In the second quarter of 2016 the portfolio gained 0.6% while the benchmark lost 0.4%. YTD the portfolio gained 2.5% while the benchmark lost 5.1%. Since inception the portfolio gained 21.1% while the benchmark gained 21.4%.
Largest contributors to performance during the second quarter were Dundee Corp. (+0.8%), a basket of Italian real estate funds or REIFs (+0.4%) and Lectra (+0.3%). Largest detractors were Houston Wire & Cable (-0.6%) and Par Pacific Holdings (-0.4%).
Update on Italian closed end real estate investment funds
Roughly one and a half years ago I started to build a basket of Italian closed end real estate investment funds (REIFs) (i) being in the disposition phase, (ii) trading at 50%+ discounts to appraised net asset value (iii) while at same time carrying none or very modest amounts of debt. Italian REIFs are currently the portfolio’s largest holding as you can see from the table below:
So far the Italian REIFs performed very well adding together roughly 3.2% to total portfolio performance.
In the second quarter, Italian REIFs attracted media attention as a number of hedge / private equity funds including Elliott Associates and Texas Pacific Group launched bids for several REIFs with some of the bids being increased afterwards. Though in Italian, there is a very good source where interested investors will find all the relevant information and news about the 26 REIFs listed at the Milan Stock Exchange.
It seems that REIFs are suddenly receiving interest from institutional investors. However, that is actually not the case. There have been takeover attempts before mostly unnoticed by market participants. In 2014, Blackstone, Eurocastle Investment (a Fortress entity), GWM Group and Capstone launched bids for several funds. However, it is not that easy to gain control of REIFs, because many fund units are buried in retail investors’ portfolios. In addition, well informed investors are not that inclined to accept offers at 40% discount to NAV.
I am currently holding four different REIFs. None of them were so far addressed by the recent round of takeover offers. Nevertheless, as already mentioned these funds have performed well and two of them have narrowed their discount to NAV substantially.
Europa Immobiliare is currently trading at a 10% discount to NAV (Current NAV: EUR 153 m). Since my initial investment roughly two thirds of gross assets have been sold. Management has done a good job in disposing the assets close to appraised value. Capstone was aware of the fund’s potential and tried to take over control in 2014. However, they were not successful.
Management plans to sell all remaining assets at appraised value until mid-2017. Assuming that all net proceeds from the dispositions will be disbursed at the end of 2017, an investment currently offers an IRR of 6% and a total return of 14%. Adjusting the NAV for current cash holdings, properties can devalue by 33% before an investor will actually lose capital from current quoted price level.
WertArt’s exposure to Europa Immobiliare as of June 30, 2016 is 4.6%.
Valore Immobiliare is currently trading at a 27% discount to NAV. (Current NAV: EUR 66 m). At the beginning of July 2016, the disposition of their property in Milan at appraised value was announced representing 42% of gross assets. After completion of the transaction fund assets will be invested 46% in cash and 53% in two remaining properties.
The REIF’s lifetime ends in December 2019. Assuming that the remaining properties will be sold at appraised value and that all net proceeds will be disbursed to unitholders at the end of the REIFs lifetime, an investment currently offers a 9% IRR and a total return of 37%. I am truly aware that the actual outcome will differ, so this is only an indication regarding the potential return. Adjusting the NAV for the REIF’s cash holdings, properties can devalue by 60% before an investor will lose capital.
Wertart’s current exposure to Valore Immobiliare is 1.7%.
UniCredito Immobiliare Uno is currently trading at a 33% discount to NAV (Current NAV: EUR 284 m). 18.3% of fund units are held by two institutional investors including Eurocastle Investment a Fortress entity and GWM Group.
After the recent disposition of the second largest asset at a 10% discount to appraised value, 65% of gross assets are invested in a residential redevelopment project in Rome in a prime location. The construction of the redevelopment project has not started yet. Therefore, an extension of the fund’s lifetime beyond December 2017 seems to be a likely outcome.
Assuming that the remaining properties will be sold at appraised value and that all net proceeds will be disbursed to unitholders at the end of 2019, an investment currently offers an 11% IRR and a total return of 48%.
Wertart’s current exposure to UniCredito Immobiliare is 1.9%.
Amundi Europa is currently trading at a 50% discount to NAV (Current NAV: EUR 180 m). Out of the four REIFs it is the only one holding debt. The current LTV is 19%. It is also the fund where the sales process is the least advanced.
Amundi Europa has exposure to properties in France, UK and Germany. Still the Italian assets make up 64% of gross asset value. Rental income is currently under pressure as a number of tenants have not renewed their lease contracts. The REIFs largest asset located in Rome (25% of gross asset value) is leased to a single tenant (H3G). H3G has a break option starting from May 2015 until May 2019. From my perspective, it will be very difficult to find a new tenant for this building in case H3G is leaving.
Assuming that the remaining properties will be sold at appraised value and that all net proceeds will be disbursed to unitholders at the end of 2019, an investment currently offers a 17% IRR and a total return of 100%.
Wertart’s current exposure to Amundi Europa is 1.2%.
(More information about the Italian REIFs can be found in former write ups posted on this site by using the search function.)
In summary, I think the portfolio’s current allocation to REIFs is too high. While Valore Immobiliare, UniCredito Immobiliare and Amundi Europa are still offering an attractive return pattern, the current market price of Europa Immobiliare is not accounting for any negative surprises. This might be due to management’s very optimistic outlook with regard to the remaining disposition phase.
Given my relatively large allocation to Europa Immobiliare and the limited return potential, I decided to sell half of my position in this REIF with a limit price of EUR 1,100 per unit starting from today. This should result in an IRR of 75% and a total return of 90% over an 18 months holding period (starting from initial investment).
Just a quick note on the current situation of the Italian banking system and its effect on the real estate market. Recently, there have been many comments on the difficulties Italian banks are currently facing. Banks are suffering from a constantly increasing non-performing loan pile:
The graph above, is from the latest Eurocastle Investor presentation. Eurocastle is not only invested in Unicredito Immobiliare but has also a large exposure to the Italian NPL sector. It is actually a good source to get a macro perspective from an investor’s point of view. A relatively optimistic analysis regarding NPLs in Italy from Pimco can be found here. The weak Italian banking system might be affecting the Italian real estate market. On the other hand yield chasing investors seem to have finally arrived. The recent bids for REIFs are only one example. Hence, the period where investors can find buckets of very low priced and well located real estate in Italy seems to have come to an end. It is now more about riding the bubble like in many other markets.
Currently, the portfolio consists of 27 investments with an average weighting of 2.9% (when accounting for the Italian REIFs separately). A detailed overview of the current portfolio can be found below:
During the quarter I invested in Sports Direct for the first time and added to my existing positions in A&O Johansen, Bellevue Group and LogiCamms (continued from the first quarter). A detailed overview of the portfolio’s quarterly cash flows can be found below:
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!