These real estate fund managers show there’s money to be made as rates rise Deep Dive

Bloomberg

Lennar was the second-largest holding of the Third Avenue Real Estate Value Fund as of Dec. 31.

Ryan Dobratz and Jason Wolf of The Third Avenue Real Estate Value Fund have bought lumber companies, home-improvement retailers and a land developer to produce returns that have far exceeded the S&P 500 real estate sector.

The $1.9 billion mutual fund /zigman2/quotes/200819840/realtime TAREX -0.51% /zigman2/quotes/207498543/realtime TVRVX -0.52% has a five-star ranking from Morningstar and has greatly outperformed its benchmark, the FTSE EPRA/NAREIT Developed Index.

Here’s how the fund’s two share classes have performed against their Morningstar category and the index (in U.S. dollars):

	Total return - 2018 through March 9	Total return - 2017	Average annual return - 3 years	Avg. return - 5 years	Avg. return - 10 years
Third Avenue Real Estate Value Fund - Institutional	-0.8%	22.1%	6.5%	9.5%	6.9%
Third Avenue Real Estate Fund - Investor	-0.9%	21.9%	6.2%	9.2%	6.7%
Morningstar Global Real Estate category	-3.0%	15.1%	3.7%	4.7%	3.8%
FTSE EPRA/NAREIT Developed Index	-4.8%	11.4%	3.5%	5.2%	4.7%
Sources: Morningstar, Third Avenue Management

The fund’s investor shares have a $2,500 initial investment minimum and an annual expense ratio of 1.36%. The return figures on the table are after expenses.

In an interview, co-lead manager Dobratz said he and Jason Wolf, the other co-lead manager, had been repositioning the fund “for a number of years” not only to protect capital from rising interest rates, but to benefit from them. He said the performance of the fund since President Trump’s election had shown the fund’s strategy was working.

When Trump was elected on Nov. 8, 2016, the yield on 10-year U.S. Treasury notes /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y 0.00% was 1.88%. The yield on the 10-year has risen to about 2.9% since then, during which time the S&P 500 real estate sector has returned 6.4%. Meanwhile, the Third Avenue Real Estate Value Fund’s investor shares have returned 25%.

The managers of the Third Avenue Real Estate Fund emphasize growth over income, and are not limited to investing in U.S. REITs. The managers invest in home builders, land developers and real-estate-related plays, such as home-improvement chains. (It held Lowe’s Cos. /zigman2/quotes/205563664/composite LOW -0.06% as of Dec. 31.)

The fund does not quote a yield the way bond funds and many REIT-oriented funds do. When selecting REITs, the managers try to invest in companies trading at share prices considerably below their net asset values (NAV), hoping to get ahead of the market and realize significant gains. A real estate company’s NAV is, essentially, the market value of the real estate it holds, less debt.

About 43% of the fund was invested outside the U.S. as of Dec. 31.

Opportunities in U.S. housing

Dobratz said he and Wolf had great confidence in the strength of the U.S. residential-housing market because of the unleashing of pent-up demand as millennials form new households. About 33% of the fund was invested in U.S. residential plays as of Dec. 31, and Dobratz said he expects the investments that he and Wolf have selected ”should benefit from a recovery in volumes, not necessarily an increase in average selling prices.”

“There has to be more housing stock in the U.S.,” he said.

Two of the fund’s largest investment positions are REITs that own and manage timberland: Weyerhaeuser Co. /zigman2/quotes/200438029/composite WY +0.32% and Rayonier Inc. /zigman2/quotes/207968084/composite RYN -1.21% .

While the prices of some REITs are under pressure from rising interest rates, “if rates are going up for the right reasons, it is probably really good for housing demand,” Dobratz said. “If we are building more homes, it is probably good for both companies. They will sell logs at higher prices.”

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