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The Next Big Bang In Real Estate Investing

Michael Torres, Real Estate Investing

With Michael Torres, Chief Executive Officer and Portfolio Manager of Adelante Capital Management

A great change is on the horizon for investors and possibly an even bigger change for the real estate industry. Some refer to this coming event as the “Big Bang”.

Michael Torres, Chief Executive Officer and Portfolio Manager of Adelante Capital Management, says that before explaining this impending event, it’s important to analyze some of the basics.

First, he explains, there are only two types of investing: either you own something or you lend money.

Real Estate Investment Trusts—commonly known as REITS— represent ownership of real assets. With that ownership come all the possibilities of reward and risk. In one sense, you can say that it is a direct ownership in the many different types of real estate investments. By putting together a number of REITS from different areas of the real estate market, one can reduce risk through diversification and hopefully benefit from the positive economics occurring in different parts of the real estate industry.

One downside when investing in individual properties on your own is lack of liquidity. If you buy a duplex, condo, or any property as an investment, it’s not easy to sell quickly or to liquidate, if necessary. Publicly traded REITS, on the other hand, are very liquid and can be sold at a moment’s notice.

Now to the BIG Bang. Prior to this month, August 2016, investing in a diversified portfolio of real estate through index funds had not been possible. That’s about the change. Real estate investments will now be separated from all other financial index funds and put into their own unique fund, which will open the door to investing specifically in a broad range of real estate investments at a very low cost and high liquidity.

This may have the effect of attracting more capital to the industry, making it easier for pension plans and large investors to benefit from the sector. Generally speaking, more capital is good for everyone.

Finally, Michael puts forth the new concept that, in fact, owning real estate is a way of investing in the housing of the economy, so that over time, as the economy does well, the companies  that house the economy should also do well.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: You know coming very soon there’s going to be what I refer to as a big bang in the real estate market.  Now this is not a scary kind of big bang, it doesn’t mean that the world is falling apart and that real estate is going to the dogs.  In fact, I think it’s going to be quite the opposite.  To talk about it, I’ve invited a man with 30 years of expertise, he’s Chief Executive Officer and Portfolio Manager for Adelante Capital Management, and he’s the person who was instrumental in creating one of the major indexes for real estate, the Wilshire Real Estate Securities Index.  With me is Michael Torres, welcome to the show, Michael.

Michael Torres:    Great Steve, great to be with you.

Steve Pomeranz: The real estate market is made up of many different kinds of investments.  Let’s list some of them to begin with.  Many people have heard of REITs, or real estate investment trusts.  What are they?

Michael Torres:    Real estate investment trusts are no different than any other corporate organization.  However, they must make a tax election, so it’s an enterprise, whether it be public or private, that makes an election which allows them to forego paying corporate taxes provided they finance or own commercial real estate.

Steve Pomeranz: Those taxes are paid by the individual who buys the real estate investment trust?

Michael Torres:    That is absolutely correct.

Steve Pomeranz: That’s different from real estate operating companies in what way?

Michael Torres:    Real estate operating companies again will go ahead and pay the corporate taxes.  They may retain earnings for reinvestment in land and in existing operating assets, so they’re slightly different.

Steve Pomeranz: Now most of us own a home and have some idea about the home’s market value, but expanding this out to the bigger world, there are some considerations when making a real estate investment that are different than investing typically in stocks.  If I were to go out and buy a piece of land or maybe a duplex that I wanted to rent out or a small commercial building, what are some of the limitations or ramifications that make that kind of investing different than just going out to the public markets and investing in a stock?

Michael Torres:    When you look at an individual asset, you’re obviously taking asset-specific risk, so the age and the quality, location, typical real estate type metrics, people always refer to location, but age is obviously really important because, in an environment where younger, new employees want the shiny, bright thing, you have to be able to track the demand in the marketplace.  We also know that structures, as they get older, they require more maintenance, so it’s the amount of capital you need to put into the asset.  Real estate really is not just buying yield, it’s really buying an enterprise whether you buy it through owning companies or the enterprise is you yourself operating the asset.

Steve Pomeranz: When you say yield you mean the actual cash flow that comes from renting it out, leasing it out, and then subtracting all your operating expense and what you’re left over is this cash flow.  What about liquidity?  I mean there’s a big difference between real estate purchased in the ground or investing in a public company. Real estate is hard to buy and sell; it’s easier to buy, it’s hard to sell.

