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4 Tips for Savvy Real Estate Investors

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Real estate investments offer numerous, well-documented benefits, such as portfolio diversification and total real return potential from both yield and price appreciation.

But real estate investment returns are sensitive to multiple factors, like interest rate levels and the economic outlook for the different property segments.

The Altegris/AACA Real Estate Long Short Fund (RAAAX) attempts to avoid the problems of a long-only exposure to real estate by using the long-short structure, as well as a highly strategic screening process for its investments.

The fund launched in early 2011; as of June 30, it had some $42 million in net assets.

Its largest long positions have been in companies operating retail stores, preferred stocks and gaming companies; the largest short sectors were interest rate and credit spreads, multifamily and housing stocks.

According to portfolio manager Burl East, CFA, the fund seeks four traits in potential investments.

The first trait is few participants in the sector, ideally a monopoly, duopoly or oligopoly.

For example, he says, there are 10,000 or so owners of suburban office space in the U.S., which leads to constant price competition. But there are only a small number of participants in industries like student housing, data centers, gaming or cellphone towers.

The small number of providers decreases the risk of overbuilding and price competition.

The second desired trait is a barrier to entry. Office buildings are subject to zoning regulations, but otherwise there are no significant barriers to building.

“But, it’s very hard to build, for instance, a brand new hospital, [and] it’s very hard actually to build medical offices,” East says.  Plus, it’s “very hard to build student housing, as those need to be built on the campus of a large university.”

Factor three: barriers to exit that deny choice to tenants. In other words, the tenant can’t easily sign a lease with another local landlord, pack up and relocate.

East cites dental practices and specialized medical labs as examples of tenants that hesitate to move.

A dentist might have several million dollars worth of equipment “bolted to the floor,” he explains, and moving and reinstalling that equipment makes relocating a practice very difficult.

In contrast, it’s much easier for the tenant of a typical office building to move, and hence these businesses have a much greater selection of properties from which they can choose.

Finally, the fund likes to own companies with tenants that have growing businesses and that are coming to their landlords to request more space.

By applying those four screens to the roughly 600 real estate industry stocks the fund tracks, East can eliminate about 90% of the companies from further consideration.

That systematic approach “keeps you from buying mediocre companies that own mediocre real estate in mediocre markets right from the get-go,” East explains.

This process also helps identify potential shorts, he adds, by reversing the process and looking for sectors and stocks that fail to satisfy the criteria.

East says the fund has several options for managing the impact of rising interest rates.

The first is that the fund can create a short position in Treasurys or investment-grade debt, for instance, which profits from higher rates. It can also short stocks in the industry sectors with the greatest rate sensitivity, such as those focused on housing and real estate brokers. 

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