Q: How did Mr. Bollinger come up with this investment strategy?
A: Mr. Bollinger was working for a large national real estate firm and noticed that the actual economic performance of properties they owned significantly underperformed the financial models used to underwrite the acquisition of the buildings. Specifically the market rent assumptions used at acquisition were wildly optimistic. Mr. Bollinger hypothesized that the industry was making similar market rent growth projections for buildings in all markets and that only buildings located in high barrier to entry markets were coming close to achieving the underwritten rent growth. As such, Mr. Bollinger set out to quantify this hypothesis using historical data from the National Council of Real Estate Fiduciaries (NCREIF). Mr. Bollinger found that this was indeed the case as properties located in high barrier to entry markets have been systemically undervalued and properties located in low barrier to entry markets have been systemically overvalued.
Q: How do I get into the fund and out of the fund?
A: To get into the fund, investors will fill out a partnership agreement and a Private Placement Memorandum (PPM) and submit these to Magnolia. Funds to be invested will be wired to the fund’s broker’s (Interactive Brokers) custodial account at Citibank. Investor’s funds will be invested the first trading day of the next month. To redeem investments, a redemption form will be filled out specifying the amount to be redeemed and submitted to Magnolia Realty Advisors and the redemption will be processed at the end of month when the fund administrator calculates the net asset value (NAV) of the redeemer’s ownership share.
Q: Who can invest in Magnolia’s Alpha fund?
A: The SEC generally only allows accredited investors to invest in financial products such as Magnolia’s Alpha fund. The rules for determining accredited investors are laid out in the link provided by the SEC below. The SEC allows 35 exemptions for non-accredited investors to allow for investments by friends and family and Magnolia has yet to use all of these exemptions so one does not need to be an accredited investor to invest in Magnolia’s Alpha fund. The Alpha fund can take both qualified and non-qualified investments meaning that one can invest both IRA and non-IRA money into the fund.
Q: Do you think the outperformance the fund has achieved so far will continue?
A: Magnolia absolutely believes this outperformance will continue. For both real estate and REITs to be priced correctly in Magnolia’s opinion, prices would need to dramatically change. If this price change does happen, Magnolia’s investors will be the beneficiaries of this change as the REITs that Magnolia owns will be the ones that need to dramatically increase in value.
Q: How can investors be sure that their investment is safe in a world full of people like Bernie Madoff?
A: Magnolia Realty Advisors will never have custody of investments as they will be kept in custody at Interactive Brokers. Therefore there is no way for Magnolia to access investors’ money. The fund is administered by a third party administrator so Magnolia Realty Advisors will not be calculating the value of investments or sending out statements. The fund will be invested in publicly traded equity REITs which make public the details of their business and the properties they own. Because all of the investments are in publicly traded equity REITS, it will be possible for the fund administrator to precisely calculate the value of investments monthly.
Q: Why is the performance fee set up like it is?
A: The performance fee is based upon the fund’s outperformance of its benchmark net of the 1% fixed fee. This is because the benchmark is considered to be one’s opportunity cost of investing in Magnolia’s fund. An investor could invest directly in the iShares Industrial/Office REIT Capped Index and pay a flat fee for doing so. Magnolia believes its Alpha fund can systematically outperform this benchmark and it charges a performance fee based upon doing just this.
A good example of how this fee structure reflects the economic value created for investors is the fee in the first quarter of 2014. In this quarter, the fund’s benchmark returned 10.91% compared to Magnolia’s fund which returned 14.55% or an outperformance 3.64%. The fixed fee was assessed at 0.25% (one quarter of the annual 1% fee) so the outperformance net of the fee was 3.39%. The performance fee was assessed at 20% of this outperformance or 0.68% which gave investors a net outperformance of the benchmark of 2.71%.
If the 20% performance fee were assessed against the total return of 14.55%, it would have charged investors for both the part of the return that was attributable to the change in value of the overall market and the part of the return attributed to Magnolia’s ability to identify value. By structuring the fee as it is, investors only pay for the economic value that Magnolia creates.
The following article in The Economist describes the rapid growth of ETFs that track indices, which is what Magnolia’s Alpha Fund’s benchmark is. By using an ETF that tracks NAREIT’s Industrial and Office REIT Index, Magnolia’s performance fee directly reflects the economic value that is created for investors.
