Bruce Flatt recently did an interview with Bloomberg to discuss his views of the current crisis and what it means for commercial real estate investors.
In case you don’t know him, Bruce Flatt is a billionaire investor and the CEO of Brookfield (BAM), which manages over half a trillion worth of alternative investments. He has been leading Brookfield since 2002 and often been referred to as “Canada’s Warren Buffett” due to his past track record in value investing.
It’s hard to find anyone who is more successful or experienced than him in the world of commercial real estate investing. His firm manages $540 billion worth of office buildings, malls, hotels, apartments, data centers, and many other property types all around the world.
So when he talks, we listen.
It has been many months since his last interview, and we now finally get to hear his take on the crisis and his expectations for the future of real estate investing.
If you had any doubts about your REIT investments, we think that this interview will clear up some of your concerns and bring back the focus on the opportunity that lies ahead.
You won’t get this type of information from quarterly REIT earnings report. Yet, it’s much more valuable information to the long-term oriented REIT investor because he focuses on the bigger picture.
We link the interview at the end of this article and recommend that you watch the entire 32 minutes if you have the time and interest. But if you just want the highlights, please refer to the five categories below:
- Why this is a generational opportunity (Most important to read!)
- His thoughts on REITs as a private equity investor.
- The future of urbanization and big cities.
- Why Class A Malls will recover stronger than ever.
- Why Office Buildings will recover stronger than ever.
(Please note that the wording of his sentences was slightly modified in some cases for better clarity)
Why This Is a Generational Opportunity
At High Yield Landlord, we have often discussed how the 0% interest rates will lead to cap rate compression, higher property values, and higher REIT NAVs.
We saw this happen in Europe when interest rates collapsed and property prices went through the roof over the past many years. Now we will see the same thing repeat itself in the US. The Fed has made it clear that interest rates will remain near 0% for years to come, and with the 30-year Treasury trading at a 1.6% yield, we have a clear indication that low interest rates are likely here to stay.
Bruce Flatt is very active on both continents, and therefore he understands the impact of 0% interest rates on commercial real estate. Here’s his take:
In addition to all the money that has been spent on stimulus, all central banks took their interest rates to 0%, and when you do that, you work backward on repricing everything else. Multiples for businesses are to be higher. And the cap rates for real estate are coming down, which means that the values are going up.
The alternative is possibly owning a Treasury bond and then you are doomed to 1%. It is possible interest rates go negative and you make some money, but you are probably doomed to 1%.
The repricing of real estate has not even started yet… Right now, assets are not trading because people are not comfortable. Even if you have a building that is let for 20 years, people are confused by what that really means. But once this clears, and interest rates are at a new low, cap rates will start coming down, and valuations will go way up.
A cap rate in a city center office building might have been 4% before, and it is probably going to 2%. If we are in a 0% interest rate world and people believe that we will be in a 0% interest rate world for a while, and the Fed has told you that, then I see no reason for a long-tailed asset with 20 years of cash flows not to be at aorund 2%.
If that building was selling at a 4% cap rate prior to the pandemic and fetched $1 billion, it would fetch north of $2 billion at a 2% cap rate. That’s one billion profit.
Moreover, forgetting the value, your cash flow also goes up because of lower interest rates. Here’s one indication of that. When we build One Manhattan West, people might have said that it is terrible that we opened it during the pandemic. Actually, it was fantastic because the tower is 100% let to great tenants. Its cash flow when stabilized is $120 million per year and growing. And we thought we would finance it at around 5%, but now we got under 3%. That’s $50 million more per year to the owners. Repeat that across a lot of real estate and you earn a lot more money.
If we are in a 0% interest rate world, even the seemingly expensive assets such as data centers may be cheap today.
His Thoughts on REIT Opportunities
We have often also argued that now is a much better time to invest in REITs than in private real estate because they are offered at deep discounts to fair value.
With REITs, you essentially get to buy real estate at 50 cents on the dollar, with the added benefits of professional management, diversification, and liquidity. The one potential downside is that you have to deal with higher near-term volatility, but as long as you have a long time horizon, this is irrelevant for you.
Bruce Flatt is in the business of raising capital for his private equity funds, and therefore, he likely would prefer investors to invest with him and not with REITs. Yet, even he cannot deny the opportunity. He says that REITs offer arguably the best opportunity in the entire marketplace, and Brookfield has been buying a lot of shares lately.
Probably the greatest discount out there between what you would see as value and price is in REITs and real estate securities.
REITs that have high quality assets trade at a enormous discounts to the tangible value of their assets, let alone if we are right in what I just said earlier about the repricing. (In other words, the discounts are high based on already discounted prices.)
I think that it’s because the narrative today by the common media is very negative on office and retail. Common perception is that, but they are wrong.
I would say one of the great purchases today is real estate securities because you are buying them at a fraction of what you would trade them at in the private sector.
The Future of Urbanization and Big Cities
We recently invested in the Empire State Building in Manhattan by buying shares of its owner, Empire State Realty Trust (ESRT). We also added more capital to Federal Realty Trust (FRT) which owns highly urban retail properties.
