Q:  What are the advantages of investing in the global real estate space? A: There are many advantages to investing in the global real estate market. Companies are accessing capital across borders and the industry is transitioning from family run businesses to more structured and highly capitalized ones. First, the global real estate market provides investors with exposure to hard assets and real assets on a global scale. Second, many economies are growing around the globe. Third, the emerging markets and some of the developed economies outside the U.S. are evolving in their real estate listed securities. This gives investors diversification benefits that they obviously don’t get by only being in the U.S. REIT market. As more companies become public, investors have access to a wider array of securities. Therefore, I think investing in the global real asset space provides investors with diversification and participation in the growth of emerging and developed markets, as well as providing access to a listed market that is different from general equities or fixed income. Q:  How has the global REIT marketplace evolved in the last decade? A: Currently, the global real estate market is $1.2 trillion in terms of listed securities across the globe compared to a $300 billion market just two decades ago, a four-fold increase. This growth makes the real estate market a deep liquid market and allows for individuals, pension funds, and sovereign wealth funds to participate. The reason this market has grown is because companies that are listed have access to debt and equity capital. Initially it was the U.S. that attracted capital but around the middle of the last decade (probably more so after the crisis), there was more debt issuance by Asian, Middle Eastern, and Latin American real estate companies. So many markets have now opened themselves up to allowing the real estate companies to access capital. I think that is a result of good corporate governance practices, transparency, delivering on performance, and the showing of a long-term strategy both at the real estate level and the capital allocation level. Moreover, these are companies that are generally fairly leveraged. In the U.S., it is six times debt-to-EBITDA. In Europe it’s a little higher and in Asia it’s a little lower, but on average about six-to-seven times debt-to-EBITDA is typical. Leveraged companies don’t generate a lot of free cash flow and have to consistently come back to the markets, whether it’s the debt or equity market that makes a deeper opportunity for most real estate companies to access capital. Another important trend we are seeing in this market is that companies are raising capital across borders. U.S. companies are raising money in Europe because rates are very low. For instance, we saw Chinese developers earlier in 2014 coming to the U.S. and raising money in the unsecured bond market. When we see global investor confidence in these companies, it helps them in a deeper, more sophisticated way. That’s important, because historically the issue with real estate has always been permanent capital. When companies cross borders and raise that permanent capital, it creates more confidence and that means higher multiples over time. It’s very important that the REIT market has been able to access capital. REIT has recently been one of the best-performing asset classes. The REIT market has outperformed the Nasdaq Index, the S&P 500 Index, the MSCI World Index, bonds, inflation, gold, and commodities in general. One of the reasons for this is that real estate leases are fairly stable. Leases have rental bumps every year and that leads to nice dividend growth, which leads to higher total return. Over the last 20 years there is global dividend growth of real estate companies at 6.1% on a compounded annual basis. This is strong dividend growth, in comparison to a 2.67% increase in the U.S. Consumer Price Index over that time period. The annual outperformance is almost a 350 basis points spread over inflation. Real estate is an inflation fighter because it can grow dividends over and above the rate of inflation, in addition to the fact that REITs have the highest dividend yields in the world. For example, currently the FTSE EPRA/NAREIT Developed Index has about a 3.9% dividend yield, compared to the MSCI World Index which has about a 2.1% yield and the Barclays Global Aggregate Bond Index which has a 1.9% yield. So REITs not only have a premium yield but they can grow that dividend over time, which fixed-income securities can’t. The MSCI World Index, which is starting off with a lower yield, can have dividend growth, but not as strong as what we are seeing in the REIT space. Therefore, REITs have high dividend yield along with good and consistent dividend growth, and that’s why there’s outperformance. Q:  How do REITs perform in a rising-rate environment? A: In my view, about 80% of the time, REITs perform well in a rising-rate environment. The reason for this is that rental bumps lead to dividend growth and rising rents over time, which leads to higher total return. For example, we looked at 18 periods of rising rates as far back as 1995 when a 10-year yield rose. During 14 of those periods, REITs had a positive average return of about 10.28% and in four instances, REITs underperformed and their average return was a negative 3.78%. REITs can sometimes be volatile at the time before rates are going up, but over time we have seen that they have had higher dividend growth, which is great total return performance even in a rising-rate environment. Q:  What are the pitfalls of investing in REITs? A: I think the one thing that investors should always be