2023-09-18 11:15:08 ET
Summary
- Stratos Capital Partners has seen success in identifying deeply discounted opportunities in the real estate sector, including Blackstone and D.R. Horton.
- Moderate signs of FOMO (fear of missing out) towards real estate-related equities indicate potential for more buyers to enter the market.
- Bridge Investment Group Holdings is a high-conviction pick with a proven business model and attractive valuations, making it a "Strong Buy".
2023 has been a rewarding year for investors who capitalized on the opportunity to acquire shares of high-quality companies at deeply discounted valuations last year. At Stratos Capital Partners, our deeply-rooted philosophy in systematic strategies and value investing has also served us well in identifying opportunities that have delivered meaningful alpha for our equities portfolio.
The real estate sector, in particular, captured our attention last year with deeply discounted valuations on high-quality large-cap names including Blackstone ( BX ) and D.R. Horton ( DHI ). These names, which we have covered in previous articles, have turned out to be among the best outperformers in our portfolio to date.
Ask any veteran value investor and they would agree that high-conviction ideas with deeply discounted valuations are hard to come by, especially when the discounts are mainly driven by overwhelming fear rather than a deterioration in fundamentals. But when such opportunities do present themselves, typically during periods of economic uncertainties, most investors can't help but err on the side of caution. These investors succumb to the flawed logic of: "Let's wait for signs that the economy is out of the woods before we buy." However, history has proven time and again that the best time to buy is when the vast majority are fearful.
From our experience, no amount of carefully presented arguments or thesis on deep-value investment opportunities can help sway sentiment when it is at an extreme. Investors would accept any reason or excuse to not invest in a great company when fearful emotions have already taken hold, and vice versa at bull market peaks.
All is not lost, however, because deep value can usually still be found even after equity markets have rebounded from bear market lows. But now that concerns of a U.S. recession are dissipating and market sentiment has improved substantially, investors will face increasing difficulty in uncovering easy pickings in the equity market in our view.
FOMO In Real Estate
Because BX and DHI have enjoyed such a spectacular rebound, it is understandable that investors may feel that they have already missed the boat. This psychology associated with a "fear of missing out" is a regular phenomenon throughout financial history, but has only recently been abbreviated as "FOMO" by social media.
From our perspective, some evidence of FOMO is not necessarily a warning sign that we have entered the euphoria phase of the market cycle. Instead, we view moderate levels of FOMO as a healthy indication that more buyers could potentially enter the market to drive prices even higher. Overall, we like that there are moderate signs of investor FOMO towards real estate-related equities.
Just to be clear, we continue to maintain a "Strong Buy" rating on BX and DHI. And we still see ample room for further upside given that these companies continue to exceed consensus expectations and we expect revenues to continue to improve meaningfully over the next 12 to 18 months. Moreover, valuations remain attractive and well under peak valuations, providing scope for potential double-digit gains even from current levels.
Needless to say, it would still be an extremely challenging task to try and convince investors who have missed the rally to buy these companies at current levels. The chart below shows the year-to-date outperformance of BX and DHI versus the S&P 500 Index ( SPX ).
FOMO doesn't mean that investors are willing to buy at any price. The psychology of getting a slightly better deal may be equally strong. We suspect that many investors are hoping for a decent pullback before jumping into the market in force. However, that kind of strategy could really backfire in our opinion. What if prices head much higher and never look back? Besides, if everyone is attempting to buy the dip, buyers may come into the market to support prices at any point along the dip. This means the dip may never materialize or it could turn out to be just a tiny one.
Instead of waiting to buy on dips, consider this strategy when experiencing FOMO: invest in companies that will benefit from the same theme, but invest selectively in high-quality names that large institutional investors are leaving on the table.
This is an ideal strategy for investors who are more cautious and are reluctant to chase returns. From a value investing perspective, it also makes sense to search for greater value in names that institutional investors have overlooked but have equally attractive fundamentals. One question that may come to mind is, why would sophisticated institutional investors leave money on the table?
Where There Are Dislocations, There Are Opportunities
Within the real estate sector, quality large-cap real estate names such as BX have benefited from a recovery in sentiment among institutional investors. One reason why institutional investors tend to invest early into a bull market and to buy up large-cap stocks is partly because they are subjected to regular performance reviews and are under pressure to deliver consistent returns year after year. Thus, failing to catch the market bottom means at some point, these investors will face overwhelming pressure to catch up with the bull market. One way to manage downside risk while trying to play catch-up is to be highly selective and buy quality names with great long-term prospects.
Institutional investors with longer-term investment horizons have the advantage of earning a liquidity/term premium versus other short-term investors. Thus when many private equity managers such as BX were facing a wave of redemptions late in 2022 because short-sighted investors were demanding liquidity and reducing risk, institutional investors were ready to scoop up shares at deeply discounted prices. So long as the long-term fundamentals of these companies remain strong and their business models are not broken, institutional investors only have to ride out the storm. Buying at a deep discount also means having some margin of safety while waiting for those returns to materialize.
