WertArt Capital published two posts this year about Italian real-estate that I couldn’t ignore since it almost sounds too good to be true: Italy is filled with various closed-end real estate funds that are trading at a sizable discount – often around 50% – to net asset value and because of fixed maturity dates they have a solid catalyst on the horizon. That sounds pretty compelling to me, although I can imagine that not everybody has the same initial thoughts. Italy? Yak…
WertArt does a good job of providing some background on the history of the funds, and even more information can be found in this report on Italian REIFs. I have been busy compiling an overview of all the funds that are currently traded on the Italian stock exchange. Not an easy task because all the reports in Italian and I don’t speak/write Italian. Luckily Google Translate exists in this day and age. But, unfortunately, the quality of the disclosed information seems to be mediocre in many cases. In almost all reports you can, for example, find information about the development of the GDP in Japan while most funds exclusively own property in Italy. More relevant information such as rental yields and occupancy levels is often nowhere to be found.
I have decided to make this a multi-post series. Today I’ll give a brief overview of the various funds and the reason why I think they are attractive as a group, and in one or more future posts I’ll dive deeper in some individual funds and other relevant details (e.g. taxes, fees).
The table below provides an overview of the various listed Italian REIFs sorted by the “unleveraged MoS” column. This column is based on the discount to NAV, but adjusted for leverage using the following formula: “(NAV – Market cap) / book value real estate”. This gives a crude proxy by how much property values could decline before NAV is equal to the current market cap. Implicitly this values all other assets and liabilities that are part of the NAV at book value, so for funds that have significant other assets the measure might be flawed:
Note that the data is a mix of values originating from 30 June 2014 and 31 December 2014. All funds reevaluate the market values of their real estate biannually, but not all have released annual reports for the year 2014. I have also adjusted various figures to account for example for dividends paid after the end of the latest report, or for liquidation payments that have already been announced. But I almost certainly have missed something for a few funds!
With the average Italian REIF trading at an almost 50% discount to NAV it appears that there are plenty of bargains available and what’s great is that a lot of funds that have a low amount of leverage. Not surprisingly, these are favored by the “Unlevered MoS“ measure as can be seen in the corresponding LTV column. Loan-to-value is calculated by dividing the value of the real estate with the amount of mortgages outstanding. Other assets and liabilities are ignored.
Also visible in this table are the expiry dates of the various funds. Most funds expire in the next couple of years, but an expiry date is not a guarantee that the fund will be liquidated at that date. Real estate is an illiquid asset class, and especially in Italy transaction volumes have dropped after the financial crisis. Because of that new regulations have been adopted that allow funds to extend their maturity date by three years. Funds with a green cell in the “+3?” column have already taken advantage of this option while funds with a red cell still have this option available (perhaps I should have switched the color coding?). The maturity date can be further extended if approved by shareholders. Given that the alternative is a possible liquidation at fire sale prices I’m guessing that there is often no real choice.
A big discount to NAV is, of course, great but preferably you also want to own property that is backed by cash flows. Cash flows not only allow investors to generate some income (and/or pay for management fees…) while we wait for a liquidation, but it also acts as a sanity check for the reported assets values.
Most properties appear to be valued at roughly a 7% gross rental yield which sounds reasonable to me for commercial properties. Nothing to get too excited about, but for an asset class that falls somewhere between equity and bonds on the risk spectrum that seems like a reasonable deal. A recent KPMG report about the European real estate markets also mentions yields in this range for offices. Given the large discounts that the funds trade at I don’t think it really matters what a fair yield exactly is. A fund with a 7% gross yield at a 66⅔% discount is yielding 21% at current prices. You have a lot of room for bad stuff at that price level!
I don’t have yield information for all funds, but I guess that the trend is visible: the funds with the highest discounts often also offer the highest yields. Unicredito Immobiliare Uno is a bit of an exception, but approximately 50% of the portfolio value is concentrated in a property that is being redeveloped and not generating any income at the moment (and the occupancy figure is meaningless since it isn’t adjusted for the sale of a big part of the portfolio after the end of the period while the other numbers are adjusted). Anyway, that’s a discussion for a future post :).
Long various Italian REIFs
Great article! Where do you find reports for the funds?
You can find it on the website of the fund/the funds manager.
Are these levered? In choosing the CEFs that you bought, did you consider debt maturities? Are there any you particularly favor, or any you would recommend avoiding?
