Liz DeMontrond: Hi, just a brief disclosure for today's episode, our guest today, Matt Werner, with Chilton Capital Management is not affiliated with UBS, and his views are his own. Enjoy the show.
Hello. Welcome to another episode of Deep Roots Forward Thinking, the podcast series by the Young Lockwood Sauer Team at UBS in Houston. I am your host, Liz DeMontrond. I'm one of the financial advisors on the team. For compliance purposes, our phone number is 713-940-2827. As always, I'm very happy to be here. Delighted to be joined by my good friend and teammate, Brittany Steitz, another one of the financial advisors on the team. Welcome B.
Brittany Steitz: Hi Liz. Glad to be here today.
Liz DeMontrond: I know, back in the seat.
Brittany Steitz: Back in the seat.
Liz DeMontrond: New studio. Well, we're super excited to welcome today's guest. I think we can say with some certainty that the dominant industry in the US over the past 15 years has been technology pretty unequivocally. I mean, there have been real tailwinds, predominantly artificial intelligence as of recently. But it seems like that dominance has boxed out most other industries from the conversation industries that are super important and vital to our economy. In particular, REITs, which stands for Real Estate Investment Trusts comprise 3% of the S&P 500, which we talked about on our prep call.
For reference, currently, technology is anywhere from 40 to 50% of the S&P depending on how you define it. I mean, that's a huge gap. And I think discrepancies like that always bring up questions. First of all, what are REITs? Why are they such a small part of the market? Will that change as macro conditions change? What do they have to do with my shopping addiction? So many burning, hard hitting questions. So thank goodness, we have an expert on REIT investing with us in the studio today. So today we welcome Matt Werner, who's senior portfolio manager of REITs from Chilton Capital Management. Welcome Matt.
Matt Werner: Thanks, Liz. Hey, Brittany. Good to be here.
Brittany Steitz: I'm so glad to be here. Matt and I are personal friends, so this is an extra fun-
Liz DeMontrond: So fun.
Brittany Steitz: ... episode for me to be a part of.
Liz DeMontrond: So fun.
Matt Werner: Full circle.
Brittany Steitz: Full circle, full circle.
Liz DeMontrond: Well, we'll definitely launch into, again, the industry and real estate at large, but would love to hear more about your background and what got you into this field.
Matt Werner: Well, I've been in the investment universe now for over 15... Actually, more like almost 20 years, and initially was involved in a fund of funds and put in charge of the real estate segment. So not really knowing what I was getting into, really had to rely on others to grow my knowledge on the subject. Found my current partner on the strategy, also working at the same company who became a mentor to me. And he was doing REITs, and we went through the 08, 09 experience. Separately, he was doing REITs and I was doing the fund of funds, and it was a pretty eye-opening moment for a lot of things during that period. But one thing that really stuck out to me was that if you were a private equity fund or something that did not have income producing properties, it was very difficult to get financing from banks or find new capital in public REITs that were a small piece of the fund of fund portfolio, but was a part of what Bruce was doing, had access to the public markets.
They had early access to the bond market. And so where they didn't go bankrupt, they were able to raise new equity and save their companies. The Fed was ultimately a pretty accommodative with monetary and fiscal policy that saved the bacon of a lot of private equity players, but some didn't make it. And it was a pretty big change for me on how I thought about investing, especially as it pertained to things you'd want to put your mother in, for example, and how I thought about risk and liquidity. And so, really refocused my career on REITs and has now been a portfolio manager for 14 years or so in public REITs strategy, and it's been fun.
Brittany Steitz: Well, great. Well, our team works really hard to ensure that we have a well diversified asset allocation, and that spans across all asset classes. So talk to us a little bit about public versus private real estate, pros and cons of each of those asset classes, and some different opportunity sets within this.
Matt Werner: Yeah. First of all, thinking high level as real estate as it fits into anyone's diversified portfolio, it's easy to say on a backwards looking basis that you should be a hundred percent in Nvidia for the past five years. And if you weren't, then you not as smart as the next guy. And you could go back to other periods. Actually, the 2000, 2007 time period, REITs drastically outperformed the equity market. And ultimately if you're a believer in risk adjusted returns, which you use diversification to lower the overall portfolio risk through lower correlations between the asset classes, real estate in general serves very important part of having diversification.
