Hello and welcome to Personally Invested. I’m your host, Dave Richardson. Today we have a really interesting topic. We’ve talked about on the podcast in previous episodes, about stocks and bonds and large global markets, but one of the things that is actually closest to home with investors, and it is actually their home; it’s real-estate. And so today I’m joined by Michael Kitt, who’s the Head of Real-Estate Investments at RBC Global Asset Management. Michael’s worked throughout his career with large institutional investors, always around real-estate, worked with a teacher’s pension plan, OMERS. And what Michael has always wanted to do is effectively bring pension style investing to everyday investors as he says it: “democratizing institutional investing” and adding an edge to retail investors’ portfolios that have previously been reserved for just the largest investors’ world-wide. I think you’ll find this discussion absolutely fascinating. Michael, welcome to Personally Invested, it’s great to have you here.
Yeah, thank you, Dave.
And this is a topic and an area that so many people are interested in, and that so many Canadians in particular and most of the people that listen to this particular podcast are Canadian investors. And obviously what’s happened in real-estate markets is the talk of every dinner party, every family gathering. Anytime you get together and I’m sure that’s your experience as well, particularly being an expert in the area.
Yeah. Well I mean everyone has real-estate in their life in some form or another. They live in a house and... either they rent a house or they own a house or they have a... child who’s buying a house, or they have a family member they’re lending money to to buy something and so, real-estate is a big part of everyone’s life in some way. And it’s been a big part of my life. I’ve always been around the industry and I’ve always believed that... they had a role in a person’s or an institution’s portfolio. And that was right from my university days.
Really? So, right out of school?
That was the direction you headed. Now, was it an investment business interest or was it more specifically right into the real-estate business?
It was... I’d worked for an advisor coming out of university and that advisory company helped certain pension funds actually in Manitoba, with their overall portfolios, so much like GAM performed that service. So I got to know how pension funds thought about, these were mortgages specifically.
And I started to understand how mortgages fit within an institutional investment program and the benefits that that had and that quickly led to thinking about well, where would real-estate equity fit and how would that work and so, I actually went back to school to become a university professor and I wrote a...
I wrote a course about why institutions should invest in real-estate. So, this would have been, you know, 25 to 30 years ago. And... So I... you know, I became a believer... you know, teachers, I don’t know what the saying exactly is, but usually what you can’t do, you teach.
You teach, yeah.
And so I... you know the course was basic but compelling and my relationships in Manitoba then translated to a job in Toronto; they pulled me out of that program, I was teaching actually at York University. And... they said: “Let’s... actually, we want to start a real-estate program here and so let’s do that.” It was at Ontario Teachers. So, 16 years later, through that teacher’s journey, we had created a platform for them that included some of the very best assets in Canada. It really strengthened their investment program overall. And then that led to another role at Ontario Municipal Employees Retirement Funds, OMERS, and their real-estate sub for another 11 years, so... You know, all told, the 30-year journey has been all about getting great real-estate investments into institutional portfolios.
Wow! And so, you grew up in Winnipeg and...
Yeah, yeah, I still have family there... a brother and a wonderful family and a mom. So, yeah, it’s a city that’s near and dear to my heart, great friends, a wonderful business community, and still to this day very supportive. So, yeah, I love Winnipeg.
Yeah, I’m sorry, I’m a St. Louis Blues fan so... (yeah, well...) I’m not a good person to be with right now on this, sorry about that, but yeah it is a great community and what’s remarkable is the stability of the real-estate market, in a place like Winnipeg versus, you know, what we see in... particularly on the personal front. (Yeah.) Places like Vancouver and Toronto or even what you see in Saskatoon, (yeah) or Regina over the last decade at different points in time.