The market is worried that the flight to suburbs will lead to the demise of REITs that own properties in big cities. We don’t buy it. We think that urbanization is set to continue, and it’s interesting to note that Bruce Flatt has very similar thoughts:
Urban centers for centuries and centuries have been attracting more people for very simple reasons: People like to associate with other people. There are a lot of jobs. They can walk to work. And this is not stopping it.
In fact, I can make the argument that this is only a reset and urbanization will only get stronger. The point is that these cities aren’t going away.
The people who suggest that these cities will go away, I think they probably haven’t looked at history books, and are only reacting to the current situation.
I can tell you that our suburban housing business is booming and we are thrilled by that, but it is an anomaly at this time.
Why Class A Malls will Recover Stronger Than Ever
We also recently invested more money into Macerich (MAC) and Simon Property Group (SPG) because we think that Class A malls will bounce back, and trading at 20-40 cents on the dollar, they offer great value. Bruce Flatt’s Brookfield owns a lot of high-end malls and here is his take:
There will be consolidation and the best malls will get better and the worst will go away.
If you are in a city with eight centers, you will get rid of four, leaving the remaining four in a super powerful position because that’s where people want to be.
Good malls are like high street shopping in strong suburban locations in most cases. If you own the best, you will do even better in the future.
In the short term, it wasn’t so great because we were shutdown. Today it’s getting much better. Now, some centers have higher sales than what they had last year in a comparable month. On an overall basis, it is coming back, and five years from now, it will likely be stronger than it was before.
Why Office Buildings will Recover Stronger Than Ever
Before the crisis, we did not own any pure-play office REITs in our Core Portfolio. This is because we prefer the economics of other property types and office REITs were priced at fair valuations.
Today, the situation is different with valuations at the lowest in over a decade because the market fears that work-from-home will lead to a permanent drop in demand for office space.
This led us to invest in one office REIT, but our exposure remains very small. We always are scouting for new potential opportunities. Here’s Bruce Flatt’s take on the office space:
I don’t think we have met a legitimate CEO who does not want people back in the office.
Everyone want their people back, but they don’t have enough space to be able to accommodate them.
All the companies that early on talked a big game about remote working (e.g Facebook (FB) , Slack (WORK)…) have taken more space in urban locations to social distance their people. They are expecting their people back.
Early on, they were probably hoping more people to stay home to sell more services to them: cloud competing, online apps, and that sort of thing.
Go out on the street and ask 9 out of 10 people, they will say they want to work from the office. And the fact the efficiencies are not even close, when people aren’t in the office, because you get distracted with 100 other things.
High quality matters. We buy high quality properties in good cities in well located places with proper ventilation and all the other things you would want in your buildings. The secondary or tertiary locations are not comparable.
What You Should Take Away From All of This:
Real estate is about to get repriced way higher. According to Bruce Flatt, cap rates could drop as low as 2%, which may seem ridiculous today, but earning a steadily growing 2% yield with inflation protection and some leveraged appreciation is much more attractive than earning 0.8% from a 10-year Treasury. This repricing has already happened in Europe, and it will begin in the US as soon as we put this crisis behind. If cap rates drop from say 6% to 3%, then the value of a property doubles.
REITs are today heavily discounted relative to the value of their underlying assets. But these underlying assets are also greatly discounted if we remain in a 0% interest rate world. As cap rates start to compress, REITs NAVs will rise, causing them to become more discounted.
When people feel comfortable investing in REITs again, we expect yields to compress to the lowest levels ever recorded, pushing share prices to new all-time highs.
We see two main types of opportunities in the REIT market to profit from this repricing:
- Opportunity #1: REITs with very low long leases and high cap rate compression potential.
- Opportunity #2: REITs that own hated property types and trade at enormous discounts to NAV due to false narratives.
Before posting the interview, I want to leave you with one last thought:
One REIT called Safehold (SAFE) already has shown you what impact the 0% interest rates will have on valuations once the market is confident that the cash flow is sustainable. It now trades at $68 per share, up from $17 in late 2018, which is when interest rates started to decline.
It’s today hitting new all-time highs, up 100% in 2020, and trades at a low 0.9% dividend yield.
The difference between SAFE and other REITs is that SAFE owns highly secure ground leases, and therefore the market does not question the sustainability of its cash flow even in the midst of a pandemic.
As we put this crisis behind, the market will become more comfortable about the cash flow of other REITs, and that’s when we will see a similar repricing happen.
The impact of 0% interest rates on the future value of REITs has been greatly underestimated. By buying today, you lock in high yields while they are still available, and position yourself for great appreciation.
Do I know when the recovery will take place?
No. But I do know that a lot of money will be made over the coming 5-10 years.
The Full Interview With Bruce Flatt, Enjoy!
Are you Positioned to Profit from the Rush to Hard Assets by Yield-starved Investors?
At High Yield Landlord, we have positioned our portfolio to thrive in today’s rapidly evolving environment. We are the #1 Ranked Service for Hard Asset Investors on Seeking Alpha with over 2,000 members.
We spend 1000s of hours and well over $50,000 per year researching the Hard Asset market for the most profitable investment opportunities and share the results with you at a tiny fraction of the cost.
Disclosure: I am/we are long BAM; MAC; ESRT; FRT; SPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.