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Interview with Greg Romundt, President and CEO of Centurion Apartment REIT – Part II

This is a continuation of part I of the interview with Greg Romundt of Centurion Apartment REIT.

4 – Apartment Syndication was mentioned as the way some of your REITs began; is this still an attractive option for investors? What are the principles behind this method of investment? Can anyone invest this way?

Some REITs started this way but we didn’t. I don’t personally like syndication of individual apartment properties for many reasons. It may be a method that the syndication company uses to grow their portfolio but that doesn’t mean that it is a good idea. It may evolve into a REIT but it may not. Investors, in my opinion, if they want to be in private apartment ownership should look to find a private REIT they like and feel comfortable with, rather than entering into a syndication on a single deal.

Here are my reasons…

1) Lower Returns. Syndications to retail (non institutional) investors tend to be of a single property. Due to pool size, cost to asset ratios tend to be higher than with a bigger organization, this lowers returns to investors.

2) Higher Risk. Investors only have exposure to a single building, they have no diversification and much higher risk than being in a REIT fund.

3) Financial Constraints. In single property syndications, there are more financial constraints on the pool. For example, if you need money to do some windows or roofs, you will need to do an equity call. Not many investors like the idea of equity calls. In a larger REIT fund, the asset manager can pull funds from other properties or a line of credit or raise new capital to fund required repairs and upgrades. We buy many buildings from these syndicator type owners, and almost always the buildings are starved of capital. The syndicator can’t or didn’t want to call capital to maintain and improve the properties. Starving properties of much needed repairs is self destructive. Not only does it damage long term returns but it also substantially increases risks…for example, you don’t maintain something and there is an accident and someone gets hurt and the company gets sued.

4) Higher Mortgage Rates. These pools, due to small size and relative quality of their financial covenant will have to pay more for mortgages; and at worst, in times of capital market stress may not get funding at all.

5) Low Liquidity. There is limited (if any) liquidity available to single property investors. You need to wait until the venture wind up date to access liquidity. A private REIT often has liquidity facilities to accommodate investors that for one reason or another need to leave.

6) Low Diversification. There is auto diversification in a private REIT. If you buy into a private REIT once, and that REIT continues to grow and buy properties, your investment automatically, without having to add more money of your own, continues to become more diversified. A single property syndication investment requires that the investor separately invest in multiple projects to achieve a modest amount of diversification. Our REIT has over 20 properties and when an investor invests with us, they are investing in ALL OF THEM. To accomplish the same they’d have to invest in over 20 syndicated deals separately, each with separate minimum investments and due diligence requirements. That’s a lot of work even for professional investors unless you are doing it on a very large scale.

7) RRSP Eligibility. Private REITs have registered plan eligibility. Many single property syndications wouldn’t be RRSP eligible. Private REITs, if properly structured, are almost always RRSP eligible. Given that the vast majority of Canadians have the bulk of their savings in RRSP’s this means that more people can participate in this kind of investment.

8) Governance. Generally there are better governance structures with a private REIT compared to syndication. We have a board or trustees which are elected by unit holders as a unit holder democracy. We can be fired as asset managers and new managers hired. In most syndications the investor is a limited partner and investors have limited say and ability to elect or eject management. As we have institutional investors, our governance is institutional grade which is far superior in most cases to what you’d get from a syndicator. Remember corporate governance isn’t just for when times are good. It is most valuable when times are bad.

9) Maintenance. REITs have lower ongoing maintenance and time commitments. You can make a single investment in a private REIT and grow your financial position as your resources grow and your personal situation dictates. You have the benefit of getting consolidated reporting from a single source. If you do have the resources to participate in 20, 30 or 50 syndications, the amount of time you’d need to read all of the reports, do the accounting and monitoring would be considerable.

If you made larger investments in each syndicated building to save time, you would sacrifice diversification. Why sacrifice diversification just so you can reduce your workload? You can choose instead to know a lot more about a single investment than little bits about many…the quality of your decisions and insight will be better and you will be able to reduce the amount of time committed to ongoing investment monitoring. Let your money work for you rather than you working for your money.