It provides income, inflation protection. Obviously, there is less volatility on the private side, but if you think about public REITs as a look through to underlying assets and you're confident in the values, there's also less volatility there unless you're buying and selling in a month or two or whatever it is. A long-term holder, it shouldn't as important. So, that's the first part. I think real estate should be part of every portfolio. It's about 17% of the economy, so you can take from there what it should be in individual portfolios depending on needs and time horizon and income. And then the public versus private. So you mentioned, Liz, that it's less than 3% of the S&P 500. Why is that, even though it's 17% of the economy? So the balance of that is made up on private investments.
And if you go back all the way, gosh, 60... The REIT structure was invented in 1960. So 65 years ago was when it came about with the idea of, "Hey, there's..." Back then it was probably a smaller number, but let's just say, it was a billion dollar building that the three of us couldn't go pool our money together and buy. And so the only groups that could buy them were pension funds or sovereign wealth fund or insurance company. And the REIT was created so that people could pool their money together and own a piece of something like that. So that structure has obviously survived and gone on and evolved over time to include all different sectors, anything that has a lease associated with it, basically. But the private side has continued to grow and it's a useful... Anyone with a very long time horizon in endowment or again, insurance companies that have very long weighted liabilities want to have a long time horizon asset to balance that.
And so, they've continued to dominate the space and there's cost to being public. There's sometimes when assets are valued more in the public market than they are in the private, and other times it's the other way around. And when it tends to be above, you'll see more IPOs and more equity insurances, and maybe REITs will grow their market share when it's the opposite. When they trade below the values on the private market, it can be the other way, and private continues to dominate. Even though the public market has grown, we've also seen... I mean, regular for equities has grown and we've seen companies stay private longer. There's been very plentiful cash available to private companies before having to go public like they used to. So, it's been an interesting time and happy to go into more on how public REITs fit into all of that.
Brittany Steitz: So in the public REIT space, we have this overarching theme that our team continues to debate and mold depending on our client's asset allocation. But talk to us about active versus passive in the space, and what are some opportunity sets that you see in the public REIT space?
Matt Werner: Yeah, so I think one the more interesting things about public REITs is the ability to have a pretty well-defined private market value that's tangible. You can go and find five brokers to tell you what the office building we're sitting in is worth, and I bet they'll be pretty close to each other. Probably a lot harder to come up with an agreed-upon value for a software company that's losing money or something with some intellectual property pre-revenue, right? So, it's a nice luxury that we have that we can really have a pretty good handle on as the volatility in the public market creates opportunities for them to trade above or below these private market values to be pretty confident in that.
Now, there's obviously reasons that is happening and they can trade below their private market value for a very long time. And ones that trade above can trade above for a long time because there's reasons that value is going to be growing. So, what active management on the REIT side, I think if you look at just performance of active managers, they've done a lot better than active equity manager, I think because number one of that, ability, number two, the average market cap size is much lower. It's not super difficult for a manager to get a meeting or a call with a CFO or a CEO of pretty much any publicly traded REIT or at least an investor relations person. And I am not sure how much Tim Cook speaks to all of his shareholders unless they're Warren Buffett or something like that.
Brittany Steitz: Right. Good point.
Matt Werner: So, we have a very good access to management. And then we can do property tours and go and look at the buildings and talk to tenants or to local employees that can give a sense of what's going on in the market. So there's just a lot of information that's available that I think gives active managers the opportunity to find things that are oversold or overbought, and that happens as a result of capital flows into the sector. And as ETFs and passive has grown, certainly there are good and bad things about it, but that does tend to create selling or buying for reasons that are different maybe than what the actual fundamentals are at the property level or at the company level.
Liz DeMontrond: It's an interesting nexus trading REITs being in this space because real estate inherently is a very illiquid asset class. I mean, I guess depending on the type of real, but you can't just decide to sell your home later today and then get those proceeds and do something with it. So maybe tell us more about the opportunity set and just the attractiveness of being able to buy, sell, really trade a market that is liquidity, be able to execute those trades with speed, especially in a market as we talked about in our prep call, that's been very volatile. I mean, earlier this year in April, we saw huge dislocations in the market and it seems like it's a big opportunity to be able to again, buy-sell during those periods of dispersions and not have to wait a super long time. Like you might have to if you were in the private real estate market.
Matt Werner: Yeah, that's a great point. Yeah, my comments before were really about finding anomalies or mispricing in the market created from the volatility, and that could be five, 10%. April was a good example, you can go back further to those crazy days in March of 2020, and public REITs were down 50% in a month or two months. That was the monkey throwing darts at the dartboard. It didn't really matter what you bought at that point when we got the stimulus and everything went up, and you were able to buy companies that very high quality companies with great balance sheets.