On the other hand, institutional investors face significant constraints as a result of managing giant portfolios with billions in assets under management ((AUM)) and are thus restricted to investing solely in large-to-mega-cap stocks that are highly liquid. What this means is that there will be opportunities for regular investors to pick up quality small-to-mid-cap companies that institutional investors are ignoring simply because these companies do not satisfy their size and liquidity criteria. No matter how attractive some of these opportunities look, institutional investors have no choice but to move on. Because even allocating a tiny portion of a multi-billion portfolio to the stock would make them a whale and move prices against them, or they would end up acquiring too large of a stake in the company.
Regular investors can take advantage of this dislocation simply by looking for quality mid-cap companies with a similar business model to BX and are exposed to similar opportunities and risks in the real estate sector.
Next, we highlight our favorite high-conviction pick capitalizing on the same real-estate-at-depressed-valuation theme, which has performed extremely well for our portfolio to date.
Bridge Investment Group Holdings
Back in June, we published an article initiating coverage of Bridge Investment Group ( BRDG ) with a "Strong Buy" rating and highlighted why we think BRDG could be our next big winner. Admittedly, BRDG has gotten even cheaper since with its stock price having fallen by another 6.3% to $10.03 at the time of writing. BRDG is still down around -13.0% year-to-date compared to a 17.3% gain on the SPX.
Ideally, we would very much prefer to see all our favorite picks outperform immediately after we publish our views. But then again, we are also humble enough to understand that we are not market wizards. We try as hard as we like, but we expect to regularly miss absolute market bottoms. We are disappointed by BRDG's recent share price performance, to say the least. But that is not to say we are disappointed with the company's recent performance. On the contrary, we are optimistic that BRDG's proven business model combined with management's strategic thinking and excellent execution will continue to deliver meaningful alpha for shareholders, especially given currently depressed valuations.
Similar to BX's business model, BRDG is an alternative investment manager with a specialized focus on select U.S. real estate verticals with revenues predominantly in the form of fund management fees and property management and leasing fees earned on AUM. BRDG owns and manages a well-diversified portfolio of assets, which the company actively adds value at the asset level. By directly operating the properties and assets managed by the company, its investment teams are able to extract invaluable insights into the communities in which it operates. This approach allows BRDG to generate significant alpha at the asset level, instead of relying heavily on financial engineering and leverage, which is commonplace among other real estate private equity managers.
After diving into BRDG's most recent Q2 2023 earnings call transcript , we are delighted to see that the company's core verticals are seeing resilient rent growth and occupancy rates from a year ago. According to figures provided by management, BRDG's multifamily and workforce assets are 93% occupied and our same-store effective rent growth for Q2 also increased 6.4% year-on-year. Single-family residential assets saw particularly strong rent growth of 9.9% year-over-year and occupancy rates of 95%.
Fee-earning AUM also increased 43% year-over-year to $22.2 billion, of which approximately $4.3 billion was attributed to the Newbury Partners acquisition. BRDG's portfolio is also well insulated from sudden redemptions that are often a major threat for asset managers with smaller AUMs. In BRDG's case, around 97% of fee-earning AUM are locked up in long-term closed-end funds with no early redemption. Although some may view closed-end funds and the lack of early redemption features as unattractive for investors and may thus impact fundraising and AUM growth, we think otherwise. Not only do closed-end funds attract patient institutional investors that tend to commit larger allocations, but investors in these funds also tend to perform better by riding through short-term economic uncertainties.
In The Right Places At The Right Price
We are unsure whether it is by pure coincidence or simply good investment thinking, but BRDG's strategic positioning of its portfolio is closely aligned with our preference for U.S.-focused real estate exposure in areas including multi-family residential, logistics, and affordable housing. More recently, we are beginning to see attractive investment opportunities in private equity secondaries, an area which BRDG has also added to their portfolio. For a quick update on recent trends in the secondaries space and why we see attractive opportunities there, we recommend reading this article published by CAIS.
We believe that the secondaries space is currently rich with opportunities for extracting meaningful alpha over the next couple of years. BRDG's recent push into this space through its acquisition of Newbury Partners seems highly opportunistic in our view and demonstrates management's good foresight and tactical agility. Needless to say, we find comfort in knowing that BRDG is making investments that are closely aligned with our macro ideas.
BRDG's newly established renewable energy and PropTech investment platforms are yet another strategic move that is highly commendable in our opinion. We believe that investing in these areas demonstrates foresight and management's ability to quickly embrace technological change that will have a significant impact on their traditional area of expertise. Investing early in renewable energy and PropTech should open up new sources of alpha for long-term shareholders. At the very least, these investments should place BRDG in an advantageous position to leverage and capitalize on current and future opportunities in renewable energy and other evolving technologies in real estate.
BRDG certainly qualifies as a high-quality company with a long runway for growth in our view, but how about valuations? At the time of writing, BRDG was trading at just 12.4x forward P/E with a TTM dividend yield of 7.7%. Although private market deal flows have been slow to recover, which may mean subdued dividend payouts in the near term, we believe that the potential returns from a rebound in valuations will more than offset lower returns from dividends.
We reiterate our "Strong Buy" rating on BRDG.
For further details see:
Bridge Investment: Our High Conviction Deep Value Pick For Alpha