Retail and Timber

Retailers are falling on the potential for some sort of border adjustment tax or tariffs.  Depending on how such things are implemented, it could materially raise the cost of goods for retailers who import goods.  Most affected would likely be the apparel shops which are already struggling.

While REITs are not direct retailers, REIT owned shopping centers and malls have been secondary victims in anticipation of potential store closures.  Within 2CHYP, CBL & Associates (CBL), Washington Prime Group (WPG) and Brixmor (BRX) had a rough week.  We are holding these positions because the fundamental damage is not as great as that indicated by the market price.  A series of mitigating factors are being overlooked by market participants.

  • Costs can be passed on to consumers. In apparel, for example, the tariffs or taxes will make is more expensive for all importers, including Amazon, so there will be a unified effort to pass cost increases through to pricing.
  • Adjustments can be made. The fallacious assumption is that a 20% tax would make goods cost 20% more and I heard this exact logic on CNBC half a dozen times today alone.  This will often not be the case as there could be a domestic alternative that only costs 5% more.  In the absence of a tariff, the import is still the better option, but once tariffs are in place the 5% higher costed US made good is the cheaper option.  In such cases the price increase is 5%, not 20%.  Those predicting doom for retailers might be missing this key point.
  • CBL and other retail REITs tend to have a portion of their rent tied to sales per square foot, not profit per square foot. Thus, to whatever extent costs are passed through to consumers, tariffs could actually increase CBL’s rent assuming sales volume is inelastic.

2CHYP is a balanced portfolio, so even though we have a contrarian view on some troubled sectors like retail, we also invest in areas with stronger fundamentals.  Offices and hotels are doing quite well which afforded a position trim in CIO and SOHO as their market prices appreciated.  We used the proceeds to buy Catchmark Timber (CTT) which has a macro tailwind from increased housing and infrastructure construction anticipated in the near future.  At a 25% discount to NAV, this tailwind is not priced in at all, so we see material room for upside as saw timber and pulp pricing increases.

Commentary may contain forward looking statements which are by definition uncertain.  We retain no obligation to update or correct forward looking statements should the available information change.  Actual results may differ materially from our forecasts or estimations.

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1/26/17 2CHYP Performance since inception

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