I guess, future earnings were in question, but if you had any confidence in the economy could make a lot of money just on the absolute performance. If you had that same conviction on the private side, there weren't apartment buildings on sale for 50% off of what the price was the month before. And even if someone was willing to let you look at a property, there's due diligence time, and then close and going to a bank and there weren't many people providing loans at that point in time. I think that's just a good example of where for someone that's looking at private versus public and seeing volatility in the public market as a negative, there are lots of positives that come along with it and opportunities to buy in when things are particularly mispriced.
Brittany Steitz: Some major themes around opportunities in this space. We talk a lot about data centers as it relates to, again, the beginning of our conversation about tech and this fourth industrial revolution, and AI and all these things. So give us some insight into data centers. We also talked about senior housing. Where are some longer term themes that you're playing into?
Matt Werner: Data centers, if you turn on your CNBC, you're going to be hearing about all of them.
Liz DeMontrond: A buzzword. Yeah.
Brittany Steitz: The buzzword.
Matt Werner: You're going to be hearing about data centers. You're going to be hearing about however many billions or hundreds of billions of dollars are being spent to create a picture of some silly cartoon on your phone. Who knows what the revenue model is [inaudible 00:14:39], but all of that needs to be housed somewhere. And obviously people are buying NVIDIA chips, but those chips need to be put into a server. Those servers need to be in a data center that requires power. So there's lots of different ways to play the AI boom that's happening.
And data centers sit right at the core of what is needed for all that to function. And they have for a long time, and AI is certainly helping that. We're really just in the very early innings of what's happening with AI. There's a very good analogy to what happened with the cloud, I would say. Because when you see these 500 billion commitments to a data center in Abilene, for example. Well, if you go buy a publicly traded data center REIT and they don't own that data center in Abilene, you might say, "Why would I want to? They're not going to benefit from that." Well, same thing happened with the cloud. Initially, Amazon Web Services and other cloud providers were building some of their own data centers to host your data on their cloud.
And the publicly traded data center REITs are much more focused on primary markets. They already are established. They're building closer to where the cables come in from under sea to go across the center of the internet. And cloud didn't necessarily need to be hosted right at that. So that when you click the button, it would come up in one millisecond. And eventually though, the demand for cloud was so much that first of all, these companies said, "We can't build fast enough to keep up with the demand that we need, so we're going to need to lease some space." Second of all, the applications for the cloud needed to become much quicker.
It wasn't just we're going to store this data on the cloud that we might need to access every couple of days, or just if someone calls and needs this data, it's great that we have it there instead of on some server in our office building. So as those applications increased and they needed less... We call it, latency, so less latency or higher speed, then those needed to be in those more centrally located data center markets. And the same thing's happening now with AI.
And so where you see data centers being built in Ohio and rural Pennsylvania and rural Texas, not directly benefiting the public REITs yet, but that's going to happen for sure. So to get a little more technical for anyone who wants to look this up right now, what's going on in AI is mostly training. And so, that's giving a lot of information to AI to learn so that when you ask it a question, it can draw upon whatever it's been taught. And that doesn't necessarily need to be accessed super quickly. But the next part of AI is going to be where AI is able to actually come up with new ideas, not just draw upon what it's been taught. They're called inference.
And so inference just similarly, this is why I say we're in the first inning, is going to be dependent upon the applications that are going to be used for it. That might need to be something a little quicker. So I guess the best example would be, and I don't know how far away we are would be a self-driving car, right? You don't want to wait an extra three seconds for your car to make a decision based on what it's seeing-
Brittany Steitz: Oh my gosh, yeah.
Matt Werner: ... because that could lead to an accident, so you would need it to be much quicker. A medical robot or something like that.
Brittany Steitz: Wow.
Matt Werner: We don't want to risk a time because it needs to go all the way to Ohio and back. So, that part is probably a few years away. And the REITs tend to own these centers that are in those markets where inference will be much more important. So, it's a great place to be. And the data center landlords that are publicly traded have been doing this a long time, have some of the smartest people working there, and they are going to capture their share, and it's just a matter of time. And they're going to be right at the nexus of this AI boom.
