The Yield Chase: Hunting in US property

PORTFOLIO POINT: The US Masters Residential Property Fund is a Listed Investment Company that presents both a currency and property play in the one package.

They seek it here. They seek it there.

After three years of range trading, and with the local bourse still sitting at almost half its 2007 peak, equity investors who were content to sit on cash and reap attractive interest rates have been forced back into the market in recent months.

While most still are wary of any serious prospect of capital gains, given the uncertainty in the global economy, they’ve been hunting for yield to replace those once attractive term deposit rates. It is a hunt that rapidly is becoming an obsession.

The obvious targets like the big four banks and Telstra have benefitted handsomely since mid-year and, until last week’s retreat, had helped power a 12% run on the local market.

But investors have begun to cast a wider net in an effort to diversify, and as the potential for gains in the banking sector becomes limited by the recent uptick. And in the past week alone, several new offers have been launched in a bid to cash in on the yield quest.

Last week I took a look at a relatively forgotten equity instrument, the Listed Investment Company. It is a sector that has consistently outperformed the broader stockmarket for decades. And studies both here and in the US point to unique advantages LICs have over unlisted funds that have helped them deliver far better returns for investors.

As a sector, LICs traditionally have focussed on delivering yield, usually via fully-franked dividends. And late last week several new LIC yield plays hit the market in an attempt to woo investors back towards the LIC structure, including Dixon Advisory’s US Masters Residential Property Fund.

While it is called a property fund, this is a listed investment company with a stable amount of capital to invest. Like all LICs, it is not forced to sell assets if unitholders want to redeem their units. It simply sells them to other investors via the Australian Securities Exchange.

Listed in June 2011 on the National Stock Exchange, the US Masters Residential Property Fund has since graduated to the Australian Securities Exchange with a unique but rather compelling investment philosophy. It has been formed specifically to cash in on two historical market anomalies; the incredible strength of the Australian dollar and the stunning decline in American residential real estate.

It owns 430 houses and 948 units in and around New York City, with the houses predominantly in Hudson County New Jersey and apartment blocks in Brooklyn and Harlem.

The investment strategy has not been without criticism. This time last year property specialist Monique Wakelin penned a blistering Eureka Report piece lambasting the management for its inexperience and a “worrying lack of understanding of what constitutes an investment grade property”.

The focus, she claimed, should be on Manhattan and upper end investment opportunities.

A year on and the fund is back to raise more cash. This time it is seeking to raise a minimum of $40 million, and up to $80 million, closing on December 6, adding to the $165 million already raised and invested.

It currently is paying a 6.4% yield with a 10c dividend on its $1.56 share price and plans to continue that payment. Crucially, its net tangible assets remain at $150.6 million while its stockmarket valuation sits above $162 million.

Answering the criticisms last week, chief executive Alan Dixon, who lives in New Jersey, said the fund aimed to take advantage of the dramatic downturn in US housing, not high-end penthouse apartments. The strategy, he said, was to focus on a market segment that was below the threshold of large institutions but beyond the financial scope of individual investors.

Investors such as Blackstone recently embarked on a similar course, picking up 6,500 homes in Arizona, and Southern California private equity firm KKR also has launched a residential property fund.

US property prices are likely to remain depressed for some time. The US housing market collapse forced many home owners to abandon their properties. Unlike Australia, there is little if any recourse for the bank to pursue them. But with a bad credit history, those former owners are banned from taking out new housing finance for several years, limiting any sudden resurgence in demand.

That has forced many to rent. As a result, rents now are significantly higher than mortgage repayments, delivering remarkable yields on the funds invested.

That market distortion will work itself out over time. But as it does, investors hope property prices will rise, delivering capital gain to the fund. A revaluation of the US Masters portfolio currently under way suggests that already has begun.

Another criticism of the fund’s portfolio is geographic concentration. Dixon, however, claims that as an advantage necessary to achieve scale in property management, maintenance and security. It also delivers a degree of internal expertise in assembling the portfolio that a geographically diverse fund could never achieve.

Unlike many LICs, the US Masters Property Fund trades at a slight premium to net tangible assets, but volumes have been very low. That may improve with the extra units issued.

The fund has taken no hedging on the portfolio, hoping to capitalise on an improved greenback in the future or an easing in the Australian dollar from its current levels. While that is a strategy that in ordinary times could be considered high risk, there are few analysts or economists who believe the Australian dollar can sustain current levels in the long term.

For those who have been hunting exclusively in the large cap pool for yield, this property and currency play could complement the portfolio and may be worth a look.