10) Fees. REIT’s have lower fees – I’ve seen the fees on some single property syndications that were absolutely ridiculous but people still bought them…obviously because they didn’t read the offering memorandum. This doesn’t mean that a REIT is always and every time a better deal on a fee basis, but I’ve seen more outliers in single property syndication land than in REIT land.

5 – If you were to invest your own hard earned money in a REIT (Obviously not your own company) what would you be looking for to make your selection? What would be an indicator of trouble with a REIT? What would be an indicator of superior performance?

1) First I would decide which sector of real estate I want to be in…apartments? retail? industrial? office? Do I have geographical goals, for example, I want to be focused on the US, Canada or elsewhere abroad. In other words, figure out what you want to invested in and where. If you aren’t comfortable with investing in hotels, you would eliminate any investment that contains them or is significantly exposed to them.

2) Then I would look around for a reputable operator in my target sector. Check out their personal experience. What is their track record? Check with the securities regulators in the province in which they operate and determine if they have been sanctioned. Do a good google background search on the company and the senior officers. This is pretty easy to do in just a few minutes. Do they have institutional investors? This matters because very often institutions do much higher levels of due diligence than individuals and, while not an excuse for being lazy in your homework, does provide some additional comfort

3) I would ask a lot of questions and look at the offering memorandum and understand the key terms, minimum investment amounts, lock ups, redemption costs and voting rights. Can management be fired? Are the managers invested in the fund? How are they paid and how does this compensation compare to what other similar funds are charging? What are the qualification requirements for investors to invest? Is the fund audited by a high quality reputable auditor (as opposed to some guy who operates out of the local mall)? Is the strategy realistic and achievable and broadly in line with your personal objectives in regard to rates of return, liquidity, capital growth or income? What is the funds tax efficiency? Do they plan to go public or stay private and who decides this? What is the corporate governance infrastructure? Is it a unit holder democracy or not? What is the policy on leverage? What is the maximum leverage? What is their operating range for debt and what is it now? What is their policy on debt laddering? What does the debt stack look like? Are there adequate restrictions in what they can invest in and do? You are buying a long term investment and you should have some confidence that the manager can’t drift too much from stated goals. For example, an apartment REIT that would start to buy office or hotel properties.

4) If you are making a substantial investment, you should ask to speak to management to ask some of the questions your financial advisor may not be able to answer. I would ask, if I wanted to, would I be able to meet the manager?

Indicators of trouble…if they are a distributive REIT, they will stop distributions. Rising levels of debt or very high debt levels would also worry me. All debt being too short can also be a concern. Finally, a lack of audited financials would be extremely troublesome.

Superior performance…that’s a hard question. This can’t be answered in the short term. You may be able to determine quickly when a manager is doing poorly but a much, much longer period is needed to determine whether they are doing well. I’d watch them relative to their comparable peers. One good quarter or one good year does not a good manager make…even a 5 year hot streak could be luck and not skill.

Far more important than almost anything in selecting a manager is “ARE THEY HONEST”? If I had the choice between a mediocre investment run by honest managers versus a superb investment (or so you think) by a dishonest manager, I would pick a mediocre and honest manager every time. If you suspect the honesty or integrity of your asset manager…don’t invest. PERIOD. I would be prepared to ride through a difficult market cycle with an honest, hard working manager. Remember, good managers in bad markets may not make you money, and this is OK. We work very hard to protect capital, not just make money. Making money is secondary to capital protection in our view and we don’t control the markets.

There is no guarantee that even a good manager, because of the markets, won’t have the occasional bad run. If you believe in them and their strategy, you should invest for the long term and ride out the cycles. I would not give a nickel of my money to a manager I had reason to mistrust. That may not be the answer you were looking for but in my experience, it is a bit of an illusion to measure performance just by short term performance metrics…it could be sheer luck and not skill in the short term that you are seeing.