Brittany Steitz: Wow, wow. And with an aging population. And it's interesting because our generation, some people are having less kids, so it'll be interesting to see how this evolves. But for right now, we've got the boomers, they're aging. Talk to us about senior housing. I know we drive around Houston, we see tons of apartment buildings. And then, there was an apartment building in our neighborhood there where we actually looked at the sign and it's a senior facility even though it looks like a big apartment building. So tell us a little bit about that space and what's been going on.
Matt Werner: Yeah, it's very much supply-demand, like any other thing in real estate. And we actually avoided senior housing for a very long time because supply was very high. If you look at what the average historical supply for real estate is new construction. So the average has been in the 2% growth of supply range, and you back out about a 1% obsolescence rate. It gets you to 1% net growth. And there was a period of 5 to 8 years in the... Call it, 2012 to 2020, where senior housing was growing up 5% per year. And there were some markets where it was 8 to 10%. And the reason why senior housing was growing so fast was that unlike apartments where tend to be mostly younger people living there, they want to be close to the cool restaurants or close to where they work.
Seniors are not working anymore, they're eating their meals at the senior facility. So the location wasn't as important. So you could just go one exit further, tie up some land that's much cheaper, put up a building, and boom, you've got a senior housing facility. So it was just very rapid growth. And then, we had 2020 and all of a sudden the demand really turned off and went the other way. As people said, "Hey, there's a lot of COVID happening in these senior housing facilities, or I was going to put my parents in one, they were going to, but this is not the safest place to be. Let's keep them at our house or let them stay at their house a little longer." And so we look at, we call it, utilization. So utilization of senior housing by people of the average age was in the low 10s, I think it was maybe 13%, and it dropped to below 10.
And at the same time, the people that needed to work in those senior housing facilities and the ones to get them to come in was very expensive. They had to do a lot of temporary labor. I mean, we heard crazy stories of paying double or triple what they would normally have to pay just to keep their facilities running. And so you had revenue going down, expenses going up. Obviously, no one wanted to build anything new because of this fundamentals looking now terrible all of a sudden. And what's happened since then has just been remarkable, because now you have supply turned off. You have not only just the utilization getting back to normal. We're still not back to where it was before, but we're steadily moving up. And then, also you have expenses coming down as the labor market stabilized. If you think about apartment, we call it same store NOI growth, but this is simply just revenues minus expenses at the property level. Average over time has been probably 3%, so a good year is five and a bad year is 1 to 0 with a few [inaudible 00:22:57] there.
And senior housing now, one of the largest ones has had same store NOI of over 20% from their year over year from their senior housing portfolio. I think it was nine straight quarters because you have expenses coming down, revenues going up, and it looks like that's just going to continue as you have more people turning 80 every year, I think for the next six or seven years. So in our boring little segment here in real estate, kind of slow moving, pretty rare to have such a huge growth engine like this. It's been a great trade for us. And again, if you were a passive investor and you just got the market weight of senior housing, you've missed out on some pretty massive gains on something that, I don't want to say, it's easy to do the research and figure this out, but when you see nine straight quarters of it, that's hitting you right in the face. And there's been multiple ways to play it, but it's been a big theme of ours. Actually, we've started buying in 2020 when these things were really getting hammered.
Liz DeMontrond: Wow. A big component of the return from REITs is income is the dividend and today is Fed Day. So we have Fed Chair J. Powell speaking at Jackson Hole, maybe providing some guidance on REITs, but maybe not. What is the relationship between the yield on REITs and the federal funds rate?
Matt Werner: So we can look at averages, historical averages. It's not going to be exactly apples to apples because you can change your dividend based on what the board wants to pay. So if you and I are bringing in a dollar a year per share of cash, and we want to pay a $1.20 in dividends, obviously, we could say that's probably a bad idea if you're running your own budget for your household, but there's nothing stopping you from doing that. And historically, some companies have done that to attract more investors, say, "This is a higher yield." And that was done actually a lot in the 1990s when REITs really took off. We call that the start of the Modern REIT Era. And the average payout ratio is what we call it, was in the '90s, and sometime over a hundred percent. You could say, it was necessarily to get these things sold because there was just IPOs happening all the time.
And today the average payout ratio is about 75%. So that means that $0.25 of every $1 that comes in is actually being retained by the company that can be used for paying down debt if they need to, renovating properties, expanding new development, making acquisitions, or just keeping it so you can show a very nice linear growth of your dividend going forward. And that historical average between the 10 years, what we look at, because REITs are longer term assets, has been about 120 basis points. So if the 10 years at four, then you think it should trade at the average, it should be 5.2% dividend yield. You can take the dividend divide by that, and they'll give you what the price should be. Today, the REIT yield is about almost even with the 10-year treasury. So, you could say based on historical averages, "Gosh, REITs must be overpriced."