Yeah. Yeah, it’s... people... I mean you make a good point, because people often throw a blanket statement about real-estate. (Yeah.) But really, that’s just like saying you invest in stocks, well actually there’s a secondary set of questions and that is, you know, what kind of stocks and why. It’s the same question with real-estate. If you’re a real-estate investor, that isn’t enough to describe yourself, you really have to get into the... what you invest in and why and where. Because, real-estate, if you look at it truly as an investment class, is just as complicated and offers just as much opportunity to those who dig as the stock and bond markets do and so... It’s been a really... it’s been a really rich investment environment where you’ve built some relationships and you get to know these cities and locations intimately over time, you get to know tenants, you get to know demand drivers. And pretty soon you can come up with an investment thesis, not just that works in Canada but also that works globally, because these ideas are transferable. And you can really construct some wonderful opportunities to invest... and so it becomes all about access...
...Do you think that’s one of the main misconceptions that people have about real-estate that’s pretty narrowed... narrow market, you know, how is this building, but there’s... but as you say, there’s a depth in breadth that you really have to really understand pretty much from the ground up to really be successful and to help build the right portfolios for your clients?
Yeah, I don’t know that it’s a lack of understanding; it’s been a lack of access. You know, there are shopping centers in Toronto that are worth 3, 4 billion dollars. (Wow.) So when an asset is worth something like that, you know, how many can access or how many can own? Whereas individual investors have always been able to buy a share of the Royal Bank or buy a share of... of another operating company like Amazon, and so... having that access means you can become familiar and there’s a reason for you to become familiar. If you don’t have access to a big shopping center or a big office building, or a big apartment building, well then you have no reason to become familiar with the... of how it works and what it’s worth and how it belongs... where... how it should belong in an investment portfolio. So... If you can create the access points for investors and give them a reason to want to understand how it works, really, that’s what they’re waiting for. There’s a large demand from the individual client base and from the institutional client base where, if you give them access that they haven’t had otherwise, they’re very willing to hear the story and understand very quickly how real-estate, if properly set up, how it benefits the... how it can benefit their portfolio.
And I definitely want to get into the way real-estate does fit in... to a traditional portfolio, the way most retail investors would build a portfolio. But I want to focus in on this access point. (Yeah.) Because as I talked to Dan Chornous, who’s the Chief Investment Officer at RBC Global Asset Management, when we taped a podcast with him, we really talked about there’s just certain areas of the market, that again are somewhat misunderstood, sometimes because of the lack of access as you suggest, I can’t just go out, I don’t have 3 billion dollars to buy a nice shopping mall, but I could buy a little bit of it. But that you’ve got to have... you have to have the right people with the right experience and background and access to the information to know how to build those portfolios and put those deals together, (yeah) to actually provide access to the small investor. (yeah) And, what is it, so as we talked about your education background, but you learned, I take it, a lot at OMERS and the other parts of your background that really showed you what the key is to making the right choices, how to put together those deals, and to get access to investors.
Yeah, and again, it’s not a complicated industry, (yeah) it really is as basic as finding a well located asset, whether it’s residential or industrial or retail or office, the principles are all the same and the principles relate directly to do tenants want to live there or work there or occupy the space and what are they willing to pay and what they’re willing to pay, how does that relate to the price that you’re paying for the asset and, it’s a very basic financial investment opportunity. But it was because of the lot sizes, because of the level of value, the value level of each of the individual assets... it really was the domain of the large private investors, which really became the domain of the large public institutions actually. They recognized the opportunity while I was at Teachers and OMERS to move into the space because they saw… they saw access as very difficult, so if they could figure out the access point, then they had an advantage and they could earn great risk adjusted returns and in fact, the real-estate component of their portfolios had been… the most successful component of their overall portfolios by and large for the past 20 years. So, they recognized that there were exceptional risk adjusted returns, and, yeah, there was a price to that access; they had to set up very strong teams and they had to invest in that. Those relationships and that knowledge base to establish that access, but once they did that, they really had a captive investment opportunity, where they knew that very few could compete against them. And so they were able to assemble these wonderful portfolios that they held for a very very long time, decades. And they were able to take those opportunities or those ideas, and also transport them into the U.S. and into Europe and ultimately in Asia. And because they weren’t competing with the traditional… you know, the efficiency of the public markets, per say, they were still protected by the inefficiency, relative inefficiency of the private markets. So, if you built a great team and you had some great relationships you had an advantage and you could make some money.
