Zenouzi |
Delaware REIT A Fund: Securitized Security
[September/October 2008]
By Allen Kenney
Babak Zenouzi and the REIT industry have enjoyed a long and prosperous friendship.
Zenouzi, the lead manager of the Delaware REIT A Fund (NASDAQ: DPREX), has been tracking the REIT market since he broke into investment management in 1992 with Delaware Investments as a novice equity analyst. The fundamental nature of the industry immediately caught his attention, and his enthusiasm eventually spawned the company's first REIT-centric investment product.
"REITs had very high yields, nice dividend growth and the industry was at a fundamental bottom," he recalls. "I began pitching different fund managers on the equity side, and one of them thought REITs were so great that we decided to build a fund around them."
By the mid-1990s Zenouzi and his colleagues at Delaware had raised between $400 million and $500 million in closed-end REIT equity-income funds. When Lincoln Financial Group bought Delaware in 1995, the powers that be selected Zenouzi to manage a $25 million domestic securitized real estate account to complement the group's existing real estate assets.
"Lincoln Financial had a very large real estate portfolio at the time, and they recognized the growth in REITs and where the industry was going," he says.
The new domestic fund flourished under Zenouzi's guidance from 1995 to 2000, finishing in the top 10 percent of REIT fund performers for the five-year period. He eventually left Delaware in 2000 for an opportunity to manage a suite of diversified equity portfolios for Chartwell Investment Partners. The lure of REITs proved too strong, however, drawing Zenouzi back to Delaware almost three years ago to oversee the company's domestic REIT products, in addition to helping kick start a new global REIT fund.
Bottoms Up
Zenouzi says his wealth of experience in the REIT market has taught him the importance of removing emotion from stock picking. What makes that possible?
"You need to have a philosophy and a process that you're adhering to in good times and in bad times," he says. "You can't fall in love with—or hate—your stocks."
Zenouzi and his colleagues follow what he calls "a dual, bottom-up approach" to evaluate potential fund purchases. The first leg of that platform involves constructing an independent valuation of a company's underlying real estate assets to determine if the market has fairly priced the company. Next up is an in-depth discussion with executives and managers.
"We try to understand how management can grow the current platform they have on the ground, what their strategy is, what their track record is, what their human resources means are," Zenouzi says. The last step is a full financial projection in which Delaware's analysts look at a company's growth potential and capital structure, as well as the market value of the company's securities versus Delaware's own analysis of the company's underlying assets. Of course, Zenouzi and his team turn the process on its head when investigating whether or not to sell a stock.
"It's a combination of real estate and security analysis with a management discussion overlay," he says. Zenouzi maintains it's a comprehensive strategy that sets his funds apart from competitors.
"We're not just looking at it from a real estate angle," he says. "This is a security traded on a stock market—we're not just buying buildings."
Delaware's dual philosophy has led the fund's managers to allocate approximately two-thirds of its holdings to some of the REIT industry's biggest and most well established names, such as ProLogis (NYSE: PLD), Simon Property Group (NYSE: SPG) and Vornado Realty Trust (NYSE: VNO). Zenouzi readily admits that his fund holds a high concentration of "blue chip names," and the reason, he says, is clear.
"Historically, these are the companies with the best properties, the best management and the best balance sheets," he says.
Feet in the Office
Zenouzi also contrasts his team's approach to information gathering against the preferred course for many fund management groups' style. Zenouzi tends to shun what he calls a "feet-on-the-ground" strategy that many fund managers prefer, which entails using information collected by personnel dedicated to visiting and studying companies and their properties. Instead, he primarily opts to keep his team together at Delaware's home office, adding "nimbleness" to their ability to act and make decisions as a group, a trait Zenouzi says has served them well. He notes, though, that such an approach is made possible by the nature of publicly traded real estate securities.
"Historically, real estate was a private industry enterprise, and having feet on the ground made sense," Zenouzi contends. "We think that securitized real estate has leveled the playing field in terms of information flow both on the equity and the debt side."
Zenouzi also points out that Delaware Investments is part of a global money management firm, which opens up a variety of other resources for his team. For example, global fund managers can leverage the expertise of Delaware Investments' emerging market teams to help guide their international REIT investment.
Likewise, the domestic fund teams talk daily with Delaware Investments' fixed-income staff for updates on the latest developments in the U.S. credit markets. Zenouzi credits those discussions with helping the fund managers make their way during the recent credit market instability.
"Understanding those situations and how the credit markets are going to treat a stock, given the widening of spreads and the lack of credit availability, is very important," he says. "That's one thing we became acutely aware of in early 2007, mainly thanks to our discussions with our fixed-income team."
There's No Free Lunch
When asked what has kept him involved with real estate for the last 15 years, Zenouzi responds with an important distinction.
"I'm working in securitized real estate," he says. "I'm a stock picker–that's what I like to do."
Zenouzi says the principal characteristics of REIT securities are what keep him coming back.
"What really attracts me to real estate is the stability of cash flows, the recurring cash flow that provides that dividend," he says. "The companies that can do it well can grow their dividends, and over time the market will capitalize on that kind of income stream to provide you with additional returns and capital appreciation. I'm not advocating that it's a free lunch, but it's the characteristics of the asset class that attract me to this sector of the stock market."
That aside, he says the opportunities that he's beginning to discover abroad have fueled his interest in the industry lately.
"I like that there continues to be great growth both domestically and internationally in the securitization of private real estate. You're beginning to see that as far away as Asia, South America and the Middle East, as well as in Europe and Russia. There's a great deal of securitization to come in all of these locales, and we want to be a part of that growth."
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