But when you factor in that payout ratio, that brings the spread down a little bit lower. And then also, REITs are actually pretty primed for some good dividend growth, which you weren't getting when you were having payout ratios that were over a hundred percent. And then there's probably some speculation in there of, "Hey, rates are probably going to come down." It doesn't mean that if the 10-year goes up 50 basis points that the REIT yield also has to go up 50 basis points, it certainly wouldn't be crazy. But there is probably some speculation in there and we'll see what happens when we hear the speech today. But it does look like that trend of rate cuts could potentially bring down the long end of the curve. And if you think about it, again, thinking about putting your mother or parents in something, do you want to put them into... Or first of all, you could be in a money market fund where if we had get six rate cuts over the next 18 months, that's going to go from down to 3% yield.
You could buy a 10-year Treasury and lock it up for 10 years at below four point a half percent, or you could buy something with slightly lower than four point a half percent yield. That's going to have some growth. And we're looking at dividend growth for the whole REIT industry of about 5% for the next three years. Our portfolio is much more tilted towards growth, so we think we'll be higher than that. And I like that trade, especially when you have the safety of low leverage, which is at an all-time low for these REITs.
This is not like some of the private equity funds I was talking about in '08, '09 and not speculative development, which thankfully is not a part of what REITs do, or at least the ones that we're buying. They want to make sure if they are going to put a shovel on the ground, that there's a tenant that's going to be there to pay rent and aren't overpaying the dividend so that it's going to be cut. There was over 50 REITs that had to cut their dividend in 2020 and only one in our portfolio because I think that there's, again, analysis that can be done to... We do stress testing of what's going to happen to cash flows. We didn't factor in a pandemic, but-
Liz DeMontrond: Who did?
Brittany Steitz: Not [inaudible 00:28:41] did.
Liz DeMontrond: Who did? Yeah.
Brittany Steitz: It wasn't on our bingo card for life.
Matt Werner: But I think that it was a good byproduct of a lot of the stress we place on companies having good balance sheets and good capital allocation discipline.
Liz DeMontrond: Active versus passive management.
Brittany Steitz: Matt, thanks so much for joining us today. I wanted to close with just a few rapid-fire questions for you. So, what is your favorite Houston restaurant right now?
Matt Werner: We like to go to Kata Robata a lot.
Liz DeMontrond: Oh, gosh. Yeah.
Brittany Steitz: Great choice.
Matt Werner: That's favorite sushi spot.
Brittany Steitz: Great choice. And what are you listening to, in your car, in your air pods?
Matt Werner: I listened to a lot of Phish, and that's fish with a PH.
Brittany Steitz: Did you go see them in Austin?
Matt Werner: I did.
Brittany Steitz: How was it?
Matt Werner: Yes, it was great. They played a great show, and it was good to see them playing indoors in the summer, which previously they'd had an outdoor Texas summer venue, which is a little rough, especially-
Brittany Steitz: Oh, of course.
Matt Werner: ... for someone our age.
Brittany Steitz: I mean, seriously. Well, [inaudible 00:29:45] for them.
Matt Werner: Right.
Brittany Steitz: I mean, right?
Liz DeMontrond: They're not spring chickens. Yeah.
Brittany Steitz: Oh, my gosh. It's all the Grateful Dead at the Sphere, and I was like, Mickey Hart, are you good? Are you okay? Was it a multi-night show?
Matt Werner: Yes, but-
Brittany Steitz: Classic.
Matt Werner: ... my wife's birthday was the second night, so-
Brittany Steitz: Becca. Shout out to Becca.
Matt Werner: ... I did only one show.
Brittany Steitz: Okay. Well, that's okay. And then what's a good summer memory for this year?
Matt Werner: We just got back from the beach in Florida and it was white sand, clear water. We really love Texas and Texas beaches, but they can't get that white sand and clear water like they have in Florida. It's a great spot.
Brittany Steitz: They can. That's great. Well, thank you so much for joining us today, and we'll bring you back, lots more to talk about.
Liz DeMontrond: Thank you so much, Matt. This has been another episode of Deep Roots Forward Thinking. You have Liz, Brittany, and Matt signing off.
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