Oh, Dear!

Management cost is an all-important consideration

June 20, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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Apartment REITs invest in and manage apartment buildings and both manufactured and single family residential homes. The Lease income is stable and the tenant mix is diverse. Compared to office REITs, Apartment REITS are safer, but it is a competitive landscape. When valuing an apartment REIT, analysts tend to look for macroeconomic factors such as demographics, interest rates, and income trends.  Pen&Paper, however, looks at costs.

Bluerock Residential Growth (NYSE:BRG) is an Apartment REIT. Its assets compose of 14 real estate properties and 6 development projects. Its asset market value is $557 million. The apartment building portfolio total number of units is 4,625 with an average monthly rental rate of $1,200. The development portfolio is expected to add 1,825 units at a cost of $392 million, an average of $215,000 per unit. Construction is expected to be completed by the third quarter of 2018.

In 2015, the company’s revenue consisted of $42 million in lease revenue and $9 million in other income. Whenever lease income increases by more than 5 percent on a yearly basis, the increase is acquisition-related. The BRG increase in lease revenue was 45 percent for the year. Other income represents 20 percent of total revenue. It is a gain on sale and an increase in income from an unconsolidated joint venture, but very little information was provided.   

That year’s expenses included operating expenses of $18 million, G&A expenses of $4 million, management expenses of $4 million, acquisition-related expenses of $4 million, and depreciation expenses of $16 million. Industry veterans would affirm that an Operating Expense to Revenue ratio of 42 percent is reasonable. But management cost is dear. Charging $8 million to manage a portfolio of real estate assets valued at $557 million translates to an expensive 1.45 percent asset management fee, an exorbitant 19 percent off the top.

Source: Company 10-k filings

Compared to private real estate ownership, REITs offer tax savings and lower transaction costs, notes Victor Haghani of Elm Partners, an active index investment fund.  To evaluate an Apartment REIT, analysts have to research property-specific issues. Among them are how likely the tenants are to roll the lease; is management able to increase rent without losing occupancy; are rental rents at-market, below-market, or above-market; is there a tenant concentration; and what is the expected supply.

But it is a Sisyphean task. Answers cannot change the location of the gatekeeper (i.e. management) standing between the real estate of Bluerock Residential Growth and its investors. While the gatekeeper is capable, well respected and honest, it is unfortunate these qualities cost so much.