|By Matein Khalid| The election of a Manhattan property developer and (failed) casino owner as President of the United State has not been positive for most American real estate investment trusts (REIT’s). The sharp rise in US interest rates since the election and the Federal Reserve’s vigilance against inflation risk hits this classic “bond proxy” sector, with its reliance on leverage to boost investor returns. In addition, commercial property values have been under pressure as banks reprice loans to developers and builders higher. Shopping malls are leprosy as investments as “brick and mortar” retail sales is replaced by shopping via digital devices.
A glut of supply in some real estate sectors (eg. Nursing homes, storage, multi-family apartments) has also hit the share prices of large cap REIT’s on the stock exchange. Yet Trump’s win also means higher GDP growth, more infrastructure spending, corporate tax cut and a rollback of Obama era anti-business regulations. This new macro tailwind is bullish for real estate values and leasing rates in defined segments of the US property market. In any case, the steep falls on the stock exchange have largely discounted the bad news on interest rates and the micro-economics of specific sector supply gluts. To paraphrase Oscar Wilde, price is never value when investing in real estate!
Of course, the timing and magnitude of Trumpnomics will be dictated by the legislative and political realities of a Republican Congress averse to unlimited deficit spending and a 4.6% unemployment rate could easily trigger wage inflation and thus more aggressive Federal Reserve monetary tightening. Trump’s economic agenda is actually negative for, say, health care REITs due to his Cabinet’s determination to trim President Obama’s Affordable Care Act.
Industrial REITs have the strongest operating fundamental sections in 2017, thanks to the sheer scale of demand from e-commerce and new supply metrics below net absorption run rates. Prologis is the world’s largest owner of industrial properties listed on the New York stock exchange. The shares have been hugely profitable in 20016 despite macro shocks like Brexit or emerging markets woes. Prologis is a proxy for the secular growth of E-commerce, particularly in major, deep markets in the world’s biggest cities, where supply is constrained – New York, Los Angeles, London, Tokyo etc. Prologis is acquired KTR Capital for $5.9 billion, a developer of business parks, warehouses and retailer distribution centers in 2015. Significantly, Prologis outbid Blackstone and Brookfield Asset Management for this trophy acquisition. Prologis also partners with global investors such as Norway’s Oil Fund to acquire industrial asset worldwide. I believe the optimal buy level for Prologis shares is 45 for a 60 target in 2017.
I have extensively invested in Singapore REIT’s and property shares during the past decade. Singapore, with its zero-tolerance for corruption, its Anglo-Saxon legal heritage, its meritocratic government, its strategic location on the Straits of Malacca, its financial linkages to China, the US, India and the ethnic Chinese elite of Southeast Asia, has also developed Asia’s most sophisticated and liquid market for real estate investment trusts (REITs). Of course, as in the US, the sector has been under pressure due to a narrowing of the spread between distribution per unit (DPU) yield and the 10 year Singapore government bond yield. However, as Singapore’s hotel, office and industrial market bottom certain trusts will experience both a rise in rents and asset values while discounts to net asset value attracts buy side share accumulation. The CDL Hospitality Trust will see revenue per available room (Rev/par) rise in 2017 as the Singapore hotel market recovers. The Far East Hospitality Trust also trades at a 30% discount to net asset value. In the industrial sector, Mapletree Logistics and Cambridge remain my favourite total return ideas in S-REITs.
Singapore REIT’s offer the highest dividend yields in the developed world at 7.5%. The Singapore property sector is also on the precipice of a cyclical upturn in capital values and rentals. The Singapore dollar has also depreciated to the 1.45 – 1.46 level, though it has downside risk to 1.50.
Currencies – The “strong dollar” policy taboo and currency wars risk
Donald Trump broke a taboo in American finance when he said the “strong dollar is killing us”, a direct contradiction of existing policy that the President never comments on currency markets. Steve Mnuchin, Trump’s Treasury Secretary nominee, limited the damage by clarifying that his boss only referred to short term strength but the US Dollar Index fell to 100, a two year low, before it rebounded. Even ECB President Draghi pointedly reminded the America President that G-20 consensus preludes competitive currency devaluations so his comment violated a crucial international economic policy taboo too.
The dollar has risen 30% since April 2014, a testament to the success of Washington’s “strong dollar” policy as well as the grim realities of Europe, Asian and emerging markets macro woes. If Trump abandons the “strong dollar” policy, he could easily trigger a global trade war and a financial panic on Wall Street. After all, the US is the banker to the world and must reassure the world that its reserve currency is not hostage to what Lord Keynes called “monetary seigniorage” – the temptation to devalue the US dollar to boost export and ease Uncle Sam’s external debt. Of course, Ronald Reagan did exactly this at the Plaza Accords in 1985 and George W. Bush engineered a “soft dollar” with his tax cuts, Iraq invasion and Bernanke Fed zero rate policies in the aftermath of the 9/11 terrorist attacks.
There is ample historical precedent and financial logic for the “soft dollar” policies crafted by Robert Rubin in the early 1990’s in President Clinton’s first term. James Baker’s threats to devalue the dollar to force West Germany to reflate had led to the October 1987 Black Monday crash. Trump, due to his ignorance of international monetary diplomacy, could easily trigger another stock market crash if markets believe he intends to abandon the strong dollar pledge. This is all the more possible since Senate Democrats are out to nail Steve Mnuchin on his Goldman Sachs/Indy Mac past. If Mnuchin’s nomination is derailed by the Senate, financial markets would go ballistic, especially if Tweeter – in Chief tries to talk the dollar down. The world does not need a catastrophic currency war unleashed from the White House at a time when the US has no top honcho at Treasury. My call? The King Dollar bull trend will accelerate as the Fed rate hikes coincide with Old World political risk and Trump fiscal stimulus. Yet another opportunity to short Canada again at 1.32 for a 1.38 target now that crude oil has gone wobbly too.