Rachelle here.  Many thanks to Mr Greg Romundt of Centurion Apartment REIT (link) for his detailed answers (and responses) to my questions. I’ve also predicted a market adjustment of 10% for housing prices this year, if I’m wrong I’ll be in elite company. Ask any REIT question you like in the comments and Greg will try to answer.

About the Author: Rachelle specializes in renting property on behalf of landlords and is the blogger behind Landlord Rescue. She also works with investors to find good investments in Toronto and surrounding areas. Her passion is bringing multi res properties back from the brink and maximizing profitability. Check out some of her other real estate posts on MDJ.

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About the author: This is a guest post. You can read more about the author in the biography above.

{ 11 comments… add one }
  • FT FrugalTrader October 1, 2010, 9:12 am

    @ Greg, thanks again for the interview. I have a question again regarding valuation. I’ve written in the past about evaluating public reits with FFO calculations. Does this calculation apply to private REITs as well? What methods would you recommend in valuating private REITs?

  • Greg Romundt October 1, 2010, 12:33 pm

    I don’t like FFO or AFFO multiples for calculating values. Personally, I believe this is a stock analysts attempt to get REIT’s to fit in a stock market box. THEY DON’T. When public REIT managers talk FFO or AFFO it’s not really because this is the best measure, it’s because that is the language the analysts understand. Analysts in the public markets are the constituency which public executives address as they are the gatekeepers to the court of public opinion. I could launch another tirade on the value of listening to analysts or rating companies (e.g. subprime mortgage securities) but that’s another article entirely. Here is an example of why FFO is a poor measure of anything in my view.

    When I buy a property I’m looking at its Net Operating Income (NOI) and capitalizing it at the Capitalization Rate. I will then budget my mortgage (interest costs) from this for the amount I’m going to finance. So as an example, let’s say a property has NOI of $70,000 per annum and capitalization rates are 7%. The property would have a value of $1,000,000. Let’s say that I have a choice of a 1 yr mortgage at 2% or a 5 year mortgage at 4%. In example 1 I will choose the 1 yr mortgage.
    Assume a 70% leverage ratio, which means you are taking a $700,000 mortgages. Interest costs would be $14,000 ($700,000 x 2%). Let’s for the sake of simplicity assume away any other administration costs and principal amortization such that our net cash flow is $70,000 of NOI – $14,000 of interest = $56,000. Let’s assume an FFO ratio 12X. This would value the equity (if this was a single property REIT) at $672,000. But wait a minute…we just bought the property at $1,000,000 and have a $700,000 mortgage. So the equity should be $300,000 or $672,000? Well, what do you think? Did the fact that you took cheap financing mean that you created $372,000 in value? NO IT DIDN’T. If you go to sell your property, no one will pay you (assuming the market hadn’t moved) more than the $300,000 for your equity position (i.e. they buy the property and assume your mortgage). You can’t magically create $372,000 in value out of thin air. But that is how you could be fooled by looking at FFO ratio’s.

    Let’s then look at what would have happened if I’d been more conservative and instead of doing a 1 year mortgage, took the 5 year mortgage at 4%. Now my net earnings in this simplified example are $70,000 of NOI less $28,000 interest ($700,000 mortgage x 4% mortgage rate) = $42,000. If we apply the same FFO ratio of 12X we get $504,000. This is a big difference to the $672,000 and it still compares extremely poorly to the $300,000 of actual REAL equity.