aware of is that REITs need to access capital and when capital is not available or if capital is getting expensive, REITs do poorly. During the global financial crisis when yield spreads tightened, capital became expensive and was not readily available, and REITs performed poorly relative to equities and bonds. There are periods where capital markets are not providing debt or equity capital and that’s where we need to be careful and position portfolios so that companies aren’t heavy in development and do not need much capital. Another time REITs can underperform is during stagflation in the economy, when credit cost and inflation are rising and when slowing growth pinches margins. That is not a good environment for real estate because the cost of money is increasing and with slowing growth REITS can’t raise rents and dividends. Slowing growth is what’s currently happening in Brazil, parts of Hong Kong, and Singapore. We believe these environments are where investors need to always understand how to tactically position their portfolios. Q:  What is the history of this Global REIT fund? A: The Delaware Global Real Estate Opportunities Fund was launched in January of 2007 and now has a seven-and-a-half year investment track record. The mutual fund manages $55 million. We manage $2.1 billion total in our Global REIT investment strategy, so most of that is in separate accounts or advisory channels. Q:  What core beliefs guide your investment philosophy? A: We have a different approach to managing real estate securities on a global basis, based on four distinct factors: First, we are a small, nimble team in Philadelphia with four people on the equity side, two on the fixed income side, and one office with no committed infrastructure across the globe. We believe that securitization has changed how we value securities, and it makes information more uniformly available and more accessible to everyone on a real-time basis. Secondly, historically real estate has been a private industry– the developer and the broker typically had all the information, including the vacancy, the occupancy, the rent levels, the tenant demand, and financing in that market. That’s why the returns were historically outsized. However, with securitization and the advent of technology, I can be here in Philadelphia and understand what’s happening with the supply of a Singapore office space, just as well as someone in the Singapore market can understand it. Thirdly, we believe that the changes in cost and availability of debt and equity capital are just as important as the actual fundamentals of real estate. If anything, the capital markets are a leading indicator and the supply-demand of real estate is actually a lagging indicator, so we take this dual approach. The reason to take a dual approach is that real estate securities have six times debt-to-EBITDA ratio; they’re the most leveraged asset class. REITS have to pay up to 90% of their taxable income and don’t generate free cash flow. It is imperative that an investor understands how the capital markets, both the debt and equity markets, view real estate -- as an industry that’s leveraged and doesn’t generate high free cash flow. Lastly, we believe that to maintain performance over time, we will limit our asset growth to the $6 billion to $7 billion mark. Our philosophy is understanding that real estate pricing is driven by two factors – fundamentals and capital markets. Fundamentals determine the local demand and supply factors whereas changes in the prices of the debt and equity capital impact real estate valuations. We believe that investments in the global real estate market can best be identified through a combination of this dual property and capital markets approach with an understanding of top-down country investment conditions. That enables us to construct portfolios with the best relative values. We strive to provide excess return over time, at moderate risk levels. Q:  What is your investment strategy? A: We try to assess if a particular environment is favorable for real estate investment, and every analyst on our team identifies this through the lens of a macro credit and a technical overview. For example, in Singapore and Hong Kong we need to have an understanding of the trend of slow home price appreciation by considering taxes, stamp duties, release of supply, or limitation of foreign investors. Secondly, we need to have an idea of credit. An industry that is leveraged and doesn’t generate free cash always has the need for external sources of financing. It is critical that we understand the credit environment in any given country. Then lastly, we consider the technicals. It is a $1.2 trillion industry but it’s still affected by certain technicals. For example, over the past five years we have had $50 billion of Japanese retail money buying U.S. REITs. Q:  What is your investment process? A: Our process begins with our valuation strength. We focus on about 400 to 425 securities that have market capitalizations of $100 million or more in the global real estate universe. Then we screen for relative value focusing on stocks selling at a discount to their own history and compelling relative valuations with their peers. We narrow that down by using our global valuation screens of price-to-Net Asset Value, implied cap rates, multiples, and discounted cash flow analysis, bringing the group of names down to about 250 to 300 securities. Once we screen for valuation we’re typically comfortable that statistically we have companies that are cheap with good downside protection. The next step is our fundamental research catalyst. We ask three questions: (1) Why is the stock cheap? (2) Is it