A: The number one headwind is always perception. Are they real estate or are they stocks? As long as that uncertainty exists, opportunities and inef- ficiencies in the REIT market will exist as well. As long as there is a healthy individual property and transaction market, sponsors will assemble and offer properties and partnerships as a better means of controlling real estate. This is not going to change for a long time.

Some financial advisors have migrated to a private REIT, which offers a more attractive dividend, and there is limited share price volatility. That doesn’t mean it is better. It means you don’t have daily liquidity. The daily pricing of publicly traded REITs creates opportunities to actively manage a commercial real estate portfolio. Interestingly, we feel that there is a preference to pay more for individual buildings and private REIT structures than comparable securities.

Q:  How do you go about your portfolio construction?

A: Every month we monitor the investment universe for changes in relative value and new companies. Our entire universe is ranked by valuations and quality of cash flow and management. Then we manage the over and underweight, relative to the benchmark, and eliminate the inferior companies.

Q:  What is the average number of holdings in the fund at any given time?

A: It’s between 45 and 60 names and today we have 48 positions so generally the turnover is less than a third. I’m trying to run a very low turnover portfolio. Unfortunately, it’s driven more by the unit-holders than by the manager because I try to be fully invested all the time.

Q:  What kind of risks do you measure and how do you control them?

A: The most important risk is valuation risk, and it’s based on our internal views and valuation work. The metrics we look at are valuation within the company, balance sheet, dividend quality and our views of the market place. We don’t start with a macro view that says we want to be overweight in apartments and then view all of them. We build the portfolio from the bottom up, one company at a time.

We will diversify by property type and limit our exposure to 1.5 times the sector exposure. Individual security weights will rarely exceed two times benchmark weight. Rising valuation in the markets presents a challenge. In a significant up market, the tide lifts stocks of all kinds of companies. When there are strains in the real estate securities market, this fund does very well so this also creates a downside protection.

Q:  Can you give an example of a company you bought in the past and how you benefited from it?

A: The portfolio has owned Equity Office Properties for many years now. However, we have been willing to own different parts of the company’s capital structure to reduce the downside risk in our portfolio. Specifically, after Equity Office completed its acquisition of Spieker Properties, it issued a 7.75% perpetual preferred. We swapped out of our equity position, because we felt that the dividend may be at risk and that the current income in the preferred was attractive. While the dividend was being overpaid, the company routinely stated that it would not reduce the dividend, until last fall. The company did reduce the dividend, eliminating a risk, while the preferred had appreciated with seasoning in the low interest rate environment. Subsequently, we have swapped out of the preferred and back into the common.

Q:  Do you look at the macro trends by region or by type of property?

A: Post 9/11 all risk and spread assets have appreciated with the infusion of capital from the Fed and the collapse of the short-term interest rates. With the Fed tightening the liquidity in the last two years, there is a lag effect in the commercial real estate market, and we are sensitive to the fall in values. We are looking for more downside protection.

Different property types have different characteristics. In hotels your leases are daily whereas triple net lease for office properties have 15 to 20 year leases. With a flat yield curve, we think about the property types and the valuation implications. We always return to our net asset value calculations.

We’re trying to invest in commercial real estate for the long-term, guard against potholes based on valuations or managements or capital structures. Our core belief is that in times of stress in the securities market, premium valuations evaporate and so does downside risk. Discounts may widen out in the securities markets, which is fine, as long as is the company holds good real estate. Our investment style has a value bias more than a deep value, so we may avoid value traps. This is a conservative fund, in the sense that it focuses on quality of property types.