And so, what is… I believe the largest real-estate investment deal in Canadian history, you were just involved in, describe how that came together and what investors where you’re now working at RBC Global Asset management, are going to be able to both institutional and individual investors are going to be able to benefit from what you put together there.
Yeah. Well… so, just going back one step just to restate it because it’s worth restating, let’s say 12 months ago, these big transactions were the sole domain of the large institutions. And what these large institutions would do is often partner with each other, and take, you know, a 3-billion-dollar shopping center and say: “Well, that’s even too much for a big institution, so let’s go 50/50. (Yeah.) And you will own 50% and I’ll own 50% and that way we’ll spread the risk.” So, we thought that that thesis, why not apply that thesis to a big institutional portfolio and say: “Institution, you can own 50%, and we’re going to collectively create an opportunity for individuals to actually bring themselves together and be a 50/50 partner with an institution. So effectively democratize what has always been the domain of the large institutions, now we’ve created an opportunity, really for the first time ever, for those individuals to be shoulder to shoulder as true partners, because of the power of the collective, to be true 50/50 partners with big institutions on big assets. So effectively, we can be owners, you and I and everyone in the room or everyone listening to this podcast could effectively be a partner on assets they’d never dreamed of being partners on. Shoulder to shoulder, truly shoulder to shoulder with another big institution.
And… so, it’s an incredible story. And, you know I think so many…when I travel across Canada and, you know for the most part we’ve done, when I’ve done client presentations and large client events, and we talk a lot about stocks and bonds, we talk about real-estate just in terms of the strength of the local real-estate market for people’s houses and that. And people come and always ask questions about real-estate, because they know there’s something there, (yeah) and they know they should be adding this to their portfolio, but again, it’s been so difficult to do, and as you say, you’ve democratized the access to this, (yeah) so now, retail investors will be able to get access to that through… at RBC… through RBC and RBC Global Asset Management. How do you think these types of real-estate portfolios that access to this, fits with, you know, someone’s traditional bond and stock portfolio cash they might have in a traditional, you know, balanced conservative growth-oriented portfolio?
Yeah, it’s going to vary, from individual to individual and based on their needs and, you know, that’s the value of understanding your own investment program, that’s the value of advice, having advice around your own investment program. Understanding the stage in your life you’re at, the importance of cash flow, the importance of tax effective yields, the importance of liquidity, and the importance of diversification and what kind of investment horizon you have, so… bringing all those things together, it’s just impossible to throw a common statement around here’s how real-estate fits. But let’s start with a why real-estate fits. And then move on to the how and how to execute it, so why? Real-estate as an asset class, not REITs, because REITs own real-estate, but they’re really companies that own real-estate and therefore behave like companies. (Yeah.) It’s very different when you invest directly into the real-estate asset class, so let’s, you know, challenge number two, and often misconception number one, is that people that buy public companies that own real-estate think they’re adding real-estate to their portfolio, but these companies behave like the stock market. They have the volatility characteristics that the stock market has, and often in times of weakness, they struggle, because when stock markets pull in, these companies are forced to pull in at exactly the wrong time in their cycle, (yeah.) when you should be moving in, they are actually at the lowest point in their ability to raise capital or to borrow funds.