temporary or permanent? (3) What is the upside catalyst? This narrows the universe down to about 150 to 160 names. We begin a dual property and security analysis by understanding the franchise value of the operating company. We identify the cap rates in the market, the supply and demand analysis of that market, the impact of doing on-site property assessment, and the understanding of the risk in real estate property analysis. We get this information during our property analysis from real estate brokers, on-site visits, or discussions with management and other vendors. We combine this with our capital markets analysis and assess how this franchise can grow over time. This is really about real estate analysis to understand internal growth, which is basically leases rolling over. We also do an analysis of external growth, a full balance sheet analysis, to look at the security’s debt-to-cap. We also look at financial risk, which is capital allocation and future capital policies. We do cash flow and adjusted cash flow projections, to understand the capital structure to see what type of capital they can raise and at what cost, and then we feed that into our models. We generally meet management at least two times a year and communicate via phone or e-mail regularly. From these discussions, we aim to ascertain if they are skilled operators and if they are good at capital allocation policy. If we feel comfortable that they are adequately talented at both, then we know that a company has a strategic vision that can help it grow and increase the value of the franchise over time. From there, we assess the execution risk, financial risk, and business risk. Through this analysis, we try to understand the business model and how it can grow over time. Once we can answer our three key questions, we construct our portfolios, typically 70 to 90 securities. We look for the upside within all the names we’ve analyzed and weight those accordingly with those names that have the most upside and we use the same metrics of price-to-NAV, implied cap rates, multiples, and discounted cash flows to establish price targets and price ranges. Q:  How is your portfolio constructed and do you have a benchmark? A: The typical portfolio is 70 to 90 securities, and it is diversified across sectors, countries, and regions. The maximum stock weight is 5% or 250 basis points above the index weight, whichever is greater. Our country weight ranges are 50% weightings or 150% over the index weight. We also have a soft rule of no more than 15% in emerging markets. We are able to stress-test the current portfolio based on movements in interest rates and movements in equity, currencies, oil, and commodities on a continual basis to see how the portfolio would react in those types of environments. Our benchmark is the FTSE EPRA/NAREIT Developed Index. In terms of a sell discipline, we generally sell a security under the following conditions: when it reaches a price range, its relative pricing versus other opportunities, or simply negative change in fundamentals. This could be asset yields drifting lower in the cost of capital, limited external or internal growth, or unfavorable change in management strategies. Q:  Would you describe one domestic and one international example to better explain your research process? A: In early 2014, we noticed that credit was easing in Europe, and there is an Italian company that we knew was quite cheap. Here’s some background on this particular international example: Despite significant actions by the European Central Bank (ECB), credit in most of Europe had remained fairly tight. Lending, which had become more available, had not flowed through into the secondary and tertiary markets like Spain, Portugal, and Italy, so the ECB began discussing options to improve liquidity. They wanted to encourage banks to increase lending and move some standards, and they focused on quantitative easing. Just the talk of quantitative easing had an immediate impact on swap rates as they fell from 140 basis points down to 50 basis points from last fall into its present day. These reduced swap rates substantially lowered the financing cost for current borrowers looking to re-finance, and for future borrowers looking to acquire. Our analysis was that easier credit standards and the extending of credit to secondary markets would have the greatest impact on companies that trade at large discounts to NAV, landlords who own property, companies with above average leverage, and companies with high implied cap rates. The opportunity we saw was a company that owned office buildings in Italy and traded at a 45% discount to NAV at the beginning of 2014, when the implied cap rate was 200 basis points above market yield. We believe the company was exposed to a high-leverage level and had one very large and potentially risky tenant. All of these factors told us that the stock was substantially undervalued and that the fallen swap rates greatly changed the stock’s outlook – that was the catalyst. So, we bought the stock in January 2014 as swap rates began to collapse. The stock re-rated and despite the still challenging fundamentals on the ground through the first eight months of 2014, the stock’s total return of 28% outperformed the index by 18%. So although the real estate markets weren’t giving a signal that there was an improvement, the fact that credit markets were improving by lowering the swap rate and allowing the company to refinance and pay down debt confirmed our view that the stock was an opportunity, not a value trap. And we also knew that the NAV of this company would be protected because credit costs were coming down. This is a classic example of credit leading real estate. That’s why an important distinction of our process is understanding not just the real estate but also the importance of the capital markets. A domestic example is the U.S.