It can be difficult to discern whether real estate is fairly valued. For example, Marc Weidner, managing director of Franklin Templeton Real Asset Advisors, thinks core real estate has looked expensive by many market metrics for some time now.
No matter that he’s been proven wrong, because there is another factor in real estate valuation: location.
“You could take this building,” he explains. “It is a unique building, but I can say that about every building anywhere in the world. If you put it 15 miles down the road, it would have a different value — the same is true for any other building.”
The local character of real estate is also the source of inefficiencies that investors can capitalize on. “You will value it in a very local context: who is the owner, what is the capital structure, the business plan, the holding period for tenants, the credit of the tenant?” he says. “Being an insider in these markets, I think, is the only way to be successful in this sector. It’s very hard to discover information because real estate information does not travel very well.”
On the home court
That suggests a twofold approach to real estate. A global opportunity set is necessary to get diversification, but so, too, is a partnership with local experts. “The tension between global approach and local implementation — I think that is the biggest challenge,” he says.
The mission, given saturated home real estate markets, is “not to get more real estate but to get a different type of real estate,” he argues.
Weidner finds non-core, value-add projects — a sort of mid- to small-cap approach — an attractive source of returns. “We tend to focus on situations that we call ‘buy- fix-sell,’” he explains. There must be a “fixable flaw,” such as a fund that is reaching the end of its life, a mismanaged or mis-marketed asset, or excess leverage.
“Often in real estate it’s the clock that gets you in trouble; it’s not the real estate,” he says. “You tend to get the call from your lender at the worst possible moment.” Sellers are not necessarily distressed, but they are motivated, and not just because of pressures from lenders. Portfolio managers in some countries also face pressure to sell off underperforming assets to close the books for annual statements.
In that case, “often you have transactions that need to close quickly, quietly and with certainty.”
That kind of transaction places a premium on a certain kind of manager, he adds. “Everything is in the execution — it is a market where the quality of the management team can make a difference.”
But there is something else at work in this kind of investing: what, in value investing, would be called a margin of safety.
Valuations in the overall market are of less weight because these value-add opportunities are meant to withstand yield expansion. “In a market where you fear that natural rental growth, fundamental improvements, yield compression have come to an end,” he says. “You don’t need cap rates to be at the same level as today” to achieve a target return.