PARTICIPANTS
Mark Brisley
Managing Director and Head of Dynamic Funds
Tom Dicker
Vice President & Portfolio Manager
PRESENTATION
Mark Brisley: You are tuning in to On the Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions to find out their insights on the market environment and navigating the investment landscape.
Mark Brisley: Welcome to another edition of On the Money. I'm Mark Brisley, head of Dynamic Funds. The global pandemic is changing the way we work, play and even live. These behavioral changes have been felt acutely in so many areas, but perhaps none more so than the real estate sector, and the questions are many. Could the impacts felt so far accelerate from here? Which changes are short term and which are more permanent?
The global economy is now recovering out from the lows we saw in March and April brought on by this pandemic, but the uniqueness of the required containment measures that were taken to minimize the risk of its impact has put the conversation, speculation and opportunities around real estate at the epicenter of the non-medical side of the crisis. Real estate traditionally has been viewed as a vehicle of protection from disruptions in the economy, but as this is unlike most economic shocks, it is also challenging long-held ideas about the future demand for and use of different types of real estate and locational preferences.
To dive deeper into the sector and the questions and outlook for a post-pandemic world, I'm pleased to be joined by Portfolio Manager Tom Dicker. Tom specializes in real estate, small-cap and equity income investing as a portfolio manager here at Dynamic and is a member of our equity income team. Tom, it's great to have you, and let's jump right in. Before we go into specifics on real estate, let's address the current environment.
We're deep, in terms of the US anyway, in the midst of another wave, unfortunately, but we also have what is clearly now very promising vaccine candidates in the pipeline. My first question is, what are you seeing as the likely course of events that leads us back to, if we can ever say there's such a term, a new normal?
Tom Dicker: I totally agree that it will be a new normal, and I think everyone gets it. The old normal, what we were used to, that is gone for good the longer this pandemic goes on. I've been talking for a while with my partners about this idea of the long COVID winter, and we're in that. That's still in front of us. A couple weeks ago, I read this article with the epidemiologist, the American epidemiologist, Larry Brilliant, and he said, "We'll beat COVID after we go through hell." I think we're going through the hell right now in terms of COVID.
The article said very clearly, and I really liked it, that Everest is in front of us, but we've also heard people like Anthony Fauci say things like, "The cavalry is coming." The cavalry is coming, but we can't stop shooting. I think COVID probably keeps getting worse in the US, but I think we're getting close to the peak right now, probably the next six weeks or so. You saw LA go into a full lockdown last week, and there's going to be more tough decisions. More tough choices are going to have to get made in the US just to keep the healthcare system intact and to hold things together over the winter when transmission is going to be really high.
I think we're going to start to see the vaccine getting rolled out in the US very shortly. We're going to see it in Canada very soon. We saw Britain go this week as well. That's very, very exciting. A very exciting moment in the history of science. This thing could end faster than people think. 20 million people could potentially get dosed by January. That's pretty incredible. That's in the US.
I think there's going to be a lot of government and non-government means of enforcing vaccination on people. Places like schools and employers, I think they're going to insist on their employees or the students to come-- If they want to come back, they're going to have to be vaccinated. I think countries will probably insist on vaccines being necessary to cross borders. I think the uptake of vaccines is going to be very high, and I think that that's going to be very important. I think the market is clearly looking ahead and believing that the economy is going to recover and that things will go back to a new normal.
I think this spring, when we start to get better weather, a very high proportion of people in the US have already had coronavirus. With vaccinations, this thing could go away faster than we think in the spring, and things could go back to the new normal faster than we think. I think a big question that remains to be seen is whether or not Trump will get a vaccine. I think it'll really help to encourage his followers to do so. 68 million people voted for him, so I think that it will go a long way. That's certainly something I'd like to see. That's how we see the next few months playing. Still a lot of uncertainty, but certainly, as I said, the cavalry is coming.
Mark Brisley: Obviously, real estate's been an area that's front and center in the news, and in terms of the industries impacted by COVID really significantly, there's been large divergences within the sector. I wanted to start though with the effects on consumption and the way we shop. People have been shifting away from in-store shopping. I know my house looks like an Amazon depot most days, and everyone's shopping online. How do you see the lasting damage to brick and mortar retail presence? On the flip side, how does this change the way companies are going to invest in logistics and warehouses going forward?
