Five years after it opened itself to investors, the Clarion Real Estate Income Fund (CPREX) — a private real estate fund managed under the Clarion Partners and Franklin Templeton umbrella — now has $800 million in assets. Through a combination of private debt and equity, the fund invests directly into single assets, CRE portfolios, and publicly traded real estate securities,
And anyone can buy into it. Unlike Blackstone’s BREIT, the CPREX fund doesn’t charge performance fees, carries a low leverage ratio (which is always important for liquidity) and uses an independent third-party appraiser to value its properties each month. The fund’s portfolio occupancy stands at 97 percent and it has generated an annual return of 9.1 percent since inception.
SEE ALSO: Sunday Summary: Gearing Up for 55 Million Square Feet of Renewals
CO sat down with two Clarion Partners managing directors, Brent Jenkins, who work exclusively with the CPREX fund, and Rick Schaupp, the fund’s portfolio manager, to discuss their investment strategy, how they view the market, and why direct investing into a private real estate fund is the future of finance.
This interview has been edited for length and clarity.
Commercial Observer: CPREX just celebrated its five-year anniversary, so talk to me about the history of this fund.
Rick Schaupp: Strategically, Clarion Partners recapitalized itself about eight years ago, we brought Franklin Templeton Investments in as our partner. We continue to be a partnership, and we still own a big chunk of our firm, but that was really a strategic vision with the goal to diversify our investor base. We started out managing capital for large institutions, and about 20 years ago, we created a series of commingled funds, and that was really to democratize the institutional world — so going from $400 million to create a portfolio for one investor to $10 million to a fund, and we think as the world continues to change, the opportunity will be in the private wealth space going forward.
So we created Clarion Partners Real Estate Income Fund, which was the first of its kind: a `40 Act tender fund structured REIT [a nontraded, pooled investment vehicle allowed under a 1940 law]. At that point, the latest generation of nontraded REITS brought in high-quality managers and we wanted to enter this space, and Franklin Templeton provided a platform by which we could use this `40 Act tender fund structure, which has more investor protections, an independent board, and a better valuation policy, with simple low fees. So that relationship allowed us to be the first ones to create the `40 Act tender fund structure.
You said, “The future will be in private wealth.” Is this opposed to the traditional banking system? And what do you mean by democratizing capital?
Schaupp: The democratization is bringing private real estate, as an asset class, which had historically only been available to institutions — because you needed to have scale capital initially — and then the private fund world was also by qualification of investor, and, just by structure, only open to institutions — so when I talk about democratization, the world has changed with technology, valuation technology, even fund distribution technology. All that has allowed us to provide the expertise that we’ve done for 40 years to a broader group of folks at a fee level that we think is appropriate and right.
We charge 125 basis points [above SOFR], which is highly competitive for core real estate investing, so that democratization is allowing an individual to invest $2,500 into a private real estate fund and getting access to a diversified portfolio throughout, at least in our case, the entire United States.
Brent, how do you view the funds, and what Clarion’s doing with this specific fund? What is its capitalization?
Brent Jenkins: Right now, in terms of NAV [net asset value] just about $800 million [$807 million as of Nov. 14] and it’s steadily grown in time. The goal of the fund is twofold: it’s to provide a mix of both income and capital appreciation over time to investors by investing in private real estate. We’re doing that in two ways, given that we really structured this fund to have flexibility in terms of how it invests. So, the fund is able to invest both in buying property, investing in equity transactions, so buying property and either holding it for itself as a 100 percent owner, or investing through equity joint ventures.
And the second piece, which is really important because it’s really played a part in the last 18 months, is we have the ability to pivot over and invest in debt, so direct lending to others. And so it’s important, given what happened with inflation and interest rates, that we have really been able to capitalize on a higher interest rate environment.
How is it structured?
Jenkins: One of the things Clarion Partners really thought about when it structured this fund, and given the 40-year history of the firm, was, in order to be successful, you want to maximize your ability to invest in all kinds of markets, throughout the economic cycle. It’s all about access points. This fund has multiple access points in the market that it can capitalize on. In fact, in the higher interest rate environment, given that it’s a `40 Act tender fund, that limits the amount of fund-level leverage it can take on. So just combine that with it’s core or core-plus strategy that it employs — buying well-leased, well-occupied properties — and you combine those two, it’s generally a low-leverage fund. Given the low leverage combined with that ability to pivot, this fund has been able to capitalize on both sides of higher rates. We’re not having to pay out a lot of interest to others, given it’s been low leverage, and then making loans to others on the flipside on the investment side of things.