You can see information about leverage in the bottom table that contains LTV numbers. I prefer the funds with little leverage, but don’t think that debt maturities are a problem for the funds since they coincide with their maturity date in most cases and it seems that they have no problem extending maturities when the fund maturity is extended.
Interesting analysis, but are you shure that the funds will be liquidated at the final maturity date calculateted by you. What will happen if the real estate is not sold at that point. Fire sale at any price? I don’t believe that. Also there might be some conflict of interest on the side of the management company prefering not to liquidate and continuing to earn their sizeable management fee. In the meantime you might get no cash payout. Potentially not a very attractive position to be in a very illiquid market (refering to the selling of the funds).
Most funds should at least be able to sell a part of their real estate portfolio, so you will get some capital back early which should be good for the internal rate of return. You already see this happening with various funds that are in the liquidation process. And most funds reduce the management fee when the maturity date is extended, decreasing their incentive to ‘stall’.
Hi, thanks for your research. How did you buy these funds? I have some access to Italian Stocks but I can’t access these funds. And what about taxes? Will the dividends be applied a withholding tax?
I bought these funds through Interactive Brokers, and yes there will be taxes, but as far as I understand only on gains/income. Not on returns of capital.
Thanks for the work. Maybe there is some fund for me. No position yet.
Expiry date for Fondo Alpha is wrong: “The duration has been extended for a further 15 years, compared to the original expiry set for June 27, 2015, thus providing the expiry to June 27, 2030”
Makes me wonder why management should ever let go due to the 1.6% management fee an NAV (not market price).
Yes, but Fondo Alpha is managed with the intention to be liquidated before 31 December 2019: see the latest report. Google Translate:
I’m Italian. If you send me a .doc file with a selection of the parts that you need, I will be glad to translate it for you (so I can give back something as simple reader of your valuable blog!).
In my experience, Google Translator is not very reliable for the Italian language.
Thanks for the offer. If there is something that I can’t figure out I’ll you know 🙂
Nice to see that your picks were among the best performing ones. Aa couple of the REIF’s you didn’t like collapsed last year after a firesale of assets was announced:
Mostly just lucky I guess. I didn’t see that coming…
The ones I didn’t like at the start of 2016 (I assume your list was more or less similar): QFSEC, QFBPI, QFOBE, QFARI, QFIRS. Apart from QFSEC all of these did terrible.
The ones I wasn’t completely sure about at the start of 2016: QFUNO, QFSOC, QFPOL, QFBET (I only bought the first two). All went up a little bit, apart from QFPOL which did good because of the tender and subsequent distributions.
The ones I liked: QFIMM, QFAL, QFID, QFVIG, QFDI, QFEI1, QFARE. QFIMM was break-even, rest did great.
Quite lucky indeed!
p.s.: A couple of other REIF’s are now tradable at IB: QFATL, QFATL2, QFINV, QFRIE, QFTEC. Maybe they were tradable before and I forgot to look at them.
Things I didn’t like (at the start of 2015, didn’t update everything last year): QFMRA, QFMRB, QFTEC, QFATL, QFATL2, QFRIE. No idea how these performed, too easy to miss a dividend if you don’t track them carefully.
Fonds I was neutral (again, 2015) on and didn’t buy: QFPOL, QFIRS, QFSEC, QFBPI, QFOBE, QFSOC, QFARI, QFINV, QFEGD
So don’t think our list is really matching
Can’t wait until it is february and I can finally sift through 20 Italian annual reports again. Google Translate Italy should install a few new servers!
I think that taxes can make an important difference. If the funds are paying out retained earnings at the liquidation date, these distributions are usually taxed like dividends.
If capital is repaid, no taxes are charged. Therefore it would make sense to select funds which have little retained earnings.
“Luckily” that isn’t too hard, since even the best of these funds have generated very little earnings since inception and most of them have accumulated losses.
This sounds good. By the way Burton Malkiel, a believer in efficient markets, recommended to buy funds below NAV in his book “A random walk down Wall Street”.
I think it is similar to net-net investing described by Ben Graham. Real estates are valued in the funds at current prices and not historical costs. In addition, the funds are liquidated in the next years so this means that equity basically represents (current) liquidation value.
Another point is this: Probably it makes sense to prefer those funds which did perform poorly in the last 3-5 years or so. Funds that performed poorly have in general a higher likelihood to be liquidated. In addition, I guess that poor performing funds did record losses (retained earnings can also include real estate valuation gains). Further, a general long term reversal effect, which is described for stocks, is also possible.