    So let’s work backwards and assume the market was smart enough to figure this out (it usually doesn’t…thus the volatility of the market) and our equity was trading at the true number of $300,000. So in example 1, our Price/FFO would be 5.36X and example 2 its 7.14X. Let’s pretend that example 1 and example 2 are two otherwise identical REIT’s and you are now going to choose between them. You’d look at the price to FFO ratio of REIT 1 and think that you were getting an excellent bargain in comparison to REIT 2. But this doesn’t consider the different debt laddering or mortgage financing strategies that these two companies have chosen. If rates were to head up, to 7% in 1 year, REIT 1 would be refinancing at 7% and the earnings would be $21,000 ($70,000 NOI – ($700,000 x 7%) Interest Costs). The price to FFO (assuming the property’s value didn’t change) would now be 14.29X. Thus what looked like the best deal, now looks overpriced by a factor of 2X. REIT 2, because it had long term financing would have the same cash flow (at least for the next few years) and its price to FFO would remain the same at 7.14x. If you were in REIT 1, its distributions would have to be slashed by 62.5% while REIT would not have to do so.

    My point is that Price to FFO or Price to AFFO (which is an even more “Cooked/Artificial” number in my view) are very poor measures of either absolute (ie am I paying alot for the REIT relative to the value of its actual equity) or relative (to its peers) value. These measures, as shown above can be very deceptive. You could argue that they are but one tool of many you need to analyse, but unless you are extremely sophisticated and spend a huge amount of time analyzing the reports, it’s my view that these tools have more potential to lead you down the wrong path than they have to provide useful insight.

    Thus, what matters in my view is Net Asset Value (NAV). If I were to buy a public REIT I would look at its NAV and its price premium or discount to NAV as an indicator of value. I’d look at its leverage ratio’s. I’d look at it’s yield and try to determine the stability of that yield. Price to FFO or AFFO wouldn’t even enter into the equation.

    For a Private REIT, I would only look at NAV and how it’s determined. I’d look at yield and want to understand how it’s determined and whether it’s sustainable. Remember this very important point about comparing yields on REIT’s though. Yield doesn’t impact value of your REIT units. Thus a 5% yield is not half as good as a 10% yield. I wouldn’t necessarily buy a REIT just because of its yield. I will make another post as to why yield is only one consideration of value and that investors shouldn’t be fooled into believing that higher is better.

  • Greg Romundt October 1, 2010, 1:37 pm

    Why not to be blindly focused on yield.

    In my previous post I discussed some of the metrics that I’d use and the ones that I’d avoid. Here is another one to be very careful about. Yield. Yes, we invest in REIT’s for many reasons, one of which is cash flow (yield). I would argue strongly that yield differences alone are not a reason to select one REIT over another. For example, would a yield of 5% or 10% or 20% say anything about the value of the real estate under the REIT. NO! Not one bit (I’ll explain later). Is a REIT that pay 10% twice as good as one that pays 5%…not necessarily. Is 20% twice as nice as 10%…almost for sure not!

    Remember that REIT’s can chose to distribute all of the cash flow or just part of it. Let’s say two identical REIT’s with the same cash flow distribute different coupon amounts…one at 9% (because they distribute all their cash flow) and the other at 7% (because they keep some back for a reserve). All other things being equal, the investor should be indifferent, because the amount held back by the 7% REIT would show up as capital growth. In other words, the total rate of return is the same, it’s just that one REIT is giving it back to you in cash and the other is holding some back and you will get the return via a higher unit value. Maybe they are being more conservative and want to have a buffer. This isn’t a reason to shun the lower yielding REIT (in fact you may want to be with them over the other).

    Yield can also be a function of leverage, and debt laddering. From the previous post, the first REIT, assuming 100% cash flow distribution would have had a yield of 18.6% (56k on 300k equity) while REIT 2 would have a yield of 14%. However, because of the conservative long term leverage, you’ve got this spread locked in for 5 years and this REIT would be much more stable than the REIT than must refinance in 1 year. You wouldn’t want to reward REIT 1 for taking undue risk would you? You may be if you just focused on the yield and not safety and stability of this yield.

    Leverage also impacts distribution capability. If we established REIT 3, that like REIT 2, borrowed 5 year money at 4%, but instead of 70% leverage used 90% leverage, how would our REIT’s compare. Well the equity would be $100,000 and cash flow (all other things being equal) would be $70,000 NOI – ($900,000 x 4% = $36,000) = $34,000 Net. On a $100,000 equity position this would be a whopping 34% yield. This seems juicy, but what if there is even a minor interruption in rentals or a move in long term mortgage rates or property values. The REIT could be easily wiped out.