Tom Dicker: Brick and mortar retail is going to bounce back, but it's probably to some lower level than it was before. We had a huge wave of bankruptcies last year, whether it was Lord + Taylor, Brooks Brothers, GNC, JC Penney, Neiman Marcus, J. Crew. We had a huge bunch of them go bankrupt last year, so that ecosystem is definitely hurting. That's a lot of space for landlords to retenant next year, so I think that's certainly going to take some time.
The other issue is when you've got lockdowns in the fourth quarter, this is a period where companies are accumulating cash in the retail space, whether it is apparel retailers and other places that sell for Christmas, restaurants. They generate a lot of cash in that fourth quarter, and then they typically consume cash in the first quarter of the year where their fixed bills are often higher than the revenues that they're generating. We're in a period right now where if those revenues are much lower now, their ability to pay bills in the first quarter could be worse than an average year, maybe by an order of magnitude, depending on the type of retailer and whether or not they have some ability to offset their loss sales through online loss brick and mortar sales.
We're clearly going to have a tough period here in retail real estate. I do think we'll see a bounce back, but it's going to take a while. The online world is the ultimate winner take all market. It favors big national global players with scale and free delivery and low pricing and better assortment. That's inherently bad for retail landlords. A big part of the wipeout due to COVID was services. The in-person economy will come back. Restaurants are going to bounce back, but it's not going to be next June. If you're a single store restauranteur, you had a loan probably. It was backed by your house, and right now, you might have lost everything. It's going to take time for capital to form, but it will.
New businesses will take up a lot of that productive capacity of that retail space over time, but I think it's just going to be at a lower level, likely lower rents. It's going to take longer than maybe other recessions have in the past. That's not an area that we're highly focused on for our marginal dollar of investment right now. I think certain areas like apparel where competition is really high, I think there's just going to be less locations of those in the future, as people who had maybe never shopped for clothes online before have done so over the pandemic. Once you do that, that's the equivalent of switching from CDs to using Spotify. You don't go back to using CDs after you use Spotify. I think it's going to be the same story with apparel.
Mark Brisley: That's really one of, I think, two major areas that are top of mind for people, so the way we consume, the way we shop. The other one is obviously the way we work. In that, I'm referring to office space. Many companies have instituted work from home policies. Many are indicating that there's going to be much more flexibility in the future. You and I are certainly in that conversation with our own roles. This has a two-pronged effect, though, on both offices and where people choose to live. How do you see this trend affecting the future of the office and, by extension, urban residential markets?
Tom Dicker: I can't have a conversation with a client or even my friends without talking about this subject because for most people that I know, they've been forced to work from home. It's definitely still too early to tell how this is going to shake out, but since the beginning of the pandemic, people have been clear. They do want the flexibility to work from home at least some of the time post-pandemic. Some fatigue is definitely setting in.
In May, when we were looking at surveys that showed people wanted to work three days away from home. Now when we see those same surveys, it looks a lot more like two days, and it's been gradually falling off as people have had a bit of fatigue from the isolation. It remains to be seen how productivity and how companies who want to grow their top line will truly work in a hybrid or an exclusively work from home world. A lot of money has been invested in technology.
I think a lot of CFOs around the world are eyeing these office lease payments as an area they could try to shrink. Trends that were already in place, like hotelling, probably do continue. When you have low occupancy in an office because people are working from home, having dedicated space makes less sense. I think that trend is something that remains to be seen exactly how that plays out. Now, if someone has to only commute two days a week or three days a week, does that change the calculation for them as to where they want to live and how far from their office they're willing to commute? I think it definitely will, especially because there's a scenario where traffic is also a bit lower in a post-pandemic world because more people are working from home now, especially if you saw people take back up their use of public transit because they felt like the virus risk was much lower.
Right now, clearly, people are unwilling to use public transit, but if that really comes back, then I think it could reduce commute times, which would be obviously much more bullish for suburban real estate and less bullish for urban real estate, residential real estate specifically. You're seeing that in rents in New York City residential as an example where nightlife's been hurt pretty badly there, and people are all working from home. Rents in New York City are the lowest that they've been in 10 years. Landlords giving away free rent, knocking down monthly payments. It's something that we haven't seen.
On the other hand, PulteGroup, Toll Brothers, Lennar are the big home builders in the US are posting year over year backlog growth in sales of new single-family homes of 50-plus percent. That's people moving to the suburbs, moving from rentals to homeownership, and that's a big reversal of some of those post-crisis trends. It'll be interesting to see if that has legs beyond the pandemic. I'm not sure that it does or doesn't. I think it does. Maybe not to the extent we've seen over the last year. Clearly, some demand has been pulled forward for single-family residential. I think that's very clear.
