For Subscribers

Get the complete article now!

Four money managers examine portfolio management strategies in the latest issue of The Wall Street Transcript, available at (212/952-7433) or http://www.twst.com/info/info576.htm

TWST: Tell us about Davis Advisors and your responsibilities there.

Mr. Davis: Davis Advisors is a money management firm with about 40 billion under management. About 1 billion of that is dedicated to real estate and that is the area we’re going to be talking about today. My partner Chandler Spears and I are responsible for that area and also for the Davis Real Estate Fund, our 350 million mutual fund dedicated to investing in publicly tradable real estate companies, such as real estate investment trusts.

TWST: Does the market usually distinguish between the well-run properties and those that are not quite so well run?

Mr. Davis: Not as much as we’d like, and this has been one of the conundrums of investing in real estate over the last 18 months or so. As mentioned earlier, the companies that have performed quite well have been those with an incredibly high yield. The wonderful thing about an incredibly high yield is that you get that every quarter. The problem, however, is that the company paying the dividend is normally using most, if not all, of its cash flow to pay the dividend, and if something goes wrong (a tenant failing to make a lease payment, for example), the dividend is likely to be cut. And because the dividend is usually the only thing supporting the stock price of these high-yield companies, elimination of that yield will invariably crush the stock price.

TWST: How will the REITs raise capital to continue to grow?

Mr. Davis: The concept of REITs raising capital is directly attributable to the fact that they must pay in the form of dividends the majority of their taxable income. So when a big opportunity comes along for a REIT to, for example, acquire a large portfolio of properties, the REIT has to source the public equity or debt markets. Now, is that a bad thing? Not necessarily. But it could be, especially if the REIT is overpaying for the large acquisition or, worse, there is no defined use of the capital raised at all. Companies like General Growth and Vornado raise capital only when they have an accretive and immediate use for proceeds that over the next couple of years are going to add to the earnings stream of the business and the fundamental value of the business. And some companies, such as CenterPoint Properties, have a business plan based on capital recycling, which precludes the need for new equity. Put simply, management buys or acquires an asset, increases its value through repositioning or extraordinary property management, and then sells it to someone with different investment objectives, perhaps a pension fund that is looking for more of a bond-like return. Proceeds from the sale are then invested back into the business and that suspends the need to raise new capital. That is what great companies are doing right now. In short, intelligent managers don’t raise money to do nothing with it. Intelligent managers raise money to enhance shareholder value.

TWST: What are the misperceptions about investing in REITs? There are money managers who won’t own them. Are they misunderstanding the investment potential?

Mr. Davis: Investors who are not looking at REITs as an investment alternative are, in our opinion, missing an opportunity. Those who hear the word REIT and remember only the industry’s mistakes of the 1970s and 1980s are walking into the future facing backward. Today’s REITs have material insider ownership, conservative balance sheets, and management teams that are cycle-tested and know how to run a public company. Many could run companies in other industries. There are very few investors for whom REITs would not be an attractive addition.

TWST: Are there any global opportunities that you identify as being interesting currently or do you only invest domestically?

Mr. Davis: We define “international” by the company’s income stream, not by the currency denomination in which the stock trades. Currently, almost every domestic real estate company has income streams that are just that: domestic. We expect that as time passes, there will be opportunities for these companies to go abroad in order to extend their management expertise internationally.

TWST: An effect of the Enron collapse is the question of management credibility. How critical is management performance when you invest in a REIT?

Mr. Davis: It is the single most important factor in our investment decision process. Fortunately, real estate management teams have matured over the past 15 years. The old-world management teams simply said, “Let’s lease the space and collect the rent” or, more dubiously, “Let’s buy this building, leverage it to the hilt, and hope we can sell it later at a profit.” There were instances of egregious self-dealing and actions contrary to shareholder interests. Those “dealmaker” management teams have been replaced with seasoned business managers. We invest a great deal of time to gain comfort with management and their strategy for creating shareholder value.

TWST: I would assume that low interests are generally beneficial to REITs. What is the interest rate outlook and what will be the impact going forward?

Mr. Davis: The concept of REITs being attractive when interest rates are low and being unattractive when interest rates are high is sophomoric. Low interest rates can help balance sheets and clearly help improve net income as the cost of borrowing drops. However, low interest rates also allow the marginal real estate competitor to develop. Imagine that you own a hotel and you’re doing just fine. Enter some marginal player flush with cash from a cheap bank loan who decides to build a hotel right across the street. That new supply from the marginal player will have an impact on your hotel and it will be negative. Conversely, when rates begin to move back up, your cost of borrowing moves up too. But the marginal player is less likely to get that cheap loan and build across the street from your property.

This special Investing Strategies Report includes:

1) Investing in Technology - Steven Bloom, Vice President and Senior Research Analyst/Portfolio Manager for HSBC Asset Management, examines portfolio management strategies in this timely and deeply informative 6,400-word interview from The Wall Street Transcript.

2) Investing in Real Estate - Andrew A. Davis, Portfolio Manager for the Davis Real Estate Fund and co-Portfolio Manager of the Davis Convertible Securities Fund & Chandler Spears, Securities Analyst for the Davis Real Estate Fund, examine portfolio management strategies in this timely and deeply informative 3,200-word interview from The Wall Street Transcript.

3) Amy S. Croen, co-Founder and a member of Geneva Capital Management, examines portfolio management strategies in this timely and deeply informative 4,500-word interview from The Wall Street Transcript.

4)Ian Anthony Rosenthal, Director and Portfolio Manager/Analyst in TimesSquare Capital Management, Inc., examines portfolio management strategies in this timely and deeply informative 3,700-word interview from The Wall Street Transcript.