The Value of Great Management: Capital Recycling

Since the modern REIT era began in the early 1990’s, REITs have learned to enhance the quality of the assets held.  The best axiom for real estate quality is “location, location, location”.  Across all sectors, the best locations tend to be high barrier markets where it is difficult to build and demand is more steady.  But, more specifically, improving a portfolio can mean different things based upon the property sector.

With apartments, age of the portfolio and high job growth markets are key attributes.  Recently, properties that cater to the millennial generation with communities located near transit stops have also boosted portfolio quality with AvalonBay Communities (NYSE: AVB) and Equity Residential (NYSE: EQR) leading the way.

In the office sector, Boston Properties (NYSE: BXP) and other office REITs have also focused on high barrier locations with solid job growth along with a focus on tenant credit quality.

With shopping centers and malls, population and income profile have been the major differentiators over the past 20 years.  More recently, redevelopment of existing assets including densification into multi-use projects has improved asset quality and strengthened brick-and-mortar importance in the face of e-commerce. The most common upgrade attempts to enhance the “experience” with signature dining options and better social interaction with customers.  Simon Property Group (NYSE: SPG) is the leader with 33 properties undergoing major refurbishment/expansion.

For these four REITs (AVB, EQR, BXP, SPG), the 15 year performance for the period ended March 31, 2016 proves our point, considering the shareholder total return averaged 15.5% annually versus the MSCI US REIT Index (Bloomberg: RMS G) at 11.5%.  We highlight two case studies for upgrading asset quality in this publication where returns of Hersha (NYSE: HT) lagged the index and Camden (NYSE: CPT) barely beat the index. Under such circumstances, it takes incredible management talent to execute successfully and patience for the activity to bear fruit.  In these cases, we do not believe they are receiving full credit by the public market for the execution of a dramatic portfolio transformation in an accretive manner.

Where Are We Now?

We are now in the seventh year of this real estate cycle, and the typical real estate cycle lasts between 7 and 10 years.  Historically, the seventh year of a cycle would be associated with decelerating rent growth, accelerating new construction, and increasing risk to meet return targets.  As we have said in numerous publications, this cycle is different and could be one for the record books.  While occupancy is increasing, construction lending for speculative projects has been muted, keeping new supply mostly in check.  As shown in Figure 1, the amount of commercial real estate under construction is barely above the obsolescence rate of 1%, following approximately four years where the supply of commercial real estate actually contracted after factoring in obsolescence.  Figure 2 shows that occupancy has been increasing steadily, and has already surpassed the peak of the prior cycle.  Therefore, there is not enough vacancy or new construction to slow rent growth in many property types.

What Does the Capital Allocation Tree Say?

Referring back to our trusty capital allocation tree from February 2015, the other important factor in determining the proper course of action is the premium or discount of a REIT to its Net Asset Value, or NAV.  For the past year, most REITs have traded at a discount to NAV – some discounts were, and still are, very significant.  Simply, the capital allocation tree says the appropriate decision to create value is to sell assets and buy back stock or pay down debt (or both) with the proceeds.  Some of the nation’s largest equity REITs heeding the red light to grow are Camden Property Trust, Vornado Realty Trust (NYSE: VNO), Equity Residential, and Equity Commonwealth (NYSE: EQC), all of which have sold assets and are either sitting on cash, retiring debt, repurchasing stock, or paying special dividends.  It should come as no surprise that the leaders of these REITs are Ric Campo, Steve Roth and Sam Zell, respectively—all three are titans in commercial real estate that have been intimately involved in real estate for 30-40 years.

Capital Recycling, the REIT Way

First, the REIT must decide what to sell.  Logic would say to sell the ‘worst’ properties.  However, the ‘worst’ properties may have the most potential for dilution given the cap rates are likely the highest, making the yield very difficult to replace.  Selling the ‘best’ properties also would be short-sighted as the best assets usually have the most long term growth potential and least risk.  An additional factor to consider is the tax basis, as many REITs own properties with significant embedded gains that can create onerous tax burdens for the REIT if gains are not distributed to shareholders.  Herein lies the difficulty of capital recycling.

Though it is nearly impossible to judge a capital recycling decision within a year or even longer of the transaction, it is easy to recognize astute management team decisions in hindsight, especially over a full cycle.  Ideally, we would prefer that each decision be made with the ultimate goal of upgrading quality and enhancing long term growth while being mindful of cost of capital and leverage.  Again, this is easier said than done, with only a handful of REIT management teams that can claim a track record that follows such guidelines.