Michael Torres:    Right, the liquidity is a function, really, of confidence in the marketplace, whether it be in the listed markets or in the private markets.  An opportunity for individuals is there seems to be greater access, but, at the same time, when banks are pulling back the amount of exposure they want to lend to the marketplace, that could cause prices or assets to get stale in the market and fewer buyers. We’ve certainly seen that recently.

Steve Pomeranz: Michael, I see ads and hear things on the radio from time to time spouting how low risk investing in real estate is, that it’s less risky, less volatile than investing in the stock market, and I think to myself when I hear that, that’s not really true.  The only difference is that the prices of your real estate are not quoted in the paper every single day, so you don’t really know how it’s fluctuating or not, but it’s still subject to the economy, it’s still an ownership position in something just like a stock is. What’s your take on that?

Michael Torres:    Steve, I’m so happy that you’re saying that because I 100% agree with you, and I’m glad that you’re bringing that concept to your listeners, so it’s really important.  Relative to private real estate as advertised, people are only being enticed by yield and not thinking of total returns, and that’s really part of the missing piece, which is the appreciation for time or depreciation that investors might have in one of those structures that are private and touting yield only.

Steve Pomeranz: You were talking about the fact that when the economy gets soft, banks start pulling away, that makes the liquidity issue or the idea of being able to sell your real estate more difficult, or because buyers can’t find the money to borrow to buy the real estate, that brings prices down.  Anybody investing in real estate, even if you’ve owned your own home and you went through the 2005-2006 crisis, you know that real estate can go up and down.  I mentioned at the beginning of this segment that there’s a big bang—I guess that’s my term, I haven’t heard it anywhere else—a big bang happening on August 31st in the markets with regards to real estate.  Tell us what’s going to happen.

Michael Torres:    Later this month S&P and MSCI (which are index providers) S&P 500 are reclassifying the benchmarks to pull property, REIT specifically, out of the financial category.  Financials today include property, banks, insurance companies, asset managers, but for the big bang effect we are now, as investors and the listeners are going to be able to see how various forms of commercial real estate behave in the listed markets.  We’ll have new information from the prices and total returns achieved over time.

Steve Pomeranz: Let me restate that. So prior, or the way it is currently as I’m recording this show, if you wanted to invest in real estate and you wanted to do that in an index form or to follow it, you really couldn’t because it’s been lumped together with banks and insurance companies.  Now they’re taking it apart and they’re going to be listing these different real estate sectors in their own little category.  One will be able to invest directly, Michael, right?

Michael Torres:    That’s correct, and we’ll be able to see it.  If you own the XLF today, which is the EFT of financials, now you’re going to only have banks and you’ll have property pulled out of that.

Steve Pomeranz: Yes, so that’s a beautiful thing, and they’ll be money managers who will now have much cleaner benchmarks to be compared against and one can invest in indexes and alike.  They can also, with ETFs you can do other things, too.  You’ll be able to short certain kinds of real estate and go long on other kinds of real estate, not that that’s something that I necessarily recommend but that will be available.  Michael, before the show, we were talking about an idea which really intrigued me, and this was this idea that when you’re investing in real estate, you are, in a sense, housing the economy, and I’d like you to explain that to us.

Michael Torres:    Sure, I take the view that as an investor, we have really two asset classes.  We either own the economy through equities, or we lend to it through fixed income.  Really, by having real estate in our portfolio, we’re housing the economy, whether it be retail commerce, whether it be services through office buildings, industrial.  I mean one of the really interesting things that’s happening right now is the quote “last mile” for Amazon reaching tenants, so e-commerce and industrial buildings are getting a lot of interest today.  We’re really housing the economy in property, and that’s really what makes it exciting.  We’re moving away from the risk of profits to collect rent.

Steve Pomeranz: When I’d spoken to you about it, we also talked about this idea, well, if you bought a rental property and you rented it out, you said, you’re housing your neighbors, you’re housing other families right?

Michael Torres:    Yes, that’s absolutely right.

Steve Pomeranz: Turning it into a commercial enterprise, so that’s really quite interesting.  There’s a lot here to talk about, unfortunately, we are out of time.  My guess is Michael Torres, he is the Chief Executive Officer and Portfolio Manager for Adelante Capital Management, and he really truly was one of the persons responsible way back when for creating one of the major indexes for real estate, the Wilshire Real Estate Securities Index.  Michael, we’ll have you back on, and we’ll get further into detail on these issues.  Thank you so much for joining us.

Michael Torres:    Great, Steve, thank you