Not every real estate mogul is as lucky as Donald Trump.
Besides his residential buildings in New York, casinos in Atlantic City and five golf courses, he has a host of other holdings. There are his stakes in The Apprentice reality show and the Miss Universe, Miss USA and Miss Teen USA pageants as well as a cologne, a bottled water and a board game.
In other words, he has diversified his wealth away from his core real estate holdings. And that is saying a lot. When most of your wealth is in large, brick structures, hedging the downside risk can be tricky. Without Trump’s cachet most moguls need to find other, less publicity-laden ways to mitigate the risk that comes with a concentrated position in an illiquid asset.
The Citigroup Private Bank has just launched a product designed to fill this need. The Real Estate Complement Portfolio is designed to be counter-cyclical to the broader real estate markets. If commercial real estate values drop, it will outperform the S&P 500; if they rise, it will underperform the benchmark.
“The typical ways people diversified weren’t the best,” says David Rosenberg, head of US investment solutions at Citigroup Private Bank. He says a common strategy was to pair real estate holdings with bonds, which only increased their exposure to interest rate risks.
“We think of real estate as an asset class and not as a business,” he says. “The work we have done is sensible. The best way to diversify is through equities.”
The strategy is to find macroeconomic factors that influence real estate returns. There are three. Economic growth determines the demand. Interest rates determine the cost of capital to construct new buildings. And unexpected inflation often pushes investors to hard assets that hold their value, such as real estate.
The strategy is insulated against shocks from a single holding. The portfolio uses an optimiser and risk modelling to smooth out bumps from any one company. In that way an ugly earnings surprise from a company in the portfolio should not affect returns, while a steepening of the yield curve will.
“Most traditional active managers are trying to have all the risk from individual stock picks – from what they know about that company,” says Alexander Lane, senior portfolio manager in the tailored portfolio group. “We are doing the opposite.”
RECP differs from other hedging strategies in that an investor can be long on equities and still have reduced exposure to the real estate cycle. Instead of shorting, it picks stocks that are uncorrelated to commercial real estate. The RECP strategy, for example, would underweight energy and commodity producers and overweight consumer staples, technology and retail. Axiomatically, it avoids hotels, casinos, and Real Estate Investment Trusts.
It will stay within a range of 400 basis points of the S&P 500 for two-thirds of the time – the tightest tracking possible without taking company-specific risks.
This strategy is a response to the market. “Selling is much more an alternative than it has been for 10 years,” says Rosenberg. “The profits have been great, and our clients are not thinking about the reinvestment option because the price of real estate is much higher.”
If you believe that, then the RECP works for you. If not, there is a product that offers the exact opposite.
The Real Estate Favored Portfolio, also managed by Lane, offers exposure to investors without a broad real estate portfolio. The advantage over a Reit or an exchange-traded fund is the wider exposure – to more than 200 stocks – and the lack of company-specific risk. A significant position of the 20 stocks in the Philadelphia Stock Exchange Housing Sector Index, for example, is Weyerhaeuser, the timber company.
Its performance will be the exact opposite of the RECP: commercial real estate goes up and it outperforms the S&P 500; it goes down and it underperforms.
“These are for clients with a strong view about real estate or believe philosophically that real estate will always go up,” says Lane. “Think of this as growth versus value; it’s favoured versus complementary.”
Some investors also believe real estate-related equities soften before hard assets, so that they could be used as a leading indicator.
Both portfolios have minimum investments of $5m and are structured as separately managed accounts. So if a stock in a particular sector falls it will be replaced by another one and the tax loss will be realised. As they are designed to mirror real estate cycles, Citigroup advises clients to invest in them for five years. “This is for long-term investing purposes only, not for market timing,” says Lane.
One downside is that the portfolios are national in scope, while fluctuations in commercial real estate markets are usually regional. The market in New York can be flat while that in Chicago is robust. Demand for office space may decline in a city, while its apartment market remains strong. In these instances, a national hedging portfolio may be of limited use.
Ultimately, the portfolios are a decent option for real estate investors who lack Trump’s flair for diversification.