Sterling witnessed the mother of all short covering trades after Theresa May’s speech conceded a role for Westminster in the Article 50 negotiations on Brexit. Yet even 1.24 was impossible to sustain for the pound as awful UK retail sales demonstrated the steep cost of Brexit for the British economy. Hard Brexit means sterling weakness as long as UK economic data momentum is so awful. Spikes in volatility will become routine now that Article 50 negotiations (and Trump tweets!) impact financial markets in real time. Readers of this column will recall I recommended no positions on June 23 – in fact, traveled to the Bavarian Alpine resort of Garmisch to resist the temptation to trade Brexit-but turned hugely bearish on sterling at 1.33 after the British people voted to leave the EU and the Conservative Party began yet another bout of regicide and political bloodletting. My downside targets on sterling at 1.20 has been achieved.
I see no compelling risk/reward calculus to trade sterling ahead of the Supreme Court judgement next week on the High Court’s Article 50 ruling. It is also doubtful if there will be any real good cheer in British fourth quarter GDP data next Thursday. After all, UK retail sales were the worst since 2011, clear evidence of recession risk in the Sceptred isle.
Amid the pageantry of the Trump inauguration parade on Pennsylvania Avenue (tickets to the three bulls fell to a pathetic $50 a head for the public!), the Mexican peso began a stealth move up almost 2% to 21.40 against the dollar. Though financial markets were relieved Trump issued no fresh threats to Mexico, I believe it is too dangerous to bottom fish in the peso. Gringolandia is on the warpath against Mexico – and offshoring south of the Rio Grande is now high treason. The border tax, the threat to NAFTA, the immigration crackdowns could all mean the peso retests its 22 lows.
Stock Pick – Blackstone Group was a quick winner. Is KKR next?
I had listed ten reasons why investors should accumulate shares of Wall Street asset manager Blackstone Group at 27 in a column published on January 02, 2017. Blackstone shares have now risen to 30 and I still believe the world’s preeminent private equity, real estate, credit and hedge fund manager still has upside, though my initial price target (34 and out the door?) could prove too conservative. While financials have paused in the past two weeks, I believe momentum has shifted from interest rate sensitive money center banks to trust banks, securities exchanges and listed private equity partnership units. In fact, as inflation rises and bond markets tank, I expect discount brokers E-Trade and Charles Schwab could benefit from higher retail engagement. As Trump’s win creates greater return dispersion among companies, sectors and even asset classes, alpha chasers, not closet indexers, will outperform on Wall Street. This means Blackstone Group and its historical rival KKR.
KKR, Wall Street’s legendary merchants of debt, was founded by ex Bear Stearns deal makers Henry Kravis and George Roberts. KKR masterminded the epic $29 billion leveraged buyout of RJR Nabisco, a deal that led to the Hollywood film “barbarians at the gate”. KKR now manages $130 billion in assets for the world’s top institutional investors, including the sovereign wealth funds of the GCC, Norway, Singapore and South Korea.
Yet despite stellar returns and growth in managed assets, KKR partnership units have been dissed on the stock market. This is the reason I decided to accumulate KKR at 16 two weeks ago, a decision that has already financed a trip to Spain. While Blackstone Group is thrice the size of KKR, I actually expect the House of King Henry to be more profitable as a stock market investment in 2017. Why?
I met Rich Pzena, the owner of one of the world’s most successful value investing boutiques and a fellow Wharton alum, at a Capital Club DIFC dinner in November, to discuss his valuation model of KKR. He was convinced that the 45% fall in the units since mid-2014 meant that the firm’s potential to earn performance fees was utterly (and irrationally) discounted by Mr. Market. I agree. Since KKR issues units in a partnership and not traditional shares, it is not a component of the S&P 500 index, thus ruling out buying from closet index huggers or exchange traded funds.
However, Donald Trump is the game changer here. His corporate tax reform could persuade Kravis and Roberts to convert KKR from a partnership to a less complex, more transparent C corporation structure, which would be high octane fuel for the partnership units I bought at 16. The linkages between KKR Group Partnerships, KKR Holdings and the owner/founders is far too complex for many investors who cannot analyze 467 page annual reports!
Mark to market accounting and the erratic timing of investment gains in private equity exits via trade sales or IPO’s makes it fiendishly complex to track KKR valuations in real time. Yet one of the world’s legendary private equity partnership trades at a mere 8.5 times economic net income, below the valuation metrics of Blackstone (Steve Schwarzman) and Apollo Global (Leon Black). KKR’s recent deal flow includes a $4 billion Ultimate Fighting Championships (Morons R Us is a highly profitable business model! Sad but true.), an Indonesian ride hailing service, an enterprise software firm and virtual/augmented reality startup in Silicon Valley and Chicago’s Sullivan Center property portfolio. My friends in the deal business in New York, the Valley, London and Hong Kong consider KKR the ultimate smart money investor. KKR has amassed an investment track record that Warren Buffett, George Soros and Banglaboy Ponzi would admire, 25-30% per annum LP returns over two decades. KKR management fees are 1.2% and 15% performance/carried interest. KKR also manages a $7.5 billion proprietary capital fund that enables it to quickly bid for the hottest deals. Unrealized losses on the First Data deal and angst over carried interest tax reform have devastated the economic net income and valuation metrics of KKR units since mid 2014, when they trades at $26. However, the tide has now turned and almost $70 billion in fee paying assets are locked in for eight years and KKR is now on a global capital raising spree. This is beyond yummy. Hooray Henry is a Sloane Ranger insult but my KKR deal is tagline for good reason – and nothing at all to do with the Kolkota Knight Riders!