Q: Is Mr. Bollinger invested in the fund?
A: Substantially all of Mr. Bollinger’s net worth is invested in the same investment vehicle that is being offered to investors.
Q: I have invested in several private REITs in the past. They argue that by investing directly in real estate instead of publicly traded REITs, I will not experience the volatility associated with the stock market.
A: Magnolia considers this the “ignorance is bliss” investment strategy. For anyone who has ever sold a home, they know that the only way to actually figure out what the house is worth is to sell the house. This is similar to private real estate in that the only way to determine how much the investment is actually worth is to sell it. Therefore an investor never really knows how volatile their investment is because they only really know what it is worth when it sells. By investing in public REITs, one always knows what their investment is worth, and can always sell. Therefore if value of public REITs drops in value by 10%, it is very likely that real estate has also likely dropped in value by 10% but the investor will have no way of knowing this as there is no market mechanism to continuously determine the price of real estate as there is with public REITs.
Q: I have a private REIT salesperson who says they are targeting a 15% investment return. What are you targeting for a return?
A: There is marketing power in using the phrase “targeting a 15% return.” It implies that there is a good possibility of actually achieving a 15% return. Mr. Bollinger wrote an article and published it on the website seekingalpha.com that specifically addresses the “targeted 15% return.” In the article, data is presented that shows that the average private equity investment in Atlanta between July 2002 and July 2012 that utilized 60% leverage would have achieved an annual return of -1.21% over the period. Nevertheless investors are drawn to this marketing gimmick thinking that a 15% return is likely.
Magnolia believes the best estimate of the future returns of its Alpha Fund can be derived from looking at Magnolia’s past market outperformance. So if the fund has outperformed its benchmark by an annualized 12% since its inception, then a reasonable estimate of its future outperformance is 12%. One can then make an estimate of the future return of Magnolia’s benchmark and add the estimated future outperformance to this to get a reasonable estimate of future return. For instance, if one thinks that office and industrial REITs are priced to return 10% in the future, then a reasonable estimate for the return of Magnolia’s Alpha fund would be 22%.
Q: How is Magnolia’s Alpha fund different than a private REIT?
A: The sales pitch used by private REITs is that they provide steady cash flow to investors and are much less risky than public REITs. What they usually neglect to mention is the exorbitant fees they charge to get into the fund. Private REITs charge around 10% for fees and commissions to get into the fund so they immediately destroy 10% of your invested wealth. Because Magnolia’s strategy invests in public REITs, putting money to work is inexpensive as one can buy $1,000,000 worth of shares of a public REIT for less than $10. Conversely a private REIT investor investing $1,000,000 can expect to pay around $100,000 in fees and commissions to get into the fund.
Private REITs tend to purchase buildings in low barrier to entry markets as these buildings tend to sell for prices that provide a higher income return than buildings located in high barrier to entry markets. Because private REITs buy properties in low barrier to entry markets, they have much lower capital appreciation than REITs that own properties in high barrier to entry markets. For example the private Wells REIT sold shares for $10 a share and went public at $14.50 a share but had a reverse 3 for 1 stock split prior to going public so the original share purchased for $10 ended up being worth $4.88 at IPO. This capital depreciation does not tend to make it into the marketing materials for private REITs.
Magnolia’s Alpha fund allows for monthly redemptions. This means that investors can get their investment back every month compared to private REITs where investors cannot get their money back until the fund liquidates. This generally happens in 5-7 years but could be longer.
Q: What are Magnolia’s future plans for the fund?
A: Magnolia’s contention is that commercial office properties and public REITs are systematically mispriced and that as a result of this mispricing, Magnolia’s Alpha fund will be able to consistently outperform the market. As this consistent outperformance continues, the “invisible hand” of capitalism will steer more assets towards Magnolia’s Alpha fund. Magnolia’s Alpha fund will continue to attract additional capital until the market adjusts the way it values commercial office buildings. Early investors in Magnolia’s Alpha Fund will greatly benefit as they will be the beneficiaries of this shift in the valuation of commercial office buildings.