How would you describe the investment strategy?
Jenkins: Like the investment strategy for the entire firm, we’re research based. It’s a research-based investment strategy, we have an in-house research team. We invest based on a set of global themes, and what I mean by that are themes such as demographics, innovation, shifting globalization, the American housing market, resiliency, and looking at how those themes drive real estate as an asset class, which assets have tailwinds behind them. Second, from a geographic standpoint, we look at what geographies throughout the U.S. are being driven by these themes.
Given that the fund is 5 years old, which asset classes and markets have you been targeting, primarily because the world has changed so much during that time?
Jenkins: It’s changed a lot. Primarily, the majority of the fund is invested in for-rent residential and then industrial warehouses. Those two asset classes, specifically residential, are being driven by those themes. There’s definitely a housing shortage in residential that’s being driven by attributes of the housing market, and you combine that with an affordability issue that is driving people into rental housing. And from a geographic standpoint, lets just stick with that asset class, when you look at geographies benefiting the most from those themes, one thing that pops up are “next-generation cities”: the Denvers, the Nashvilles, the Austins, all the cities in high-growth metro areas. Some of those areas have experienced some pockets of excess supply, driven by lower interest rates in 2021 and that time period, but I’d say that we’re really focusing on long-term themes, we’re long-term investors, and this fund is core/core-plus [strategy] and that’s all about the long term.
Rick, I saw that the fund trades in publicly traded real estate securities. Can you tell us how you choose which securities to invest in?
Schaupp: The fund has quarterly tender, with a target of 5 percent per quarter, which we’ve always offered, so really that real estate securities sleeve is the liquidity sleeve for the fund. We’ve tried to balance a product that has the benefits of private real estate, with the liquidity premiums, but with an amount of liquidity that the marketplace can accept, so when you come in, you know you can get your investment out.
One of the tools we use, we have a $125 million credit line, and we have a liquidity stream that’s invested in commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS), it’s a broadly diversified portfolio. We choose these securities on a balance of duration, product type and liquidity. All of those securities are liquid, but RMBS tends to be highly liquid, while CMBS tends to be a little less liquid, it takes a few days to clear. So it’s about balancing liquidity with the assets we like, and with the duration that we want, and we find securities that do that.
So publicly traded REITs are highly correlated to small-cap stocks. When we started this portfolio, we tried to provide for folks whose portfolios have low correlation, low volatility, strong income, and we think the private debt securities are more appropriate for those goals of the overall portfolio.
So basically, instead of putting some of the money into publicly traded REITs, you’re choosing CMBS and RMBS for their periodic returns, and you’re using those investment returns to pay back a 5 percent quarterly tender to your investors each quarter?
Schaupp: Yes and no [laughs]. So the 40 Act structure allows you to invest in this fund daily. We have a ticker. So every day we learn how much money we’ve raised, and we take money and buy properties with it. In the short term, we might put some in securities as a short-term piggy bank, and we also have a credit line to manage the flows, as well. The way you get money out of the fund is we offer a tender process. In nontraded REITs, in other funds, it’s called a redemption process. The structure of this fund is called a tender. Every quarter, we send a notification to our investors that we’ll offer to buy back a certain amount of the fund. The goal in our prospectus is 5 percent. Fortunately we’ve never been fully tendered, so no one’s wanted enough money back to get to 5 percent. That doesn’t mean you as an investor only get 5 percent out — it’s 100 percent of the money up to 5 percent of the request. If our fund is $800 million and you have $1 million in our fund, if you want to get your money out, we’ll send a notice saying we’ll buy back 5 percent of the fund, you have 30 days to respond to the notice, that’s the tender, and if you wanted your $1 million, you’ll get your $1 million, as long as we didn’t get more than 5 percent of the fund tendered. And that process takes place on a quarterly basis.
Why do you think this trend of individual investors getting access to private real estate has grown so much of the last 10 years? Did this exist in the 1990s and early 2000s, or is it a product of our modern, post-GFC system?