Hersha Hospitality Trust

Hersha Hospitality Trust, a gateway city limited service lodging REIT, has not had the luxury of issuing large amounts of equity at a premium to NAV in the past five years to make accretive acquisitions.  But, the HT management team did not let itself become a victim.  In fact, HT was one of the most active companies in the transaction market over the same period.  From 2011 to May 1, 2016 (Figure 3), HT acquired 3,233 rooms for $1.2 billion, and sold 5,437 rooms for $900 million (pro rata ownership), which equates to 4,335 rooms and $2.1 billion combined.  In comparison, as of March 31, 2016, HT owned interests in 8,892 rooms and had a total enterprise value of $2.5 billion.

HT’s transformation began in earnest in August 2011 when the company announced that it would be selling 18 hotels to Starwood Capital Group for $155 million.  Proceeds from the transaction were used to enter the new markets of San Diego, Los Angeles, and Miami, and also for the acquisitions of Hyatt Union Square in New York City and the Rittenhouse in Philadelphia, which dramatically increased portfolio quality.

When its share price was again trading well below its private market value during late 2013, HT announced the sale of 16 hotels to Blackstone (NYSE: BX) for $217 million.  The portfolio consisted of hotels in Connecticut, Long Island, suburban Philadelphia, and Rhode Island.  Proceeds from this sale were recycled into purchases in Santa Barbara, Northern California, Miami, Key West, and Washington DC.

The company also followed the capital allocation decision tree properly for share repurchases, completing one of the largest REIT share buyback programs as a percent of market capitalization in 2015.  During the year, HT repurchased 5.2 million shares for $124.5 million, which represented over 10% of shares outstanding!

Despite these efforts, HT traded at one of the biggest discounts to NAV as of February 2016.  Once again, HT did not shy from dramatic moves, deciding to sell a 70% share of 7 of the company’s Manhattan hotels for $575 million, equivalent to a 5.4% trailing cap rate.  Remarkably, the weighted average cap rate of HT’s $900 million in dispositions from 2011-2016 was 6.7%, while the weighted average cap rate on the $1.2 billion of acquisitions was 7.2%*.  Therefore, the capital recycling program was accretive to earnings, a feat that is very rare.

The increase in quality and geographic diversification has been a huge benefit for shareholders.  Management projects that 2016 portfolio RevPAR (Revenue Per Available Room) will be $171, which would be 50% higher than the company’s RevPAR in 2011.  The company’s West Coast and South Florida portfolios were the top two performing markets in 2015, and will comprise approximately 33% of HT’s EBITDA, pro forma for the New York joint venture transaction.  The midpoint of HT’s 2016 Adjusted FFO per share guidance implies a 52% increase over 2011’s Adjusted FFO per share, and Adjusted EBITDA is projected to be 38% higher than 2011.  HT’s pro forma net debt plus preferred equity to EBITDA ratio is 6.0x, a far cry from the 7.6x ratio employed at the end of 2011.

In summary, Hersha was able to increase asset quality, diversify geographic exposure, lower balance sheet risk, and lock in value creation through accretive acquisitions and share repurchases.  We would be willing to bet that management takes full advantage of the cash from the New York joint venture to create more value for shareholders, and will continue to display top-notch capital allocation decision-making for shareholders in the years to come.

*Excludes Ritz Carlton Georgetown and Rittenhouse

Camden Property Trust

Camden Property Trust has demonstrated a long track record of success as an apartment owner and developer.  However, the Great Recession provided the ultimate test for CPT on development discipline and balance sheet strength, as it did for many other REITs.  The result of the test produced a “right-sized” development team, along with one of the strongest balance sheets among all REITs.  Along the way, CPT was able to tactically execute acquisitions, dispositions, and developments to take advantage of the favorable environment, while simultaneously de-risking the company.

At the end of 2009, CPT had 63,286 units across 183 operating communities with an average age of 12 years and average rent per unit of $922/month.  Additionally, Camden had only one wholly-owned project still under construction (with one other within a joint venture).  As the economy continued to slowly recover, management saw signs of the historic opportunity.  In the 4Q 2010 earnings call CEO Richard Campo even ventured out to say the next few years “will be one of the best operating environments for our business that we’ve seen in a very long time.”

He was right.  The time between 2010 and 2016 was unprecedented especially for management teams looking to improve portfolio quality in an accretive manner.  On the 4Q 2012 earnings call, Dennis Steen, the CFO at the time, mentioned Camden was able to dispose of 20+ year old properties near a 6.3% cap rate and recycle the proceeds into relatively new properties with higher expected growth profiles near a 6.0% cap rate.

