To find out about current opportunities and challenges in the sector, the InvestmentNews Content Strategy Studio recently talked with a 30-year veteran of the real estate business, Stan Kraska, Jr. He is co-portfolio manager of the Ivy LaSalle Global Risk-Managed Real Estate Fund, which reached its three-year anniversary on April 1. The fund is managed by Ivy Investment Management Company and subadvised by LaSalle Investment Management Securities, LLC, where Mr. Kraska is Global CEO.
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Stan, what is your assessment of the global real estate sector currently?
Stan Kraska, Jr. | Real estate fundamentals remain healthy. Economic growth continues to spur greater demand for space, occupancy levels are firm or improving and rental rates are increasing in many markets around the world. We have seen vacancy rates decline dramatically as economic activity has improved. As a result of these conditions, many properties are in a position to increase their income, which in turn should support the potential for real estate companies to generate strong earnings growth. We believe the stock valuations of most companies remain attractive relative to the value of their underlying real estate. In fact, these stocks are more attractively priced now than they were a year ago. Strong private capital flows into the sector have led property values to rise, while stock prices have seen only moderate increases.
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How big is the public portion of the global real estate market?
Kraska | I'd say there is a robust opportunity set of public real estate companies around the world today. One way to view it is via the market capitalization of the publicly traded real estate companies within a widely used benchmark. In this case, I'll use the FTSE EPRA/NAREIT Developed Market Index, which is the benchmark for our Fund. The index consists of 330 companies with a market capitalization of $1.3 trillion at the end of 2015, up more than 20% from the end of 2013. Going forward, we expect more opportunities as existing companies grow, new companies come to market and additional countries develop real estate securities markets. Public real estate securities comprise less than 8% of the total value of investable real estate around the globe, and we think there are opportunities for continued long-term expansion.
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U.S. interest rates may be on the rise. What would be the impact of higher short-term interest rates on real estate and real estate securities?
Kraska | While the potential for rate increases may cause volatility, we think real estate securities over time are influenced primarily by underlying fundamentals, not just short-term interest rate movements. The key is the performance of the broader economy. Consumer spending, business travel, corporate profits, demand for office and warehouse space — these and other factors are what really drive the long-term performance of real estate and real estate securities.
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Let's talk about the Ivy LaSalle Global Risk‑Managed Real Estate Fund. Does its name say it all?
Kraska | You could say that. We wanted to make it clear how the Fund differs from traditional global real estate securities funds. The key is its lower risk profile, which we pursue through our proprietary risk-review process. We focus on companies with lower leverage, lower business risk and lower-risk property types. That means we generally exclude companies that have higher financial leverage, substantial exposure to non-core asset types such as hotels and home‑building companies, and significant exposure to non-earning assets and ancillary activities such as merchant building – which is constructing an asset and immediately selling it for profit – or investment management. Over time, and particularly during the global financial crisis, these risk factors pushed up volatility and created more downside risk for real estate companies.
We believe the lower risk profile of our Fund should reduce downside risk, which we define as the risk of material relative loss of value during a downturn in the economy or in the real estate and/or capital markets. However, these lower-risk companies in the portfolio are not passively waiting for a market downturn. These are quality companies actively seeking to add value to their portfolios and shareholders. Through active management and our proprietary risk-review process, we think the Fund can provide attractive risk-adjusted returns over a full market cycle.
By investing in lower-risk companies, we believe our Fund looks more like the type of real estate that institutional investors historically have owned and which typically is not available to retail investors.
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How does the Fund differ from other risk‑managed strategies?
Kraska | We think our risk-review process identifies the key risk factors within global real estate. Rather than try to manage risks through derivatives exposure or other methods, we aim to do it at the source – in other words, through the security selection process.
The Fund does not use strategies designed to reduce short-term volatility, such as a “black-box” minimum volatility strategy; illiquid private real estate or debt securities; or high cash balances. We are not managing variability versus the benchmark. Our portfolio differs from the benchmark and will act differently.
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With the breadth of global real estate, how do you get insight into so many different markets?
Kraska | First of all, we benefit from having one of the largest and most experienced teams of portfolio managers and securities analysts. They are located in Baltimore, Amsterdam and Hong Kong. Our parent organizations, Jones Lang LaSalle (NYSE: JLL) and LaSalle Investment Management, are among the world's leading real estate service and investment firms and are focused solely on real estate. Our portfolio managers and security analysts can draw on JLL's resources – meaning a global organization with 60,000 employees in 75 countries. This direct real estate market platform provides us with great real-time information and a critical input to our investment decision-making process.
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How has focusing on lower-risk companies within global real estate helped the portfolio's performance in recent years?
Kraska | Our positive relative performance for more than two years has been driven by the low-risk bias of the Fund and our focus on blue-chip companies in several sectors: regional malls, apartments, office and self-storage. Our risk-review process avoided higher risk companies, such as Hong Kong developers, the U.S. hotels sector and development companies in Japan. At various points in 2014, 2015 and 2016, these types of companies underperformed the benchmark index.
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Broadly, how are public real estate companies positioned at this point in the real estate cycle?
Kraska | Let me speak generally first. In most markets, real estate fundamentals are strong; we expect that to continue. This is the seventh year of the economic and real estate fundamental recovery, and we are in a more mature phase of the cycle. Supply is increasing in response to the positive demand for space. While fundamentals are expected to remain healthy, the increased supply may moderate the pace of improvement. Most companies are seeing the benefit from these healthy conditions through growth in income from their properties and value creation from new developments.
Unfortunately, economic and real estate fundamental recovery cycles don't last forever. When the next downturn does occur, we believe global real estate securities – and specifically the lower‑risk companies in this Fund – should be well positioned. These companies own higher quality properties that can compete for tenants. They have strong balance sheets which should provide the financial flexibility to be defensive if necessary or to take advantage of available opportunities.
In addition, the Fund has exposure to domestic and international markets, which can be at different stages in terms of fundamentals, capital markets and other cyclical factors. We think a strategy that seeks to take advantage of global real estate cycles can be effective for investors in the long term, helping to reduce volatility and temper the swings that cycles can cause.
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Real estate will be listed as a separate sector in key indexes later this year. What's your view on this change?
Kraska | We see a favorable result from the creation of a separate real estate sector because it will draw more attention to the asset class from all types of investors. I may be biased, but after working with clients for more than a quarter century, I believe that real estate and real estate securities should be a long-term allocation to a multi‑asset portfolio.
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Where can people go to learn more about the Fund?
Kraska | They can go to
www.ivyinvestments.com for additional information.
