This post has been excerpted from a letter by Michael Winer, Jason Wolf, and Ryan Dobratz, Lead Portfolio Managers of the Third Avenue Real Estate Value Fund.
“Resource conversion” is a term that we have long used at Third Avenue to describe actions that management teams and boards can take to surface value in the underlying businesses and investments that they control. Some of the most frequently utilized resource conversion activities include: mergers, acquisitions, privatizations, initial public offerings (“IPO”), spin-offs, share repurchases, tender offers, and special dividends. As investors that focus on well-financed companies with securities trading at meaningful discounts to Net Asset Value (“NAV”) that are also run by motivated control groups, the Third Avenue portfolios have historically experienced a substantial amount of resource conversion events in its portfolio holdings. This quarter was no exception.
The “main event” in the quarter was the initial public offering of Five Point Holdings LLC (“Five Point”), a real estate operating company that is the largest developer of mixed-use communities in coastal California. The IPO created a New York Stock Exchange listing (Ticker: FPH) for the Fund’s longstanding investment in the company (which dates back to 2008 through the reorganization of its predecessor company Newhall Land & Development). The Fund increased its position in Five Point to 5% of the Fund’s net assets by participating in the offering at prices that seem incredibly favorable when taking a long-term view.
Fund Management is not aware of another publicly traded property company in North America with such a substantial opportunity for value creation. Five Point currently has plans to build approximately 40,000 home sites and up to 20 million square feet of commercial space in some of the most desirable markets in the US through its strategically-located master planned communities, comprised of: (1) The Shipyards in San Francisco, (2) The Great Park Neighborhoods in Irvine, and (3) Newhall Ranch in Los Angeles County. In the process, the company also has plans to further strengthen its surrounding communities with 15,000 acres of public parks and accessible open space, 10 new primary and secondary schools, and approximately 6,000 affordable residential units.
While the opportunity at Five Point is substantial, it will undoubtedly require a great deal of capital and sound execution by the company’s management team. Five Point seems well positioned on both fronts. To wit, the company has an even stronger financial position after its IPO with $200 million of net cash (i.e., no debt) that should allow it to fund the improvements at its projects without adding significant liabilities to its balance sheet. Further, Five Point is led by Emile Haddad, who was previously the CEO of Five Point Communities, and prior to that served as the Chief Investment Officer of Lennar Corp. (one of the largest US homebuilders; a separate holding in the Fund; and 40% shareholder of Five Point). Mr. Haddad and his team have a long track record of creating value in complicated urban development projects and seem poised to deliver similar results within the company’s existing pipeline while doing so in a sustainable manner.
An equally important resource conversion event for the Fund materialized shortly after the quarter end: the proposed privatization of Global Logistic Properties (“GLP”). As we wrote about last quarter, GLP is a real estate operating company based in Singapore that owns and controls leading industrial real estate platforms in China and Japan. While the company’s business had been performing reasonably well, GLP’s stock price never recovered from the market dislocations experienced in the region in late 2015. As a result, the company’s largest shareholder (GIC, with a 40% stake in the business) urged the Board to undertake a strategic alternative process to seek out transactions that would maximize value for shareholders. Given the secular tailwinds that industrial real estate owners are enjoying with the rise of e-commerce and demand for distribution space, it was our view that there would be a considerable amount of institutional interest in GLP and ultimately a cash bid for the company given the unique opportunity to control such a valuable platform. This view ultimately proved right.
In mid-July, GLP announced that it had agreed to sell the company to a consortium of Asian-based buyers for $3.38 per share, or a 25% premium to prevailing market prices. The transaction is expected to close in the fourth quarter unless a competing bid materializes, which seems unlikely given the substantial premium offered and fact that key shareholders and executives of GLP are included in the consortium.
The Fund’s investment in the common stock of GLP has been a big win so far. This transaction could also have follow-on effects for other companies in the region as the GLP acquisition marks one of the largest “takeovers” ever recorded in Asia. . The Fund holds sizable positions in several companies in the region that own incredibly valuable assets but trade at large discounts to readily ascertainable NAVs such as Henderson Land, Wheelock & Co., Cheung Kong Property, and City Developments. Should these companies consider similar transactions, a tremendous amount of additional value would be unlocked. This portion of the portfolio currently accounts for 25% of Fund capital.
