressed property/real estate debt at bargain prices, and/or offer the best chance to generate good returns independent of significant property price appreciation.
ii) Bank de-leveraging does, however, also permit/encourage a re-allocation of bank risk. I’ve highlighted the compelling fundamentals of the German market for investors – these should prove attractive to banks also. I believe Germany’s one of the few markets where increased bank funding will lead to increased valuations, and vice-versa. Japan may also prove interesting, as banks were relatively untouched by the financial crisis, and there’s an attractive property vs. debt yield spread. [But there’s few investment vehicles for private investors, and they’re vulnerable to possibly significant JPY depreciation & macro disruption. This is probably best left to the professionals – in fact, Japanese property investment might be an interesting way to fund/hedge widely touted (& v painful) bets against the JPY & JGBs.]
I think my other main property holding reflects both i) & ii) above: Sirius Real Estate (SRE:LN), a 3.3% portfolio holding. It also offers German property exposure – to commercial property, in this instance. Its Net LTV of 61.0% is bang in line with its peers, its property yield & valuation is far lower, its occupancy rate of 76% offers significant operational upside, and cash-flow & fundamentals have steadily improved in the past year or two. More importantly, the company has a number of potential catalysts in place. First, it’s embarked on a major EUR 100 mio sale programme. Second, it’s got a veritable roster of large shareholders & activists on its board/share register, so I’d be less than surprised here to see an ultimate push for a wind-down, or other value-realization strategy. Meanwhile, Sirius is hoping to announce results & the completion of a re-financing this month, which may provide another near-term catalyst for the share price.
Another special situations category that’s interesting, and mainly London-listed, is foreign property companies/funds. These were mostly launched in the glory days of 2005-07, and many have since been mired down with frozen markets, too much debt and/or too little experience. This has produced a swathe of companies that are now in wind-down mode (or should be), with balance sheets ranging from fortress quality to the completely ridiculous… Some of these present intriguing opportunities – the challenge is to determine likely sales values (vs. B/S values), the timeline(s) involved, and whether the board’s actually inclined to return cash to shareholders. Finally, let’s look to a couple more markets:
Russia is most definitely interesting, with property yields still on offer at 10-12%. Considering yield compression elsewhere in the world, and continued/attractive domestic GDP growth, this looks like an arbitrage/opportunity which investors will rush into, sooner or later. I’ve owned an (undisclosed) low risk play on the market for the past year or two. Despite the lower risk, it offered substantial upside potential – which has, in fact, crystallized since – I may consider recycling this holding into another Russian opportunity at some point.
Asia is always attractive to me, but I find most property plays have too much exposure to the still over-heated HK/China markets. This is something that is definitely worth avoiding still, if you can. I don’t tend to be bearish on China, overall, but it’s long apparent the authorities have been intent on slowly pricking the property bubble… I actually think they’ve done a far better job than, say, the Fed (actually, not an appropriate comparison – the Fed didn’t do its f**king job at all!).
China has to compensate for the air that continues to be let out of the property bubble. Genuine infrastructure spending will help, but obviously exports are China’s life blood. In light of this, economic & fiscal prospects in the Western world must be quite alarming for China’s leaders. This guarantees a long term push for reduced savings & increased domestic consumption, which we’re already beginning to see. This trend will also tend to be reflected across the region, for slightly different (less autocratic) reasons – in fact, we should see it mirrored more generally across all emerging markets. What’s really fascinating to note is that this trend is basically self-reinforcing – it both creates & is a natural consequence of a rising ‘middle class‘ in all of these markets.
This suggests an Asian/emerging markets equity investment strategy that’s focused on domestic consumption & a rising ‘middle class’ might prove more defensive & also perhaps more promising. In terms of property companies, this suggests a bias towards development & investment in apartments/condos, hotels/resorts, shopping malls, etc.