Investment Manager Profile

Prescott Group’s Stupin: Real Estate Great for Diversification

(Investment Management Weekly)

by Dave Lindorff

August 7, 2006 - Diversification is the big word in investing these days. And Susan Stupin, co-founder and managing director of New York-based Prescott Group LLC, said that you can’t get better diversification than property.

"Real estate as an asset class has a very low correlation to other asset classes," explained Stupin. "This characteristic enhances its overall value for risk management in a portfolio."

As well, she said that real estate "tends to offer attractive returns in comparison to public debt and equity funds. For example, over the 10 year period from July 1993 through June 2003, real estate offered risk-adjusted annualized returns of 10%. This was only slightly less than the 10.3% annualized return offered by equities. In contrast, Treasury bills gained only an annualized 4%, and global bonds, just 7.2% for the period.

"Real estate is a great tool to hedge portfolio returns and protect against economic cycles," said Stupin.

The Prescott Group, which includes Prescott Capital Management and Prescott Capital Advisors, was founded in 1987. The firm has a long history of investing in real estate, but only recently began offering its investment funds in real estate to private clients. Stupin said that the group’s target for these investments is annualized current cash returns growth of 6%-8% net of fees and carry and an annualized internal rate of return of 12%-15%. The funds are structured so that in the invent of any equity gains, for example through the sale of appreciated assets, investors will get their money back plus 10%, after which gains will be divided with Prescott receiving 25% and investors getting 75%.

"Institutional investors have made significant allocations in real estate for years," said Stupin. "In the institutional world, real estate now represents typically about 5%-10% of total assets. But for individual investors who wanted diversification, the options were limited to hedge funds or, if they wanted to invest in real estate, there were the retail-oriented real estate investment trusts (REITs), but they often come with heavy fee loads. Otherwise, you had to just invest in local real estate deals."

What Prescott offers individual investor clients is the option of investing in its own real estate funds. Prescott over the last 18 months has acquired some $300 million worth of property, everything from offices and retail space to hotels and multi-family residential properties. Stupin said Prescott expects to be acquiring more property holdings at a rate of about $500 million per year. So far, all those assets are domestic, but Stupin said the company is starting to look at some international markets.

"The company is also investing in net leases and is about to offer a dedicated net lease fund. Net leases are arrangements where a company like Prescott will buy assets from a company that wants to raise capital by selling its property holdings—typically office space or retail outlets. As interest rates have risen, more and more companies have been looking at their real property assets as a cheaper source of debt capital. In a net lease, the company will sell its assets and then lease them back under a long-term "net" lease that requires the tenant to pay for maintenance, repairs, taxes, and insurance against damage or loss.

"The advantage of net leases, as well as office property or other rental property acquisitions," said Stupin, is that the long term leases provide a steady source of revenue even during economic downturns."

Multi-family housing can also provide a hedge, Stupin pointed out, since as families have to give up on plans to buy a free-standing home, they can move down to buying a unit in a multifamily dwelling, which tends to keep valuations in that area higher during recessionary times.

Prescott has been bolstered by a recent major investment in the company and its funds by the Gordon P. Getty Family Trusts. "This has given us growth capital," said Stupin. "It affords us the opportunity to build a platform that can become a significant factor in serving private clients in real estate." She said the Getty Trusts invested in Prescott "because we offer a significant amount of experience and market presence, have had staying power, and have been successful at what we do."