Is Property Too Expensive, This Sovereign Wealth Fund Says Yes

Includes: AVB, CLNS, PLD, VTR
by: Reuben Gregg Brewer


Norway's sovereign wealth fund plans to invest more in real estate.

But right now, it thinks prices are too high.

Is a source of growth capital about to dry up for REITs?

In a short four-paragraph article (WSJ subscription may be required at link), The Wall Street Journal noted that Norway's sovereign wealth fund is worried about property prices. That's the same concern that many real estate investment trust, or REIT, CEOs have been voicing for a while now. Worse, Norway is planning to pull back on its property investment plans, which, if other big investors follow suit, could be a problem for REITs that have been working with them.

A global issue

Karsten Kallevig, the new head of Norway's sovereign wealth fund's real estate arm, recently told The Journal that the fund is having a hard time finding attractive property investments in Europe, North America, and Asia. That's a pretty big part of the world and includes most of the safest places to invest. The problem? Prices are too high.

Norges Bank Investment Management. Norway Kallevig explained Norway's response, "It's natural for us to proceed at a slightly slower pace, because uncertainty makes it more difficult to find the combination of the right assets and the right price." But this is roughly similar to what many REIT CEOs have been saying.

For example, Ventas (NYSE:VTR) CEO Debra Cafaro noted during her company's third-quarter conference call that, "With interest rates still low and the private bid for cash flowing assets still high, this quarter we saw some notable large transactions price at historically low cap rate." In plain English, that means property prices are high. She summed Venta's current tact up as, "...approaching the investment market with discipline."

Sounds like Norway's response, too. But that means less portfolio growth. And Ventas isn't alone. For example, AvalonBay (NYSE:AVB) CEO Timothy Naughton noted during his company's third-quarter conference call that, "'s hard to argue that it's not a good time to sell non-core assets today, just given the liquidity and activity in the private equity market."

CFO Kevin O'Shea went into more detail, "...with U.S. multifamily transaction volume exceeding $130 billion over the past year, the transaction market continues to benefit from strong buyer demands and remains a compelling capital source for funding development, for harvesting value from our Fund platform and from improving the asset quality of our portfolio." In other words, prices are high so it's a good time to be a seller. The flip of that is that it's not such a good time to be a buyer. AvalonBay, which has a long and successful history of building from the ground up, is clearly still growing its portfolio. But building is a longer process than buying, which could translate into slower growth in the near term.

More than just a price issue

But Kallevig's comments about the concerns in Norway are bigger than this. Prices are high, OK. But if Norway is pulling back on its property purchases, there's a potential tap-on effect. For example, I recently highlighted Colony Capital (CLNY). This REIT is increasingly focused on managing money for others. If big investors start to pull back, that business might not be as exciting as the company hopes. Especially when the CEO says things like, "...the Colony Capital investment management business should provide the growth engine that has the potential to turbo charge our financial results over time."

I won't dispute that over the longer term, but it may not be what happens over the near term. That doesn't mean Colony's asset management arm isn't a valuable business, just that it might be more sedate a business in the near term than some investors, and perhaps the CEO, hope.

Yet, this isn't the only place to look for concern. Take the June 2015 deal in which Prologis (NYSE:PLD) acquired the, "...real estate assets and operating platform of KTR Capital Partners." Prologis didn't pony up all the money itself, it was a 55/45 joint venture between PLD and Norges Bank Investment Management (NBIM). NBIM, for reference, is the manager of the Norwegian Government Pension Fund Global, Norway's sovereign wealth fund. So there really is a direct relationship here and a bigger picture to think about.

Not the end of the world, but...

That notable real estate investors are saying property prices are high isn't the end of the world. For example, Norway's Kallevig pointed out that using downturns to buy assets on the cheap is something that the country has done in the past. So Norway will be back in a bigger way at some point. And big REITs like AvalonBay have been through this before, which is why it's just as happy shifting gears and building from the ground up.

But it says something about the broader REIT space. One, if prices are high and your REIT is spending lots of money on acquisitions, it might be spending more than it should. Two, slower growth at some REITs might be baked in the cake if they pull back from acquisitions. Three, REITs tapping outside investors via partnerships or asset management agreements might find that the money flowing into the sector starts to slow (which could spell slower growth).

I believe REITs, on the whole, are pricey today despite 2015's risk-off price drop. So I'd make sure you own companies you understand and that you understand the bigger picture risks you have in your REIT portfolio. Valuation and growth are two risks that I think are worth a deeper dive right now. Norway's concerns are another reminder of the potential risks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.