Dear Fellow Shareholders:
We are pleased to provide you with the Third Avenue Real Estate Value Fund’s (Fund) report for the quarter ended October 31, 2015.
Quarterly Activity
The Fund’s fiscal fourth quarter marked one of the most active periods in its seventeen year history. In fact, the recent activity wraps up one of the Fund’s most transformative years, as cash balances were reduced from more than 20% early in the year to nearly 7% once factoring in anticipated investments (see Trinity Place Holdings discussion below). The bulk of the activity included: initiating positions in a select set of new investments; increasing existing investments in commercial real estate businesses positioned to generate outsized returns primarily through well-located development projects; and adding to positions in companies that should continue to benefit from a further recovery in the US residential markets. At yearend, the Fund is as close to being fully invested as it has been in over four years – a testament to the opportunities currently available in global real estate securities for investors that share our long-term view.
The largest new investment during the year was the common stock of the Macerich Company (MAC, Financial) (Macerich). Macerich is a US REIT (Real Estate Investment Trust) that owns the fourth most valuable mall portfolio in North America with a particular concentration of market dominant malls in key East Coast markets (e.g., New York City, Washington, D.C.) as well as one of the strongest positions on the West Coast (e.g., California, Arizona, Oregon). Nearly a year ago, Simon Property Group—the largest mall owner globally—purchased a 4% stake in Macerich and launched a bid to buy the entire company for $96 per share. This offer was ultimately rejected by the Board, and led to Macerich’s stock price falling sharply, allowing the Fund to swiftly purchase shares at prices well below private market values, and making it a top five position.
Since rejecting Simon’s bid, Macerich has made improvements to its corporate governance and recently sold stakes in nine of its malls to institutional investors at prices representing an implied cap rate of nearly 4%. The transaction represents great execution and will generate nearly $6 billion of gross proceeds which Macerich will return to shareholders through a special dividend, as well as a $1.25 billion share repurchase program. Should Macerich’s stock price not respond to these moves, it is not inconceivable that some other type of corporate activity could result. In the meantime, Macerich’s business continues to perform quite well despite weaker results from some of the department store retailers and the continued rise of e-commerce. The company is generating industry leading cash flow growth, largely due to its top performing West Coast properties, and progressing on a number of value creating retailled urban development and redevelopment projects that should only increase the appeal of Macerich’s portfolio over time.
The other new investment of size during the year was the common stock of Global Logistic Properties (GLP, Financial), a real estate operating company based in Singapore that owns leading industrial real estate platforms in Japan, China, and North America. The company also has a sizable development pipeline, primarily in Japan and China, as well as a leading asset management platform with more than $25 billion of assets under management. GLP had long been on Fund Management’s radar as it formerly represented the Asian business of ProLogis, one of the largest industrial real estate owners and a former holding in the Fund. During the financial crisis, ProLogis sold this platform to the Government of Singapore Investment Corporation (GIC) who subsequently relisted it as GLP in 2010. The Fund’s initial investment in GLP Common earlier this year coincided with a significant drop in the share price (to levels well below any reasonable estimate of Net Asset Value or NAV) in response to a couple of unexpected events—primarily the passing of its Executive Chairman and a large scale acquisition in the United States—as well as a more cautious tone towards development in China.
In the most recent quarter, the Fund continued to add to its position in GLP, making it a top 15 position in the Fund. At the same time the Fund was adding to its stake, GLP utilized its strong balance sheet to opportunistically buyback stock at discounted prices, a move that Fund Management supports. With value enhancing share repurchases, strong fundamentals in its core industrial real estate markets, and continued growth in assets under management and fee income, Global Logistics seems poised to generate NAV growth in excess of 10% per year over the next three to five years.
The Fund also increased its investments in other real estate operating companies in Asia ex-Japan including the common stocks of Cheung Kong Property, City Developments, Hang Lung Group, Henderson Land, and Wheelock & Co. All of these companies are incredibly well capitalized, have common stocks trading at meaningful discounts to conservative estimates of NAV, and are run by control groups with substantial investments in the companies and have a track record of compounding NAV at above average rates over time. The Fund has increased its exposure to Asia ex-Japan—primarily Hong Kong and Singapore—from 12% earlier in the year to 18% at year-end, as this region is currently offering some of the best values globally. Alongside the investments, the Fund has maintained its currency hedge relating to its Hong Kong Dollar exposure.