New York was losing people pre-pandemic. It's clearly accelerated. It'll probably reverse for a bit next year as employers call people back to the office, but it'll be interesting to see whether or not the long-term trend remains that there is deurbanization in some of these major cities. That's been a key facet of how a lot of big pools of capital within real estate have invested. They've been big believers in urban centers. It'll be interesting to see whether or not the suburbs maybe have the advantage over the next cycle. That would be a big change.
Mark Brisley: It certainly has me saying something I never thought I'd say, which is I miss my commute, and I miss the office.
Tom Dicker: I'm with you. I really miss my co-workers. It's something that I'm surprised to say now versus mid-March.
Mark Brisley: Tom, another area that you cover and invest in is the retiree demographic in terms of real estate. I'm referring to retirement, nursing homes, long-term care. I don't think anywhere have we seen the same risk exposure hit this particular area as hard as COVID has in terms of the vulnerable populations and just a lot of negative media coverage. How has the pandemic though impacted your view on this space from an investing perspective?
Tom Dicker: In the early stages of COVID, here in Ontario, the long-term care homes were really the nexus of the pandemic, and there were just months of tragedy. This is an industry that's funded by the provincial governments and where there have been persistent year-long staffing shortages and known issues that were really brought to light during the pandemic.
There's a saying that you shouldn't waste a good crisis, and I believe that the provincial government of Ontario is not wasting this crisis. They're changing the funding model. They're improving funding for long-term care, which I think will get much better outcomes for the residents of these homes and give families much more faith that the seniors, their parents are going to get much better care when they go into these homes.
As an investor, the saying goes demographics is destiny. We have an aging population, and that's definitely going to continue to take place. In 2026, the first wave of baby boomers is going to turn 80. We're on the edge of that big wave of population growth and a big wave in demand for seniors housing and long-term care. The industry was in a bit of a oversupply in Canada pre-COVID, as the industry built out capacity ahead of those years of demand. We've seen a big slowdown in starts. I think that'll persist for a couple of years right now because occupancies are very low.
The one thing I know about real estate is there's a lot of operating leverage. Whenever you see a building go from low occupancy to high occupancy, there's a disproportionate increase in free cash flow and distributable income. I think demand will start to outstrip supply for a long time starting in a few years, and the stocks right now represent a lot of value.
The operators in Canada are run by compassionate, dedicated professionals, and we know these people well. We're very happy to be shareholders for a long time in a sector where we think there are great demographic tailwinds in a needs-based essential service. No one wakes up in the morning thinking that today's the day that they want to move into a long-term care home, but you have to because you can't provide the care at home. That's an important part of the investment thesis for us.
Mark Brisley: That seem to really highlight the quality of management and oversight that these companies had in terms of how they handled the outbreak. I know my own grandmother at 96 in a retirement home didn't have a single outbreak in theirs, but it didn't stop a lot of pessimism towards that space. My next question for you though, perhaps including this particular area, where else have you seen what we could consider unwarranted pessimism that's been priced into the real estate sector?
Tom Dicker: Certainly a couple of months ago, I would've said healthcare real estate, that'd be seniors housing and long-term care. That was the sector where there was the most unwarranted pessimism because we had this big demand wave coming, but they bounced a fair bit off the bottom post, the vaccine. We've seen the stocks move fairly meaningfully. I think there's still pessimism baked into the stocks, but it's not the standout biggest discounted sector.
Apartments in the US and coastal cities, and maybe even Canadian apartments, are probably where there's the most unwarranted pessimism. While I do think, especially in Canada, there could be some moves to the suburb over time, it's not just market forces at work here. It's tough to build single-family houses in Canada. It has been for many years, especially in a place like Toronto where there was the Places to Grow Act, and the green belt around the city makes it very tough to build single-family. In a city like Vancouver, very tough because of the mountains and the ocean. You can't just build houses infinitely.
It will constrain supply in these markets of single-family, first of all, and secondly, there's going to be a lot of immigration into Canada and into the US in the post-COVID era. That's certainly a way that Canada, especially, is going to fuel its economic growth over the next cycle. The Trudeau government's been very clear that they want to increase immigration greater than 400,000 people a year. Those are big numbers against a population base in Canada of around 38 million. Those are big numbers. I think we've certainly seen apartment stocks sell off. There has been some rent control especially in Ontario and out east. That's a bit concerning in the short run, but the longer-term picture we think is very, very strong for these assets.