So there’s a lot of volatility and drawdown risk associated with any public company, you know there’s infrastructure or real-estate or any private asset class. Not that they’re bad companies, they just behave like public companies in stocks. So they do nothing to diversify your portfolio. But owning direct real-estate in a very diversified way, actually, this is what the institutions quickly caught on to 20 or 30 years ago, is that there’s a very very low correlation, essentially zero to public asset classes. So what you have is an asset class that behaves very differently. So when stock and bond markets are moving one way, this real-estate acts as a ballast, and your portfolio really lowers the overall diversification or lowers the overall volatility of your portfolio. That’s number one, number two, real-estate generally has a positive relationship to inflation, whereas the stock and the bond market struggle with that correlation, often a negative correlation to inflation. Meaning that as inflation exists and creeps into the system, often real-estate rents move up with inflation, are inflation protected. And the nature of those real-estate contracts the leases that are in place, which are often for a long-term, actually building incremental rent increases to protect the owner from inflation. So what you have is an asset class that actually offers a little bit of inflation hedging protection. Is it perfect? But it’s one asset class that offers that. Unlike stocks and bonds that struggle with that direct relationship. So you have those two benefits: first of all, a diversification through the lower correlation, lower volatility of portfolio. Number two, it has some inflation protection and number three, it’s an asset class that offers a very … typically a strong cash flow yield. So, it’s… a cash flow yield that has been historically greater than fixed income, greater than overall dividend yields. And so it’s an asset class that again has ballast because you’re always starting at a, you know, a +3 or a +4 or a +5, whatever that dividend yield is, and so if you add in lower capital volatility overall, if you’re always starting with a nice strong cash yield every year, you do have, you tend to have a very low overall volatility, through your holding period. And then finally, the real-estate sector can be tax efficient if structured properly. And you have a number of expenses that can help, it can be flow through to investors and create a very tax efficient investment vehicle for those that are taxable. So that’s a pretty compelling set of reasons for the inclusion of real-estate in a portfolio and there are a number of technical models used to construct portfolios. One of the more traditional ones is the… they refer to it as the efficient frontier where basically you put in all the inputs of the asset classes and you run all these mathematical models and you… the end result it spits out: okay, you should invest 30% bonds and 60% stocks and 10% something. So, cash. And so when you add real-estate and you ask that model: okay, how much real-estate? It always spits out way too much. The model is telling you to put 40% in your real-estate portfolio. And why is because the model is saying: “Oh, this is a good thing. It doesn’t move very much, it actually generates a great yield, it gives you some cash, buy more.” That’s what the model tells you. The problem is access, (access) it goes right back to access. (Right back to access.) People can’t do it. And it’s not wise to buy… the model isn’t telling you: “Buy that shopping center.” The model is telling you to (buy basket) buy basket. And people can’t find the basket. And so really that’s the opportunity that we saw, it’s let’s work hard to create the basket for people to…
So you can take a standard balanced or conservative portfolio that’s made up of stock and fixed income from all around the world for example, but now add in with this access, (yeah) to this type of real-estate portfolio, and in some ways create something that looks like the pension plans of some of the most… the best known sophisticate… like OMERS, teachers, (yeah) in the entire world. (yeah) at a retail investment level.
That’s right, and in fact, these pension plans now over… if you rewind the clock back to 20 or 25 years ago, would have had the traditional 60/40 mix, you know, 60% stocks and 40% bonds. Or maybe they would have been 50/50, but they would have been all around that. And then when they started to discover the positive impacts that these private asset classes had, and then they formed those access teams, and then they found that they were ready to find opportunities and move into that space. So now you fast-forward to 25 years, to today. The average private asset class holding of those funds now is pretty close to 50%. (wow) So they have almost half of their money in private asset classes. And the other half is now stocks and bonds. That’s stocks and bonds. So they have committed 15, roughly 15%, some as high as 20% even higher to real-estate, 15, 20% to infrastructure, 10 to 15 to private equity, and then the rest is traditional stocks and bonds. So, as an individual, you’re basically playing with half the field, if you’re only looking at stocks and bonds.
Of what institutions can, so… Michael, just a fascinating discussion. Loved to have you back, cause I heard there’s a… we…
Scratched the surface…
We just scratched the surface, I know of how this is going to be… is part of really a new frontier for retail investors and again we talk mostly about the Canadian market, (yeah) but for markets all over the world and I’m sure our listeners enjoyed it. Thank you very much for your time.
Alright, Well, my pleasure. Anytime. Thank you.
Thank you for listening to Personally Invested. If you have suggestions for future podcasts, please email us at firstname.lastname@example.org.
Thank you for listening to Personally Invested. If you have suggestions for future podcasts, please email us at email@example.com.