The Fund also increased its exposure to companies that own highly productive timberlands in North America, with additions to the common stocks of both Weyerhaeuser and Rayonier. Collectively, these positions account for more than 9% of the Fund’s net assets. Weyerhaeuser and Rayonier are very well-financed companies with stocks trading at substantial discounts to private market values, despite strong prospects for significant cash flow growth as a further recovery in the US residential markets takes hold. In fact, the US timber REITs have been trading at some of the largest discounts to their private market values of any real estate securities globally, leading us to believe that if the discounts persisted, some sort of merger and acquisition would result. However, we didn’t anticipate the transaction that materialized when Weyerhaeuser announced it had agreed to buy its next largest peer, Plum Creek Timber Company (Plum Creek), in a stock-for-stock deal.
After assessing the terms of the acquisition, the transaction seems to have a lot of merit long-term. By acquiring Plum Creek, Weyerhaeuser is essentially doubling down on the US South, a region that will benefit disproportionately from a further recovery in residential construction activity given the dominant species in the region (Southern Yellow Pine). Further, there are ample synergies by combining the two companies, both at the corporate level ($80-100 million of annual savings) as well as in the timberlands segment where the companies have overlapping operations ($50-100 million of annual savings). And finally, Plum Creek has an accomplished real estate team that will likely unlock a significant amount of higher-and-better-use (HBU) values from Weyerhaeuser’s timberland portfolios which haven’t been mined for HBU in an aggressive manner.
Plum Creek shareholders will receive 1.6 Weyerhaeuser shares for each Plum Creek share currently held. This effectively allows Plum Creek holders to fully realize the private market value of their timberland holdings and HBU land. However, with Weyerhaeuser stock trading at what we believe is at least a 25% discount to private market value, our initial view is that a disproportionate share of the value that would be created by forming the dominant owner of timberlands in North America is being transferred to Plum Creek shareholders. Weyerhaeuser plans to launch a $2.5 billion share buyback after the deal closes, which will mitigate some of the dilution, but both sets of shareholders will benefit from this buyback equally. For the transaction to go through as planned, a majority of both Plum Creek and Weyerhaeuser shareholders need to approve the transaction. As in any deal, we plan to review the merger documents in their entirety once they are released before committing to vote in favor of the merger under the proposed exchange ratio but believe that the combined entity would also offer exceptional risk-adjusted return potential given prevailing prices.
Another addition to an existing position came from the Fund committing to subscribe to the Trinity Place Holdings (Trinity Place) Rights Offering. Trinity Place was formerly the retail operations of Syms and Filene’s Basement that emerged from bankruptcy in 2013 as a company focused on realizing the value from the remaining assets, including: (i) well-located real estate properties, (ii) intellectual property primarily from Filene’s Basement, and (iii) substantial tax attributes. Since the Fund made its initial investment in 2013, the company has achieved a number of significant milestones under the leadership of its CEO, Matt Messinger, and is now primarily focused on the biggest opportunity within the company’s portfolio: a 240,000 square foot development project on the site of the former Syms store in lower Manhattan. To fund this project, the company will utilize existing resources, construction financing, and proceeds from the company’s $30 million Rights Offering, which is fully backstopped by existing shareholders, including the Fund’s commitment to take up at least its pro-rata share of the offering. The capital raise should enable the company to unlock substantial value in the company’s existing assets. Additionally, it creates the opportunity for Trinity Place to continue to evolve into a platform for additional value creating investments in real estate and real estate related opportunities over time.
With weakness in most securities markets during the quarter, the Fund’s selling activity was limited. However, the Fund did engage in tax-loss selling by paring back its stake in Brookdale Senior Living (Brookdale) as the Fund had a mark-to-market loss on a portion of its investment. This tax planning will further reduce the long-term capital gains portion of the Fund’s dividend which will be paid before the calendar year end. Additional details relating to the Fund’s distributions can be found on the Third Avenue website: www.thirdave.com.