We've seen cap rates or yields on these assets go down, i.e., prices go up over the last couple of months because bond yields are low. Financing's very cheap, so wealthy individuals and companies that have cash available to them really want to get their hands on these apartment assets in Canada. Those stocks we think are still trading relatively cheap compared to pre-COVID. We think that there'll be maybe another year of operating challenges where occupancy is a little bit tougher to come by. We're going to really need to see employment come back, but when we do see that, we think that that story, which was a very strong pre-COVID story of growth in rents, we think that that will resume, and we'll move back to trend line growth there.
Mark Brisley: A longer-term theme in the real estate space has been private capital. Tom, maybe you could walk us through a little bit about why that's the case and if there have been notable changes in what kind of assets private capital has found most attractive in 2020.
Tom Dicker: Yes, it's definitely been a long term trend that private equity owns real estate. That's been happening for a really long time. What we've seen though is as bond yields have gone lower and lower and lower, institutions globally have in order to meet their return hurdles needed to move more of their fixed income and overall portfolio allocation into real estate where the yields are higher and where the total returns are higher.
Especially for us, a medium-sized pension fund, or even very large pension fund, sovereign wealth funds where they don't have the operating capability, they've turned to private equity companies to deploy that capital for them so that they can earn those mid-teens type of returns or even high single-digit, low single-digit or low double-digit type of returns that are necessary in order to meet the 5%, 6%, 7% return threshold that they need.
It used to be that you could get 5% or 6% or 7% in the bond market, but with US Treasuries where they are today under 1% for 10-year money, clearly, you can't do that in the bond market. You're only going to get another 100, 200 basis points for corporates above that. If you're earning 100 or 200 or 300 basis points on part of your portfolio, if you want to get to 6% or 7%, clearly some of your assets need to be invested over that 10% type of return target. That's where private equity really comes in. Clearly, private equity real estate has grown dramatically directly over the last cycle. Now if you were to look at some recent studies by Preqin, they think that actually growth in private equity and real estate is going to slow down a bit. That's because office and retail, which are the two biggest categories within private equity real estate, are likely to slow down and shrink a little bit. Maybe not shrink fully, but certainly the growth is going to be less than it was before because the challenges in these asset classes.
Deals this year in private equity have been much less. It's down by over half compared to the year before. A lot of that just has to do with the fact that it's really tough to do due diligence. You can't go and kick the tires on assets when there are travel restrictions, especially across border deals have been very tough to do. Where we have been seeing deals has been in private equity, where those players especially within a single country where they've got good platforms and they have the ability to due diligence assets very quickly. They can close on assets, and they have a lot of dry powder.
There's about $150 billion in North American focused commercial private equity real estate funds, so that's a really big market. The AUM in that category is $416 billion. That's a very, very large market. We think that while growth is expected to slow, private capital it's still a big player, and they're likely to consume public companies over the next 12 months, if these discounts that we see in the public market continue to persist. Right now, there are certain sub-sectors that are trading at double digit discounts to private market values. Those will not persist with the amount of dry powder that's out there.
You'll see the Blackstone's and Brookfield's of the world go out and take private these public companies so that they can deploy that capital on behalf of those institutional partners that they have like Canada Pension Plan, sovereign wealth funds, et cetera.
Mark Brisley: We still have the lingering risk or concern that we will be dealing with a more severe impact of a second wave, which you could argue we're in right now, another widespread large scale lockdown, and the question around how markets might react. At the same time, we do know a lot more about the virus, about how it's impacted where we've been already through this pandemic. How meaningful, in your opinion for markets, do you think it's going to be if we revert back to another widespread large scale lockdown?
Tom Dicker: Typically, the market doesn't repeat itself exactly, but we do have to keep in mind that President Elect Biden has made it a priority to get the virus under control. He's talked about 100 days of wearing masks, not a national shutdown, but we can't rule it out. That's probably not the sort of thing that you'd say two months before the lockdown, but right now, it doesn't appear as though that's likely in the US. Could happen in Canada. Could happen on Ontario. I think it's a lower probability event, but it could happen.
The good news is, typically, the market doesn't repeat itself exactly. If it could happen, I think everyone would understand that the scope of it would be much shorter, that the cavalry is coming, and the market would more or less look through. That's not to say that we couldn't have some sort of correction. It could even be a fairly meaningful 10% or so correction. The valuation start point today is not super low broadly across the market. I think for real estate, it probably doesn't make quite as big of a difference because your valuation start point is definitely lower, but certainly, it could have an effect on that sector.
