How the war in the Ukraine impacts OrbVest’s strategy and your investment mandate

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CIARAN RYAN: We’re talking war in the Ukraine and what impact this will have on inflation and, specifically, one rather unique way of hedging against some of the negative spillover effects of this war. Joining us to discuss this is Justin Clarke, COO at OrbVest. OrbVest is a global real estate company, and it allows investors from around the world to invest directly into US commercial properties, specifically medical real estate.

Justin, we spoke last [month] about inflation, but events have moved on quite rapidly since then, with the Russian invasion of Ukraine. We’ve seen some dramatic reactions on the financial markets, particularly with some commodities like oil seeing a surge in price. What’s your outlook on all of this?

JUSTIN CLARKE: Hi Ciaran. Yes. It’s amazing what a difference a week makes – or 10 days I suppose, since our last conversation. I don’t think any of us profess to have a clear view of what’s going to happen in the next couple of months. Let’s think about it. We were talking last time about inflation edging, what, 7.5% – annual inflation recorded in January. That was the highest since 1981. We said [two weeks ago] the very strong view in the US was purely a cyclical thing as a result of Covid, and would drop off back in the region of around 2%, which is where the Fed is comfortable. And that would happen by about mid-2022.

I think there’s absolutely no doubt that the war in Ukraine and the measures taken, especially by the West to sanction Russia, will have some sort of blow-back effect on the world economy.

Let’s face it Ciaran, I think the first thing we need to consider is fuel prices. They’re definitely on the march. I think you mentioned well over $100/barrel at the moment – and there are other impacts.

One of the more bizarre consequences for me is the freezing of Russia’s reserve bank assets and the blocking of the Swift interbank payment system. That will create a shortage of USD, and I’m trying to get my head around this Ciaran – they’re talking about having to get the old printing presses going again to create USD because it’s going to create a shortfall.

All this stuff is inflationary. I think it’s going to push out the inflation outlook over a longer period, and it’s a guess what impact that will have and how the US will try keep that under control. The assumption was they would be raising rates by about 0.25%. They could go a bit faster, [but] we don’t think that’s going to happen. Our view is they’ll stick to 0.25%. They’ve got other ways of reducing liquidity, but I don’t know if that’s viable at this point.

I think the only thing [we can say] is that it’s going to spike global inflation, which will affect the US.

CIARAN RYAN: Your investment offering has traditionally focused on the syndication of single buildings … now, looking at some of your new products, you’ve got [OrbVest] Triple Net, you’ve got OrbVest Diversified Holdings, (ODH). Are you moving away from this single-building concept?

JUSTIN CLARKE: We are moving away, and I think it’s [due to] some of our new products. Maybe the history is important. I think a lot of high-net-worth investors, small family offices all over the world want transparency. They’d like to go to the US and buy their own building, but they don’t have the ability to acquire, find, manage, assess, so they need a partnership, and effectively that’s what this started off as.

Hennie [Bezuidenhoudt], our chairman, who has a huge amount of knowledge of SA, discovered the US was very similar. He went over, acquired a couple of buildings, and got a few mates to come in and effectively co-own those buildings with him.

All we’ve done is just progressed with that model. We acquire a building and syndicate it effectively  to high-net-worth individuals. Now that’s expanded to smaller retail investors. As soon as I mention the words ‘small retail investors’, then you have to start getting concerned.

Remember, this is an investment in a building. Things can go wrong, and do go wrong. Tenants get taken over by bigger tenants, Covid comes along, medical practices can go bust – and we’ve had one or two of those. Our job is to manage them and get the money in, but it disrupts income. It disrupts dividends.

So how do you try and protect the retail investor who is now investing for dividends, for constant yield in US dollars? How do you protect them?

I think you can see by our most recent products – and I’ll talk particularly about the sort of low-risk product we brought out called ODH. Effectively we have taken over a small slither of each one of our buildings, or later buildings we were able to do this in, and lumped it together into one product.

It’s the same thing, still a five-year investment, but the benefit is that you may have, for example in ODH 5, our fifth version of this, as many as 100 medical tenants. So you’ve got a lot of income streams coming from a lot of different tenants, and the chances of something disrupting that income flow are very, very small.

So to answer your question, this is the first move away from the single-building model. Bear in mind we still have big investors, family offices that want to participate in a particular building. So we will always find buildings for that particular market segment. But we feel much more comfortable creating this little diverse byproduct.

We’ve got another one called Triple Net, which is effectively a different mandate where we buy small Triple Net buildings and put them all together into one pot.

You’re absolutely correct, it is kind of a migration away from the single buildings, especially to protect retail investors and to give them what we effectively have been talking about – and that’s consistent dividends and cash flow in US dollars.

CIARAN RYAN: All right. In terms of returns, we’re talking about inflation of about 7.5% at the consumer level in the US, and your returns historically have been about 2% per quarter. So it looks like, even at very, very high inflation rates for the US, you are quite clear of that benchmark.

JUSTIN CLARKE: Yes. There are so many moving factors, and what’s so amazing about this free market is that the scale balances itself always. There is a huge amount of money that’s concerned about interest-rate increases that is moving out of the markets and other sources, looking for safe haven – we talked about this last week and I don’t want to go through it again – but looking for bonds and looking for commercial real estate, and looking for gold because it’s seen as an inflation hedge.