Aside from acquisitions, proceeds from dispositions were also being used to fund development.  In 2011, the jobs to apartment completions ratio was 10:1 across CPT’s 17 markets, far above the “normal” ratio of 5:1. This led to initial yields ranging from 6.5% to 8.0% for Camden’s development pipeline, 300 basis points above the market cap rate in some instances.  Anecdotes from CPT and other apartment REITs indicate that all apartment REITs achieved yields far above their pro forma underwriting during this historic period.

As of March 31, 2016, CPT’s capital recycling efforts had produced terrific results. Due to the  transformational activity since 2010, the portfolio’s average age remained flat at 12 years while the average rent per unit increased 44% (from 4Q 2009 to 1Q 2016) to $1,327 per unit per month.  Additionally, despite shrinking the portfolio to 60,172 units, Camden’s recurring FFO and dividend per share increased 69% and 67%, respectively, over the same period.  Importantly, Camden was also able to enhance the company’s balance sheet to one of the strongest in the sector by lowering its net debt to EBITDA ratio to 5.2x as of March 31, 2016, down two full turns from the beginning of 2010. Furthermore, the company expects the ratio to be near 4.5x by year end 2016.

Today, management believes that “apartments are fully valued in the private market” as private companies enjoy a cost of capital advantage versus public companies due to their higher leverage targets.  As a result, Camden plans to continue to enhance its portfolio quality through capital recycling by being a net seller in 2016.  In fact, on April 26, 2016, Camden announced it had sold its entire Las Vegas portfolio for $630 million, equating to a ~5.4% cap rate.  Concurrently, the company also increased its 2016 disposition guidance to $1.1 billion at the midpoint, which would equate to a ~9% reduction in assets.

The disposition of the Las Vegas portfolio not only enhances Camden’s overall portfolio quality, but it also improves the company’s return on invested capital growth. CPT’s Las Vegas portfolio was almost two times the average age of the overall portfolio at 23 years and had average rent per unit of $874/month. Despite the properties having higher NOI growth, a lot of capital had to be reinvested to maintain the growth due to the portfolio’s age. Capital expenditures (capex) for Las Vegas were almost $1,500/unit, or 25% above the portfolio average.   Some of the proceeds will be distributed to shareholders as a special dividend, while the remainder will be used to fund CPT’s $1.4 billion development pipeline that is projected to produce initial yields of 7%.

Camden’s portfolio recycling efforts since 2010 have undoubtedly enhanced its portfolio quality and growth profile. Management has been opportunistic and bold, acting on what the market has been signaling even when it took the company out of its bread and butter business (development) in 2009/2010 or when it signaled to drastically shrink the portfolio size.

Though Camden’s geographic exposure may not have been ideal for the past six years, the management team made astute decisions on acquisitions, dispositions, development, and the balance sheet.  Thus, we believe the company’s share price at a 9% discount to NAV as of May 24, 2016 does not reflect any future value creation that will result from skillful capital allocation.

Chilton Buys Come in Different Shapes and Sizes

Camden, Hersha, and all of the aforementioned REITs exemplify the importance that capital allocation and management team strength factors into the Chilton investment process.  While these companies may not have been the best performers in the portfolio over any given period, we can use such confidence to increase position size when the market is not ascribing the proper value to such a company.  Conversely, to our own detriment, we have avoided some companies that have outperformed our own portfolio due to a lack of confidence in capital allocation.  Ultimately, we believe our long term outlook will prevail and the market will correctly recognize the intrinsic value of each of our portfolio companies through some series of catalysts.



Parker Rhea,, (713) 243-3211

Matthew R. Werner, CFA,, (713) 243-3234

Bruce G. Garrison, CFA,, (713) 243-3233

Blane T. Cheatham,, (713) 243-3266


RMS: 1904 (1.31.2017) vs. 1904 (12.31.2016) vs. 346 (3.6.2009) and 1330 (2.7.2007)


Previous editions of the Chilton Capital REIT Outlook are available at

An investment cannot be made directly in an index.  The funds consist of securities which vary significantly from those in the benchmark indexes listed above and performance calculation methods may not be entirely comparable.  Accordingly, comparing results shown to those of such indexes may be of limited use.

The information contained herein should be considered to be current only as of the date indicated, and we do not undertake any obligation to update the information contained herein in light of later circumstances or events.  This publication may contain forward looking statements and projections that are based on the current beliefs and assumptions of Chilton Capital Management and on information currently available that we believe to be reasonable, however, such statements necessarily involve risks, uncertainties and assumptions, and prospective investors may not put undue reliance on any of these statements.  This communication is provided for informational purposes only and does not constitute an offer or a solicitation to buy, hold, or sell an interest in any Chilton investment or any other security.

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