From the December 2010 issue of Investment Advisor • Subscribe!

Counterintuitive Success

CNL Financial Group's contrarian approach means they avoided the worst of real estate Armageddon

Okay, it’s not really what we mean when we say “overlooked managers,” but it will do for our examination of how the REIT space is doing. Over the past two years, we’ve heard about REITs on death’s door, then a REIT bubble; earnings are bad, but REIT stocks are performing well; dividend yields are great, then not so great, and now they are headed for awful.

Even as we prepared for the piece, we received the following from the National Association of Real Estate Investment Trusts (NAREIT):

“REITs continued their strong rally through October, and REIT total returns year-to-date through Oct. 31 were triple those of the S&P 500 for the same period,” which also informed us that the FTSE NAREIT All REITs Index dividend yield was 4.41% while the S&P 500’s dividend yield was 1.96%.

Forgive us for going slightly off topic, but you can see why we’re confused.

The Wall Street Journal partly answered the question by warning of tepid REIT earnings while at the same time noting “the strong performance of REIT stocks this year, which have outshone the broader market. The reason: Investors are looking past the current weak fundamentals and into next year, where a strong recovery is expected to take root.”

Since inception in 1973, CNL and its affiliates have formed or acquired companies with $24 billion in assets. Jeff Shafer sets the strategic foundation for the company’s business operations and is responsible for raising capital. In addition, he’s responsible for the firm’s partners in the broker-dealer space. He previously served as chief operating officer, a time when CNL Securities Corp. achieved more than $1 billion in sales in 2007.

Byron Carlock, Jr. is president and CEO of CNL Lifestyle Properties Inc., which owns a portfolio of 121 “lifestyle properties” in the United States and Canada. The Harvard grad (and board member emeritus of the business school) previously managed the investment activities of W.B. Johnson Properties, founder of Ritz-Carlton Hotels.

When we sat down with Shafer and Carlock to discuss Orlando-based CNL in general and CNL Lifestyle Properties in particular, they gave us a good explanation of why they’re thriving in such a confusing period.

“We’re 35 years in business, have six non-traded REITs, and three have gone full cycle,” Shafer says. “I’m on the capital raising side. Ironically, we were overlooked at the height of the commercial real estate bubble in 2006 and 2007, because we were a net seller of real estate at the time.”

Shafer takes pride in the firm’s disciplined and well-executed strategy that allows them to avoid bubble madness by sticking to fundamentals, which he wants to pass to the advisors with whom the firm works.

“What we are trying to do with the FAs is ask, ‘What is your investor looking for?’ It usually has to do with two characteristics; geographic location and return. We then have four different portfolios that can address those characteristics.”

For instance, CNL Macquarie Global Growth Trust is a non-traded REIT that takes advantage of opportunities in the commercial real estate market in the United States and internationally. It is able to target assets it believes provide the greatest opportunity for growth and capital appreciation. According to Shafer, it does this by taking advantage of attractive pricing on underlooked properties and repositioning them for growth. This means they might not have dividends at 7% because the properties don’t yet support them, but they eventually will.

And that “attractive pricing” of course comes from their contrarian views.

“Restaurants, especially with the hit the consumer discretionary sector took, were a contrarian play for us that paid off well,” he says. “As were hotels, and we recognized very early on that demographics will require the need for assisted living, so we believed heavily in the value of retirement properties.”

“The assisted living spaces and related properties have been the most successful REIT space ever,” Carlock adds. “Seniors want to be actively engaged, but need help. The senior cohort will be tremendous moving forward. We sold our senior assisted living portfolio a while back, but the covenant not to compete is just about up, so that will be an area we’ll soon be adding to the portfolio again.”

As for CNL Lifestyle Properties, it claims $184 million in cash, low leverage and no significant near-term maturities. It has a weighted average lease rate of 9.1%, a low leverage ratio of 26% and $2.6 billion in total assets. It also has $117.9 million in cash specifically to acquire new properties.

Carlock says it performed its way through the downturn, again, due to this counterintuitive thinking.

“It invests in ‘attractions,’ which despite problems with other areas that involve discretionary spending, they are, in fact, recession proof,” he says. “People still want to experience life and family. This is the counterintuitive part. Despite all that’s happened, I guarantee you have not, and will not, give up on your child’s memories.”

Those memories involve “iconic assets” included in a portion of the CNL Lifestyle Properties’ portfolio; names like Elitch Gardens, a 120-year-old amusement park in Denver, Colo.; the historic Omni Mt. Washington Resort in New Hampshire that hosted the United Nations Monetary and Financial Conference during World War II; and the 62-year-old ski area Jiminy Peak in Massachusetts.

“We consider assets like these to be overlooked jewels because they have withstood multiple economic cycles and have proven themselves in good markets and bad,” Carlock says. “Attractions like golf courses, ski areas, marinas and destination resorts are getting smart money at the moment. Blackstone, for one, just entered the attraction space. They see that with 203 million boomers, Gen Xers and echo boomers, the thesis is sound.”

For an idea of how the REIT works, consider Vail Resorts Inc.’s acquisition of the leasehold interest at Northstar-at-Tahoe in California.

As the announcement of the acquisition helpfully points out, “through its purchase of the leasehold interest for $63 million from Booth Creek Resort Properties LLC, Vail Resorts has become the long-term tenant and operator of Northstar-at-Tahoe. The land and improvements, such as buildings, ski lifts and other facilities, are owned by CNL Lifestyle Properties.”

Sounds good, but if your clients want in, they’d better hurry. The CNL Lifestyle Properties fund closes in six months.    

John Sullivan can be reached at jsullivan@investmentadvisor.com.

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