In addition to GLP, Parkway Inc. announced that it had entered into an agreement at the end of the quarter to sell the company at $23 per share, or a 20% premium to prevailing prices. The Fund first initiated a position in Parkway Inc. after it was spun out of Cousins Properties (“Cousins”) in 2016 as a separate REIT that controlled more than 8 million square feet of office space in Houston, including market-leading positions in the Galleria and Greenway sub-markets.
As we have witnessed in a number of spin-offs over the years, the shares of Parkway were sold indiscriminately by legacy shareholders upon listing, leaving Parkway Common trading at prices that represented a significant discount to the private market value and replacement cost of the underlying portfolio.
It was our view at the time that although fundamentals in Houston were unlikely to improve anytime soon, public markets would ultimately recognize the value when market conditions within Houston stabilize. In this case, the private markets recognized the value before that transpired as Parkway announced its intentions to collapse the discount by selling the business outright, leading to an IRR that exceeded our initial estimates.
Fund’s Management preferred route for exiting a security is through a transaction such as GLP and Parkway (e.g.., an acquisition). The reason being: these types of negotiated deals typically include some sort of control premium paid by the buyer, which can be as high as 10-20% of NAV. Nonetheless, there are three other primary reasons why securities are typically sold in the Third Avenue Real Estate Value Fund.
First: when a mistake is made in the initial analysis (or conditions change materially) and the original case for owning the security no longer exists. Given Fund Management’s strict underwriting criteria and focus on companies with readily ascertainable NAV’s (i.e., not rocket science to value), this isn’t the most common reason securities are sold. When they are, though, it is clearly our least favorite reason.
Second: for portfolio management reasons, such as when cash is required for redemptions or when an individual security–or overall exposures to certain property types or geographies in the Fund–become outsized relative to the Fund Management’s internal risk guidelines. As a reminder, we tend to limit positions to less than 6% of assets, individual property types to less than one-third of the portfolio, and any single country outside of the US to less than 25% of the Fund.
Third: for valuation purposes. When a security price appreciates to a point where the discount that was available at the time of the purchase is largely eliminated, the position tends to be trimmed back. Further, should the price exceed a “best-case” estimate of NAV without durable growth prospects for the business, the security will likely be sold entirely. This was exactly the case with Inmobiliaria Colonial (“Colonial”) during the quarter.
Colonial is a real estate operating company based in Spain that owns class-A office assets in key European markets including: Madrid, Barcelona, and Paris. The Fund initially purchased shares of the company in early 2014. At that time, Europe was still in the doldrums and Colonial had just launched a €1 billion rights offering in order to reduce its debt to more sustainable levels and raise the capital necessary to fund the repositioning of its portfolio, which included vacancy rates exceeding 20% in its Spanish assets following the financial crisis.
More than three years into the investment, conditions in the region have improved materially and Colonial’s management team delivered results well above our expectations and its peers. Not only did the group prove capable of increasing the company wide occupancy rates to above 95%, but they also made a number of clever acquisitions that added additional value along the way.
With the operations stabilized and the company finally enjoying rental rate increases in all of its major markets this year, Colonial recently elected to convert from a real estate operating company to a Socimi (i.e., a Spanish REIT). The change could trigger a gain for US tax purposes and also diminish the value of the company’s deferred tax asset going forward. As a result, the price of Colonial common exceeded our “high-case” NAV estimate and Fund Management elected to sell the position. The security has been added to our “T-2 list”, a shadow portfolio we maintain comprised of well-financed and well-managed real estate companies that the Fund would like to own when the securities are available at larger discounts to conservative estimates of NAV.
This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this publication has been obtained from sources we believe to be reliable, but cannot be guaranteed.
The information in this portfolio manager letter represents the opinions of the portfolio manager(s) and is not intended to be a forecast of future events, a guarantee of future results or investment advice. Views expressed are those of the portfolio manager(s) and may differ from those of other portfolio managers or of the firm as a whole. Also, please note that any discussion of the Fund’s holdings, the Fund’s performance, and the portfolio manager(s) views are as of June 30, 2017 (except as otherwise stated), and are subject to change without notice. Certain information contained in this letter constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe,” or the negatives thereof (such as “may not,” “should not,” “are not expected to,” etc.) or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of any fund may differ materially from those reflected or contemplated in any such forward-looking statement.Current performance results may be lower or higher than performance numbers quoted in certain letters to shareholders.
Date of first use of portfolio manager commentary: July 26, 2017.
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Current performance results may be lower or higher than performance numbers quoted in certain letters to shareholders.