Buller of Fidelity puts faith in London’s enduring appeal and takes new routes in European housing in pursuit of the ‘trifecta’ of winning bets

Germany’s large landlords are not the only show in town to bet on residential real estate in Europe, and companies specialised in Central London offices present good value, according to Fidelity Management & Research’s veteran fund manager Steve Buller.

Steve Buller

Steve Buller is a portfolio manager for real estate funds in the Equity division at Fidelity Investments, the company he joined in 1992 after graduate and post-graduate studies at the University of Wisconsin-Madison. He became a fund manager at Fidelity and its various affiliates after working as an analyst covering fixed-income, high-yield investments, the environmental industry and real estate investment trusts (REITs). Buller is a CFA charter holder.

Germany’s large landlords are not the only show in town to bet on residential real estate in Europe, and companies specialised in Central London offices present good value, according to Fidelity Management & Research’s veteran fund manager Steve Buller.
The Boston-based manager, who has worked at Fidelity since 1992, manages more than USD 11 billion through real estate funds for US and Canadian investors. Buller has been adjusting his five portfolios, including the Fidelity Global Real Estate Fund and Fidelity Advisor Global Real Estate Portfolio, so that the funds are overweight on listed companies in Europe and Japan relative to its benchmark, the FTSE EPRA Nareit Global Real Estate Index series. He has done so as rising interest rates and slowing fundamentals have made him reduce exposure to the US market, which now accounts for less than half of the fund’s investments in listed real estate.
Buller has three main criteria when he picks stocks from more than 400 listed real estate companies from around the world: supply-constrained markets where there is strong demand, good financing conditions that allow management teams to implement their strategies and share valuations that are attractive relative to the underlying real estate. The presence of all three has the potential to be what Buller calls a “trifecta” of a winning investment.
“Many of the European markets, especially in continental Europe (and I also include Ireland in this group), offer good fundamentals, an environment where companies can raise capital and do something accretive with it, and stock valuations that are at a slight discount or fair value relative to net asset value,” he said.
While the opportunities in housing are a major theme in the Fidelity manager’s strategy for investing in Europe, he does not favour Germany’s large listed landlords because he expects the aggregation driver of their growth to slow.
“I do not see many acquisition stories to drive their future growth and, from a rental income point of view, there is only regulated growth,” he explained. Germany’s rules on rental housing effectively cap rent increases, whereas if the companies were permitted to align rents with free-market pricing, they could grow their income by 20-30%, he said. “This is why we have tried to play the development angle in Germany with companies with good portfolios and platforms to build homes to let or sell,” he said.
Buller has invested in Sweden’s housing market, which he sees “has the potential to head towards the depth of the German market over the next ten years in a shift from a housing association model to the listed form.”
Another market where the Fidelity fund manager has made big bets is Ireland. Specifically, Buller has targeted Dublin’s market, where there is a housing shortage. The region attracts large multinational companies, particularly from the US technology sector, which bring higher paid quality employment to the region.
He finds Ireland more compelling than Spain, where the housing market is finally recovering from the crash in 2008: “Supply is starting to emerge, and there are lots of ways to play the residential development theme in Spain. What I worry about is execution risk there, so I am more comfortable with what is happening in Ireland, which is, I grant you, a smaller market.”
Irish companies represented 3.2% of the fund’s portfolio at the end of the first quarter, whereas the country accounts for 0.2% of the weighting in the benchmark global index.
Buller’s overweight allocation to the UK stems primarily from the opportunity caused by the sell-off in shares of companies specialised in the Central London office market following the June 2016 referendum vote to leave the European Union.
“We have stayed invested overweight in the London office market, where the primary tenant base is based in the new economy – technology, social media and so on,” he said. “These companies are talent driven, and we believe that London will remain an enormous magnet for talent. These companies are often dollar based, so the depreciation of sterling following the Brexit referendum has helped ensure tenant demand has stayed.
“The frosting on the cake has been the amount of capital that has been prepared to invest in Central London. We are a firm believer that capital from many parts of the world still wants to be in economies that are stable over the long term where there is rule of law. In our eyes, the UK and London still fit that need.”
The UK represented 8.8% of the portfolio at the end of March, compared with a benchmark index weighting of almost 5.5%.
Buller says “alternative” real estate sectors such as healthcare, student housing and self-storage have been something he has invested in during the past five to ten years as Europe, led by the UK, has mirrored what the US experienced several decades ago. The number of companies is limited, mainly concentrated in the UK, and their shares, however, are often trading at a premium to net asset value (NAV),.
“It is not a major theme for me today,” he said. “In the UK, we’re more attracted to the valuation discounts of the major sectors than to alternatives.”
Buller is bearish about retail, particularly in the US, where the over-supply of space, rise of online commerce, administrations and bankruptcies of retailers, and changing patterns of shopping weigh on the sector. Europe is not immune to the same trends, he said, pointing to the rising supply pipeline in France and recent weakness in retail sales in Germany.
The corollary to the underweight allocation to retail-focused real estate companies is the Fidelity fund’s over-weight holdings of logistic warehouse owners. Holdings are concentrated mainly in US companies with global platforms, and because there are too few listed companies in Europe to provide sector exposure, he noted.
With a mandate to invest in listed real estate anywhere in the world, Buller says European executives should focus more on outperforming their respective markets and stop trying to predict the investment cycle in an attempt hold up their company’s share price.
“I would rather have them do their job: to buy, run and take care of buildings as best they can,” he said. “They are trying to be too clever, and there is too much of that in Europe compared with other parts of the world.”