Schaupp: Historically institutions have had 10 percent or more in private real estate. In fact, if you go to the endowments, like the Yale [University] model, they need almost no liquidity, they’re only funding 5 percent a year out to the university, so endowments go heavily into illiquidity premium, if you want to call it that. The reason why institutions have invested in private assets and private real estate is because the low correlation, the low volatility, the strong income. It’s one of the few asset classes that pushes your efficient frontier up into the left — you improve your risk-adjusted returns. So I think the structures in the technologies have allowed us to manage assets like this at a fee that’s competitive. Twenty years ago, because these products were more challenging to manage, and harder to distribute, because the technology wasn’t there to do that, the fees were excessive at the time. So investors, therefore, didn’t have great experiences because they were paying too much in fees and not getting enough in return. The modern technology process of distribution, valuation processes, and fund management has just become more efficient. We can now provide this asset class to a broader group of people at an appropriate fee level. The desire for the asset class has always been there, but we’re at this perfect point where the strong managers are now providing the product — because they can at competitive fee levels — and the distribution networks are sophisticated enough to understand them. That’s why we’re at this inflection point.
Jenkins: That’s right. As to why investors are now turning to it, when you look at what individual investors typically targeted in their portfolios, it was some mix of 60 percent stocks and 40 percent bonds within their portfolio. There’s a lot of market correlation associated with assembling a portfolio like that. But to the extent you have real estate as an alternative investment, it has low correlation, low volatility, and that brings better risk-adjusted returns. Real estate, in particular, is also an inflation hedge. And from a historical standpoint, real estate has tended to bring a solid mix of income, along with capital appreciation, at least over time, to a portfolio.
Brent, how do you differentiate yourself from other products and competitors on the market, such as Blackstone’s BREIT?
Jenkins: It’s pretty tough to make direct comparisons, but what I can say is we’re a 2019 vintage fund, and that brings with it an ability to make a majority of investments in a post-COVID world, or at least a world where we better understand impacts of COVID on real estate. Second, being a 2019 vintage fund, we’ve been investing using that `40 Act tender fund structure in an economy that has elevated interest rates, elevated inflation. So we’ve been able to build a modern portfolio given those inputs and conditions. And the portfolio itself is interesting given our flexible investment mandate, being able to invest in both equity and debt. The portfolio, if you take a snapshot today, is about 60 percent equity investments, which provide capital appreciation along with income, and its 25 percent private debt, direct lending, and the remainder is the liquidity sleeve. It looks a lot different than others who might have a heavier component occupying the equity investment slice.
And then there’s the low leverage. Being a `40 Act [tender fund], with the leverage limitations, something we’ve focused on is maintaining low leverage in a high interest rate environment. You don’t want to be beholden to leverage, you want to use leverage judiciously and to your advantage, and I think that CPREX is positioned to that.
Schaupp: And maybe a point on our fundamental structure. The difference between a `40 Act structure and a nontraded REIT is, first, we have daily valuation, so you can invest every day, rather than monthly like a nontraded REIT. Second, the valuations policy of a `40 Act fund has more stringent standards, so we have every asset independently valued on a monthly basis. And third, the fee level. We don’t change incentive fees, and many nontraded REITs do. So those are three characteristics that are fundamentally different from a structural perspective which provide more ease of access for CPREX.
Switching gears: What are the broad trends each of you are seeing today?
Jenkins: The two biggest trends are demographics, where you have a couple of big cohorts moving through age continuum. You have the baby boomer generation, with a tremendous amount of wealth, that is transitioning in their life. The second is millennials, in that they are coming into their big household formation years, and it’s a large cohort with a growing amount of wealth they are able to spend in the market. That’s all impacting a number of asset classes like residential, and industrial warehouses for sure. The other is housing, in that, we’re probably 3 million to 5 million rooftops short today, internally. That impacts rental and for-sale housing. Layer onto that the affordability issues with for-sale housing, and it really provides a tailwind and a great story behind potential income and capital appreciation with respect to rental housing as a whole.
Schaupp: I’d like to highlight that it’s a good time to invest in private real estate, as well. Interest rates have peaked, inflation has moderated, and the soft-landing economy makes it healthy for real estate. If you look at real estate cycles, when values have declined, which they have, coming in at that bottom could be a good entry point, and we think we’re potentially entering a good real estate cycle.
Last question: What’s your best advice when it comes to your investing?
Schaupp: Things are never as good as they seem and never as bad. Be steady and think long term, and be consistent with your thoughts, and you’ll do well. When everyone is following one trend, you don’t need to be contrarian, but those trends tend to revert back to the mean. Real estate is a long-term vision, so don’t react to short-term trends, but be smart holistically.
Jenkins: Don’t be reactive. Think strategically and invest strategically.
Brian Pascus can be reached at bpascus@commercialobserver.com