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Janus' Patrick Brophy on Real Estate Trends: The Weekend Interview

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It’s been more than two years since real estate prices collapsed, and investing in global real estate today remains a very tricky business. Volatility and varying performance in the world’s markets and sectors are just two factors that make it challenging.  

AdvisorOne spoke with Patrick Brophy (left), portfolio manager of the Janus Global Real Estate Fund (JERAX), about where he sees opportunities and how he structures the fund’s portfolio to best take advantage of short-, medium- and long-term trends.

The fund – launched in November 2007 – has had a pretty stellar rebound from the crisis bottom but is still below the ’07 peak, along with other funds and the major market indexes.  

On a three-year basis, it has outperformed its peers, according to Morningstar, and is in the top 1% of funds in its category for this time period. The four-star fund’s three-year annualized performance is 5.32%, and its improved 22.01% for the past 12 months.

Top holdings for the Janus portfolio include Health Care REIT, Hang Lung Properties, Macerich, ProLogis and HCP.

Q. Can you share with us your overall outlook for the real-estate sector worldwide?

A. Our outlook is for more volatility and more macro-driven markets. This is hardly ideal for research-intensive, bottom-up stock pickers like us, but it reminds us of why we’re so partial to real estate, or more specifically commercial real estate.

For one, it’s a relatively inefficient asset class when it comes to valuation, meaning there are almost always opportunities.

Secondly, because “all real estate is local,” there are usually markets bucking the trend, and having a global mandate allows us to be sufficiently nimble to go to where we are finding suitable opportunities, and, equally important, steer clear of markets that are stretched or headed for a bad stage in the cycle. And finally, we believe well-managed, conservatively financed, strategically located hard assets with contractual cash flows (often inflation-indexed) are excellent vehicles for wealth preservation, especially in uncertain times.

Q. What’s your view on the difference between the performance of real-estate holdings in the more developed economies and in emerging markets?

A. We suspect that we will continue to confront a bifurcated investment universe, punctuated by ongoing de-leveraging, a muted recovery and limited growth prospects in the developed world; and a wide range of development and acquisition opportunities in fast-growing emerging markets, which benefit from strong demographic trends.

But no matter the geography, we stick to the key tenants of our long-established investment philosophy: focused businesses, disciplined allocation of capital, compelling valuation, high barrier-to-entry markets, attractive/irreplaceable real estate assets, development/re-development expertise and quality management.

Q. What impact do higher oil prices and higher commodity prices overall have on your real-estate outlook and investments?

First, in commercial real estate, you’re sort of the landlord to the global economy, so if higher oil prices slowglobal growth, real estate fundamentals will be negatively impacted. 

Second, commodity costs are important as we consider replacement costs for buildings – cement, copper and these types of inputs. As these costs go up, development  becomes less economically  feasible, which clearly hurts developers but actually helps existing landlords by providing further supply constraints. 

In developed markets, declining labor costs have helped offset some of the rise in commodity prices. If inflation pressures creep into the labor market,you’d get the full whammy of higher prices on all of your development inputs.

We expect this year to be more difficult in the developed markets, although thatis not the way it has started. So far , the developed markets are out performing emerging markets. Real estate has not been spared and has followed the market on that front.

We do think that the capitalization, or cap-rate, compression story  has largely played out in most developed markets, which means we're going to need a sustainable recovery  in fundamentals to drive growth  from here.  As investors' attention shifts more to fundamentals, we think the emerging markets will start to look more interesting.

Q. When do you expect to focus more of your investments toward emerging markets?

The fund tracks the FTSE EPRA NAREIT Global Index, and the developing, or emerging, markets are a small but growing component of that index. We have our investment in the emerging markets capped at 20% of the portfolio, which is more than double the level of the index.

We expect our investments in this area will increase gradually over time, and  right now it's where we are really starting to  find opportunities, particularly after the recent correction.

Geographically, our breakdown is North America, 64%; Asia/Pacific ex-Japan, 20%; Europe, 9%, Latin America, 4%; and Japan, 3%.

We might look underweight in, say, China. But many of our Chinese real-estate investments are actually listed in the Cayman Islands, so they show up as North American holdings. Also, we are overweight in Singapore, which gives us an anchor in the area on which we can piggy back our way more into China. This is a more conservative way to invest in China's rapid growth.

Of the emerging markets, Brazil has been a our largest investment. We believe its shopping-center owners have benefited from solid growth in retail sales, a byproduct of the rising consumer class; and its homebuilders continue to execute well, taking advantage of strong secular demand trends and extensive government-sponsored efforts to promote homeownership.

It’s true that we’ve been significantly overweight in the U.S. for the past two years, but this level should be coming down. There are now better opportunities elsewhere. This is really an interesting time for the real-estate space, which is still in its infancy in many respects, especially in the emerging markets.




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