There is a risk if there's an air pocket either way in the economy over the next few months, just because you're starting to see mobility scores fall. If you look at Google data, see how far people are going from home, it's starting to fall off a bit, and that could create a little bit of a slowdown over the next few months. I think the market will ultimately look through to more stimulus from the US federal government, more stimulus in Canada, and a healthier economy, and a rapidly growing economy as the vaccine rolls out.
I think the biggest risk to the market, over the next six months, you could have 100 million people take this vaccine. If you have 100 million people do something, some of those people are going to die the next day. It may or may not be related to the vaccine, but when you get 100 million people doing something, a lot of things are going to happen. I think that there's risk about noise and news around the vaccine safety and efficacy that could slow down the rollout of it.
I think that's probably my biggest worry over the next little while is that media attention to potential adverse outcomes of the vaccine slow down the rollout of it and make people hesitate to take it. I think that's probably the thing that the market would be the most impatient about, we'll call it, where the market wouldn't want to look through. That's really where I see the biggest risk.
Mark Brisley: Although not a bad place to be when you think about where we were four months ago and wondering if a vaccine was even on the horizon, right? Just unbelievable speed at which things have evolved.
Tom Dicker: Truly remarkable. Then the other thing that we've seen is really effective antibody treatments. Lilly has a very effective one. Regeneron has what looks to be an extremely effective antibody treatment. If this is the sort of disease where ultimately if production in those antibiotic cocktails can be ramped up where it's just not as high of a risk of death anymore because there are effective treatments that can reduce the amount of time you spent in the hospital, it becomes a lot less of a scary thing either way as well. It's not just about the vaccine, but clearly, the vaccine right now from the market's perspective is the be-all and end-all.
Mark Brisley: As far as our conversation on real estate goes, this has been incredibly insightful. It is really nice to hear the optimism in your voice and specifically towards where you're seeing some of the opportunities from an investing perspective. You mentioned you missed your co-workers and the watercooler chat that we were typically able to enjoy. One of the things I've missed is seeing you and chatting about books we've been reading. As we're heading deep into the holiday season, very quickly, I thought maybe we could close things off with one or two suggestions you have to help people get through the holidays from a reading perspective.
Tom Dicker: The Ride of a Lifetime by Rob Iger. That's his autobiography. He was the CEO of Disney. Just a fantastic read, really interesting business book. My favorite and maybe only economics book I'll ever recommend because I don't read that many economics books, and they're usually pretty boring is The Deficit Myth by Stephanie Kelton. You don't have to agree with her ideas, but certainly, the ideas within modern monetary theory are really, really influential right now. It would behoove anyone who's really interested in finance and investing to understand these ideas as they're laid out by Stephanie Kelton in fairly plain language. I quite liked that book.
One of my favorites so far this year that's not related to investing or economics at all, it's called The Body by Bill Bryson. He's a great author. I thought he knew a fair bit about science and the body, but my mind gets blown about every 90 seconds when I read this book. It's just a fantastic one, and I would highly recommend that. It's just for personal interest and a great gift idea.
Mark Brisley: Those are great recommendations, Tom, and overall, just excellent chance to have this conversation with you. Thanks so much for being here, and we wish you all the best for the holiday season.
Tom Dicker: Thanks a lot, Mark.
Mark Brisley: I want to thank Tom for joining us today and to all of our listeners who also joined us. For more information on anything that was discussed today or anything related to Dynamic Funds, we would encourage you to visit our website at dynamic.ca. As always, we believe the best source of information is through a qualified financial adviser. Thank you very much for listening. You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete fund lineup, contact your financial advisor or visit our website at dynamic.ca.
Speaker: This audio has been prepared by 1832 Asset management LP and is provided for information purposes only. Views expressed regarding a particular investment, economy, industry, or market sector should not be considered an indication of trading intent of any of the mutual funds managed by 1832 Asset Management LP.
These views are not to be relied upon as investment advice, nor should they be considered a recommendation to buy or sell. These views are subject to change at any time based upon markets and other conditions and we disclaim any responsibility to update such views. To the extent this audio contains information or data obtained from third-party sources, it is believed to be accurate and reliable as of the date of publication, but 1832 Asset Management LP does not guarantee its accuracy or reliability.
Nothing in this document is or should be relied upon as a promise or representation as to the future. Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compound total returns including changes in unit values, and reinvestment of all distributions does not take into account sales, redemption, or option changes or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed. Their values change frequently and past performance may not be repeated.
