Short, Sweet Property

Australians love property trusts; we invest proportionately far more in listed property trusts (LPTs) than any other nationality.

That love of bricks and mortar via listed vehicles has paid off handsomely for many years, but there are increasing doubts about some sectors of the LPT industry as trusts take higher risks to try to maintain returns in a mature market. And it might be worse in the United States (where locally listed LPTs hold up to 40% of their assets).

For funds manager Stuart Stuckey, it’s reached the point where he believes there’s money to be made going short LPTs. Stuckey is fund manager of Pengana Absolute Return Real Estate Fund and executive director and co-founder of Pengana Capital.

To most people, Pengana’s name is linked with the underperforming Pengana Managers, an attempt to set up a fund-of-hedge-funds that received more publicity than it deserved because Liberal backbencher and investment banker Malcolm Turnbull was an early backer.

However, in contrast to Pengana Managers, the Pengana long-short property hedge fund has been doing very nicely indeed, as shown by the January performance report on its rather modest website. For more details, click here.

This Cayman Islands-registered company seems to be something of a unique animal in the hedge fund jungle by specialising in listed property. It’s not for small players, but whether or not you’re interested in the riskier world of geared long-short funds, the thinking behind the vehicle has relevance to all LPT and real estate investment trust (REIT) investors.

As he explains in the accompanying video, Stuckey is trying to exploit pricing differentials between markets. He’s a big fan of the sector in Singapore, but he’s short the US REIT market and happy to be long in some Australian funds setting up American REITs.

Stuckey is mostly on the long side in his Australian property trust plays, but there’s still a significant proportion of LPTs here that he’s shorting. To find out why and what sort of companies he’s selling, see today's video interview or enjoy the transcript.

Michael Pascoe: What does it say about the state of the listed property trust market, the REIT market, that you can find plenty to go short as well as long in?

Stuart Stuckey: It may at first [past] indicate that the real estate market is over-valued to use the term short selling, and in some markets we do believe that the real estate market is fully priced, particularly in some regions, and more than fully priced. But I think it’s more than that. What we’re looking to capture is idiosyncratic pricing movements in various markets, particularly from a cross-border perspective. We’re looking at the pricing perspective of individual securities within the market and across borders, particularly as the REIT markets (the Real Estate Investment Trust markets) begin to expand in many other regions around the world.

Well which areas do you think are overpriced or at least fully priced?

Definitely in the United States. That market has had an extraordinary run since late 2002 or early 2003 following the problems in the tech market, the over-valuation in that market and the collapse in the NASDAQ. Investors in the United States clearly turned themselves towards yield-oriented investments and real estate securities were one of those five years ago. But today, we don’t believe that’s the case and as an example the dividend yield across the sector is approximately 4.5%. Contrast that with the sovereign curve with a 10-year Commonwealth bond or 10-year Treasury is some 4.75% '” you’ve got a 50 basis point discount to the sovereign curve. We think that’s expensive and the last time the US market was at that level was at 1997-98, which was a lead indicator of a four-year bear market in the US real estate market.

Your latest monthly report has you totally short in the US. Nothing long. That’s a market that a lot of Australian property trusts are diversifying into.

They do continue to do that. Of course our investment profile is in the listed market not in the physical direct market, and the Australian REITs that are acquiring assets in the United States and doing so in a physical form but at this point in time we have no long positions in the United States. Everything is short sold. That market looks particularly expensive to us as I’ve just mentioned, but also in a cross-border context, the US market looks particularly expensive against some other regions of the world and our short-sold positions in the US are pairs traded strategies against other markets where we had long positions to balance that short.

In the Australian context, roughly every $6 that you’re long on Australian property trust you’re short one. What does that mean?

Our long positions are a function of two elements. Number one, they’re a function of event-driven activities and the Australian market is very deep and very mature. It’s a world leader with respect to real estate securitisation on a number of different fronts, and one of those particular measures would be the level of securitisation of the physical real estate market. In this country roughly half of all real estate assets are owned by publicly traded vehicles. That’s far advanced compared to any other market '” Europe, for example: only 3% of that market is publicly owned. Even the United States: only 12% of that market is publicly owned, so the Australian market is very deep, very broad and a world leader.

Now many of our long positions are a function of the developing and event-driven activities that are occurring in this market. The Australian capital is flowing into international markets; we’ve been a participant of that. A lot of the REITs have been acquiring offshore real estate and it gives us the opportunity to play the valuation differential. And I think a good example, as you can see in our portfolio right now while we are short in the United States, you’ll find that we are long Australian REITs that own US real estate because there is a very substantial valuation differential that we find quite attractive.

You mention the diversification of Australian property trusts into the US. How much of what you’re holding in Australian LPTs is actually an American investment?

It would be approximately 30–40% of our Australian exposure, so you’re absolutely correct when you look at our portfolio and you see a fairly substantial Australasian component in our holding on a look-through basis. It is in fact investing in two markets other than Australia: the underlying real estate.

The justification or the pitch for long-short funds is that you stand to win both ways, not just from the long position. At the moment, you’re finding it easy to go short on some LPTs in Australia?

Yes, there are some Australian stocks that we do believe are expensive and fully valued and in particular some of the names in Australia have been priced by the market in a perpetual growth sense and we think that’s dangerous. Whenever we see a price movement that reflects a perpetual growth degree of thinking we believe that it prices in too much return and doesn’t allow for the risk. In particular, I’m talking about some of the stapled securities that are involved in off-balance-sheet activity, which is far riskier activity. It can be quite attractive, but it is far riskier activity than mainstream real estate ownership and '¦

For example?

I find some of those names expensive.

For example? What sort of names?

We don’t like to disclose too many of the individual names but the stapled securities you’ll find some of the names that fall into that space could be names like Centro, Stockland, Macquarie Goodman. They’re the types of names that fall into that space.

Were you short Multiplex before Wembley hit the fan?

You’ll probably find our portfolio was in fact short Multiplex and I think that’s a good example of a stapled security that didn’t price in the risk profile correctly.