-based Washington Real Estate Investment Trust, one of the oldest U.S. REITs. The company owns a diverse portfolio of retail, office, and industrial properties in the Washington, D.C. region. The company had gone through a number of changes at the executive level, including numerous CEOs and CFOs, most of whom had been promoted from within. But the company’s poor performance over the prior 20 years led many investors to simply ignore it. Our analysis showed this company was trading at a 20% discount to NAV in a market that’s at a 5% premium. Despite a very solid balance sheet, we became much more interested when a new CEO from outside the company was hired. We concluded that the suburban office and retail properties were a drag on cash flows and the company would be much better served if it increased its focus on pure sectors, which would also improve the multiples. Plus, we felt the company’s previous focus on its dividend led to poor capital decisions. So, we had a discussion with the new CEO. This conversation led us to conclude that he agreed with much of our assessment, and significant changes were planned. However, the changes would take a significant amount of time, and stocks typically underperform when going through such transformations. Our credit analysis proved that a 20% discount to NAV would provide great downside protection should we be proven incorrect, so at the worst we had a flat stock and would be earning the dividend. Our ultimate decision was to buy the company, and within the past 12 months the company has exited its industrial portfolio, purchased assets within the D.C. market, and changed board members, the CFO, and other senior executives. We purchased the stock in April 2014 and since then it has outperformed the index by about 7%. In terms of Asia, I’ll talk a bit about our exposure to Japan in general. Japan had underperformed for several years since the global financial crisis, and despite very low valuations, tight monetary policy, and lack of growth, we still saw deflation. So in early 2014, we began to get more excited about Japan, considering the valuations and potential upside given implementation of central bank stimulus. We increased our exposure to Japan. At the time it was our largest underweight, but we went to market weight and then the announcement of the Bank of Japan’s Quantitative Easing program combined with some favorable regulatory changes changed the landscape for investing in Japanese REITs. Japan was very cheap on a spread-investing basis in the fall of 2012. In terms of real estate, the discount to NAV was 30% to 35%, the dividend yields were plus 5%, and then multiples were very low at 11 to 12 times. So, we had cheap valuations: cheap versus its own intrinsic value of real estate; cheap versus bonds and other asset classes: and we had the backdrop of this QE program increasing the monetary base, trying to increase inflation which was obviously a positive for cheap real estate. With cheap valuations, and the ability to spread-invest in a favorable monetary policy which was no longer deflationary, the stocks did incredibly well in 2013. They were up 60% plus and were the best-performing real estate market. The stocks reacted favorably from the end of 2012 to early 2014, and it was because the credit markets opened up very similarly to what we talked about in Italy – the financing rates came down, transactions increased, stocks went up. What’s interesting is that it wasn’t until February of 2014, that land prices went up for the first time in six years in downtown Tokyo. The real estate market lags the credit market, hence the need to understand both capital markets and real estate. Q:  Do you see opportunities in emerging markets? A: There are opportunities in emerging markets, whether they are in Latin America, Asia, the Middle East, or Eastern Europe. But we have seen more risk in emerging markets because of the slow-down of growth across the board relative to the growth risk in developed markets. Yes, emerging markets still have more growth than developed markets, but that growth is slowing with rising credit cost – for example, in China, Singapore, Brazil, and Russia. Today, it makes for a very difficult backdrop to invest in real estate. The other aspect of this is the political volatility in most of these countries. It introduces a risk factor that we haven’t been comfortable with for four years now, and with China slowing, that affects a lot of the greater emerging markets given how much they had benefited from a growing China. Over the last four years, China has gone from 11% growth to 7% growth and we believe it’s going to 5%. With regards to emerging markets, we are constantly viewing, analyzing, meeting with companies, and visiting and looking for opportunities there. But we have found that on a risk-adjusted basis, the developed markets, specifically the U.S., are still more attractive than most emerging economies. Q:  How do you define risk and manage risk? A: We define risk in three ways. One, on the real estate side we look for levels of occupancy and eventually higher occupancy means higher rents. Two, we are looking at supply, generally the lower supply the better, since this means less competition. And then third is management strategy. On the capital market side, we like to understand what the capital allocation policy of the company is and how they are laddering their debts. We assess risk in both the real estate and capital markets.