Tips from Canada's top-performing real estate fund managers on how play the volatile sector – The Globe and Mail

Investors considering adding some real estate into their portfolios should take a page from some of the top-performing fund managers who have succeeded by playing on long-term trends such as low vacancy rates for apartments and the embrace of e-commerce.

“Definitely over the last three years the ‘beds and sheds’ theme has worked” for investors, says Derek Warren, a vice-president and portfolio manager with Lincluden Investment Management in Mississauga. (‘Beds’ refers to residential real estate, while ‘sheds’ is a reference to industrial space such as warehouses and fulfilment centres).

Mr. Warren, who manages the Lipper Award-winning CIBC Canadian Real Estate Fund, says the strategy works because people need to live somewhere and the shift to online commerce seems unstoppable.

“The cheapest place to live is in a rental apartment. So as home prices have appreciated and as immigration has increased over the last three years, that market has done very well and is very stable.”

Industrial real estate, meanwhile, has gained “dramatically” in recent years owing to the growth of online retailing, he says. “Everything you buy online has to come from a warehouse … and of course COVID only exacerbated that trend and accelerated it.”

Taking the e-commerce theme a bit further, the portfolio manager added U.S. funds that offer more niche plays such as data centres and cellphone tower real estate investment trusts (REITs).

The CIBC real estate fund is also currently overweight two office REITs, namely “brick and beam” (warehouse style office space) property owner Allied Properties Real Estate Investment Trust (which also has some urban data centre ownership) and Dream Office REIT. He expects both to do well as workers begin to fill office spaces again.

The pandemic has been particularly hard on the valuations of traditional office owners and retail property companies, as well as for some in the assisted living and apartment sectors.

Acting tactically and buying these out-of-favour commercial real estate sectors has been a winning formula for Dean Orrico, president and chief executive of Middlefield Capital Corp. of Toronto, whose Middlefield Global Real Estate Class fund was a 2021 Lipper Award winner.

Last year, early in the pandemic, his firm loaded up on e-commerce companies including U.S.-based cell tower and data centre REITs. He has recently added Canadian grocery-anchored REITs, believing that people would eventually have to get back to their normal routines.

“We felt strongly [last fall] that eventually we would get vaccines,” Mr. Orrico says. “Eventually you were going to start seeing a reopening and some of those office, apartment and grocery-anchored REITs were oversold.”

His top picks include the Granite REIT (industrial/logistics properties within North America and Europe), the U.S.-based Alexandria Real Estate Equities REIT which owns and operates urban science and tech campuses in North America, retail developer RioCan REIT which is diversifying out of traditional retail as well as CAPREIT, Canada’s largest apartment REIT.

Mr. Orrico remains bullish on the real estate sector generally despite predictions of rising interest rates.

“Even during periods of rising rates, real estate actually tends to perform very well,” he says, because owners can pass of rising costs as leases expire. Many real estate companies have also been extending their existing debt in the ultralow interest rate environment.

“For investors who want income and who want tax-efficient income, in my view there is no better asset class than the REITs,” Mr. Orrico says.

Another often overlooked sector for would-be real estate investors is manufactured homes, better known as mobile homes or trailer parks.

“Most of my funds have been overweight manufactured homes since their existence,” says Steve Buller, a Boston-based portfolio manager with Fidelity Investments who manages the 2021 Lipper Award-winning Fidelity Global Real Estate Fund.

Trailer parks may not be pretty to look at, but they have displayed attractive financial fundamentals, he notes.

“It’s been an extremely good sector. Many people don’t want them built in their neighbourhoods or their towns [but] it is very low capex when you have a concrete slab,” he says.

Park or trailer campground operators typically provide minimal services such as utilities and lighting and have a financial advantage apartment building operators could only dream of; security for their rent.

“If [tenants] don’t pay their rent on their slab you have a first lien to take over their manufactured house, so you have security of rental stream,” he says.

Looking ahead, the Fidelity portfolio manager sees the fundamentals of the out-of-favour hotels sector improving as leisure and business travel returns to more normal levels. His fund remains underweight in office markets in North America and Britain where work from home practices may take longer to end than other countries.

He also likes the commercial real estate fundamentals in general; economies are improving and capital is relatively cheap to raise which is leading to more real estate companies issuing equity for acquisitions.

“Access and cost of capital is as good as it has ever been even with the slight uptick in global interest rates,” he says.

Mr. Buller also doesn’t believe that rising inflation will be bad for the commercial real estate sector. In fact, he believes it may boost the value of existing properties as the replacement costs for buildings spiral higher as costs of raw materials such as steel and concrete and labour soar.

“Too much supply is always the danger [for real estate] with inflation what it is and the replacement costs, you are going to need to have to higher rents to economically justify new construction,” he says. “So we are starting to see supply actually taper off unless you have higher rental rates.”

For the full list of 2021 Lipper Awards winners visit: www.globeandmail.com/investing

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