    Yield also doesn’t necessarily reflect the risk of the underlying sector of real estate that different REIT’s may be in. Would a 7% yield on an apartment REIT be comparable to a 7% on a strip plaza REIT. I don’t think so. You need to adjust for risk. Yield has the potential to lead you down the wrong track if used blindly. It is an important measure for sure but you must balance the cash flow that comes out, against the risks of the business (yes real estate is a business) you are investing in, the conservative or aggressive nature of the financing/debt strategy for a more balanced view of yield.

    Thus yields between different REIT’s aren’t directly comparable as a sole measure of value…they are but one tool to look at.

  • Rachelle October 1, 2010, 3:36 pm

    Folks may want to take another look at Landlord Math (if you didn’t understand the above)

    https://www.milliondollarjourney.com/landlord-math-cap-rate-and-return-on-investment.htm

    To recap things to look at are

    NAV (Net Asset Value) = Value of the Buildings
    Leverage = How big the mortgages on those buildings are
    Premium over NAV = Once you add up all the shares issued they are worth more than the buildings
    Discount under NAV = Once you add up all the shares issued they are worth less than the buildings

    A good REIT manager can’t pay out all the money in distributions otherwise they can’t improve or add value to their buildings or buy more buildings (because improving and buying buildings costs money) (Some REITs being traded are paying out more in distributions than their income)

    A more conservative REIT will pay out less in yield, possibly because, they are going longer term on debt and keeping some money to increase the value of the building and fixing it up, instead of starving the buildings of money (which is not sustainable) over time one REIT may collapse because of their aggressive leverage and debt positions and the other will increase and continue to increase because they are employing sustainable, reasonable business practices.

    Did I get that right?

  • Greg Romundt October 1, 2010, 5:15 pm

    That’s absolutely right

  • FT FrugalTrader October 17, 2010, 7:46 am

    @Greg, quick question, are private REITs eligible for TFSA (provided they have the contribution room)? If so, what is the process of purchasing a private REIT in a registered plan?

  • Greg Romundt October 17, 2010, 10:24 am

    Yes provided that the REIT has been properly organized and meets the requirements specified by CCRA then it is an eligible investment for registered plans like RRSPs RESPs RRIFs and TFSAs. To purchase you would speak to the REIT operator to obtain the documents you need to fill out and they will send the documents to the REITs plan custodian (of course you must qualify first). In our case, you also have the additional option to buy from your own broker or financial advisor as we are on FundSERV just like most major investment and mutual funds are.

    • FT FrugalTrader October 17, 2010, 11:39 am

      Hey Greg, say an investor purchased a private reit like Centurion within their RRSP. Would it give updates to the NAV like other investments within the discount broker account? As well, say years down the road and the investor needs to cash out, what is the process? Is there paperwork, or can they simply click “sell fund”?

  • Greg Romundt October 17, 2010, 12:43 pm

    The answer depends on the REIT and also on the account where you hold it. Each REIT could have different processes. Not all accounts will allow you to hold all REITs. The plan custodian will require the REIT manager to keep NAV’s up to date just like other investments. In our case, NAVs are updated monthly. Sales are by written notice which starts the process. Its not a difficult process but it isn’t “click to sell”

  • kam December 1, 2011, 7:42 pm

    Hi Greg, I’ve been investing with League Assets in their IGW REIT for quite some time. While i believe the IGW REIT has been an excellent investment, I am looking for an alternative just so that i don’t have all my eggs in one basket. How do you compare or differ from the League? Also does your REIT have a monthly PAC plan? Thanks and look forward to hearing from you.

  • Greg Romundt December 1, 2011, 9:00 pm

    Kam, as a forum isn’t the appropriate place to discuss your personal investment needs, could you please contact me at gromundt@centurionreit.com and I will ensure that you get a response to your enquiries.

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