Quite simply, we buy these buildings, and we [still] lock in the debt at 3.5% for five years. So it doesn’t affect us on the cost side of a building if we peg the debt. So you pay the debt, and your income is secured for a long period because of the long-term nature of medical tenants.

The only other wild card is the expenses. That’s when we start talking about ‘double net’ and ‘triple net’ leases, where you pass the expenses through to the tenant. So in a lot of our buildings we’ve got triple-net, double-net tenants at least, and we can push increases and expenses through to them.

Ultimately you’re buying a building at a price. In five years’ time with inflation it’s going to be worth a lot more for a number of reasons; escalation in the rentals and of course, cost push. At the same time you’ve got an income stream and, as we roll leases over – as the [tenant] comes to renew [their] lease – we can push this rent up to something that’s more market-related. That comes back to that conversation about inflation.

That’s why we’ve got so much money rushing into these buildings.

Now the scale balances itself. On the other side, of course, the price of these buildings is going up, so that 8% is getting harder and harder for us to achieve. In fact on a secure core product like ODH, we are down to kind of 7% cash-on-cash, a little bit less than 2.% per quarter, but remember you hold the asset for five years and then you’ll get anything from 10% to 13% overall return over the period.

We are basing this on our assumptions of future income and future values, so it is an assumption. Just bear that in mind.

CIARAN RYAN: When we spoke a couple of weeks ago you mentioned that your investors have traditionally come from SA, but you expected this would change in favour of investors from the US and other first-world economies like Israel. What has changed, and why do you see this happening in the US and countries like Israel?

JUSTIN CLARKE: Ah, yes. It’s really difficult to invest into real estate in the US, and that’s the problem we set out to solve. That’s why we use the list environment in the Seychelles. But we still have to give comfort to the investor from SA that it’s viable for them.

And think about it, Ciaran – if I said to you we’ve got a building somewhere in a place you’ve probably never been to, would you like to take some money, move it offshore, and hand it over to me; I’ll go and put it into a building and then I’ll give you some returns in US dollars? It’s much easier to go down the road and buy this townhouse on the corner that you can drive past every day.

The same thing applies when it comes to the US. I mentioned that the US is absolutely awash with investment money looking for these types of building. We are saying, no, no, no, sorry, we can’t help you in America because of the specific compliance and the rules of the SEC [Securities and Exchange Commission] – how they control any sort of solicitation of investors in the US.

So we decided to not do it the hard way. Let’s go to the US market, where there’s an abundance of investors and money they’d want to invest in these buildings, and that way we’ll be able to accelerate our equity raise quicker.

The solution is that we’re going through a process of making sure we are compliant with the various SEC regulations and [I won’t] get into the details of that, because it’s super-boring.

But we really expect that to unlock a lot more capital from the US.

Obviously we’re not losing focus in our core market here. We have a substantial office [in SA], we’ve got investment advisors that work for us, a team around the country. We have a Category 2 licence here. We’re certainly not walking away from SA, but it’s easier to do [business] where the money is.

CIARAN RYAN: A lot of investors are asking about the way you structure your investments, specifically out of the Seychelles. You’ve chosen a listed environment, the MerJ Exchange. Why would an international investor not just invest directly into the US?

JUSTIN CLARKE: It actually is possible to invest directly. As I mentioned, that’s how we started off. So you can go in, set up an LLC [limited liability company], get an accountant and make the investments from that LLC in the US. But then you’ve got to worry about the account, paying the account, tax returns and all those things. And of course [there are] the taxes –  capital gains, withholding taxes and all that. It does get super-complicated.

So we came up with this idea that we needed to, firstly, consolidate all the investors in a place. Ultimately we wanted to have a listed environment for a number of reasons because, when you are raising money, there are [many] restrictions in the way you do it. So we need to consolidate the money into preferably a low-tax environment, and we needed it to be a listed company.

It so happened that the exchange was opening up in the Seychelles and we managed to negotiate some good rates from them. That’s really what has come about.

We developed the model effectively to solve these problems so that you don’t have to go directly into the US and deal with all the costs. Our gross return in the US, compared to our after-tax return – obviously before your SA taxes – is like 1%. So the only leakage that we have from bringing your money out of the US and parking it in the Seychelles trading account at the exchange is 1%, which is phenomenal because you would obviously lose a lot more than that in just costs alone.

CIARAN RYAN: Great. Thanks. You mentioned when we spoke before that you’ve acquired two new properties in Phoenix, Arizona, and Boynton Beach, Florida. Are these available to local investors?

JUSTIN CLARKE: Absolutely. They have just been launched. The Boynton Beach property is a fantastic building. We like Florida because it’s similar to SA [and] it’s right in the heart of one of the wealthiest areas of Florida, where quite a lot of South Africans are living.

Already, of the sort of $5 million-odd worth of equity, I think $3 million has been accounted for, and we literally put it live on Monday. So it’s been super popular.

There are a number of ways you can find out about these deals. This is not a sales show Ciaran, but perhaps we can talk about the webinar coming up on Moneyweb with Simon Brown next week, Wednesday, March 9. It’d be great if anybody is interested. They can go to OrbVest.com or email support@OrbVest.com or go to the link below this podcast.

CIARAN RYAN: Yes, indeed. We will post a link there. And, as Justin said, you can join Simon Brown next week on Wednesday night, March 9 at 7pm. There will be a link below where you can register, or send an email to support@orbvest.com.

Justin Clarke, chief operating officer at OrbVest, thank you very much. We’re going to leave it there.

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