What the World's Largest Sovereign Wealth Fund Will Buy Soon

NEW YORK (TheStreet) -- "What is a sovereign wealth fund?" asked one of my colleagues the other day. "Good question," I countered, and then I began to stumble through a rough answer of what I could remember about these types of funds.

Checking with Investopedia I reacquainted myself with the correct answer. A sovereign wealth fund is "a pool of money derived from a country's reserves, which are set aside for investment purposes that will benefit the country's economy and citizens.

"The funding for a sovereign wealth fund (SWF) comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources."

The nation with the world's largest SWF ($682 billion), built from its vast oil and natural gas resources, is Norway. The Norwegian Government Pension Fund Global, which is managed by Norges Bank Investment Management is ready to go on a specifically targeted shopping spree with Norway's SWF money.

What is it targeting for investment purposes? American real estate in areas of the country the SWF believes are the best markets. According to a recent article in Monday's Wall Street Journal, Norway's SWF "...has been in talks about deals with potential real-estate partners in New York, Washington and Boston in recent months."

The NBIM's real-estate chief investment officer said recently the fund may begin working on its first U.S. deal as early as the first quarter of 2013. He also mentioned the focus would probably be on either high-end retail or U.S. office space. Prices in this kind of real estate have already soared.

According to the Journal, "Market participants, however, say Norway's appetite for high-priced properties and its long-term horizon for returns could help it find success in the world's biggest property market, " the U.S. Even though prices are high now, past strategies like this have paid off in the past.

"They're the Norwegian SWF not necessarily looking to make triple-digit returns and to tell their friends at cocktail parties. They're there to find a stable source of low-risk assets which meet their pensioner' needs," said Michael Ashner, the chief executive at Winthrop Realty Trust ( FUR), a real estate investment trust that engages in the ownership and management of real property and real estate-related assets headquartered in Boston.

FUR frequently invests in large real estate transactions but hasn't worked with NBIM yet. Winthrop is currently paying a dividend with a yield to price of around 6%. Its share price has ranged from $10.32 to as high as $11.40 since Oct. 15. Below is a one-year price chart with its improving free cash flow. FUR Chart FUR data by YCharts

FUR's generous dividend represents a payout ratio of 250% of the company's earnings (or "funds-from-operation" as they call it in the world of REITs), which is quite lofty. Winthrop trades at a forward (one-year) PE ratio of only 9.

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The NBIM executive quoted in the Journal article stated, "We like having partners -- 50% owners or thereabouts." For tax purposes the SWF will set up domestic REITs in the U.S. in which it plans to hold, at most, a 49% stake. "I don't know when we will get comfortable with other structures," he said.

Gateway cities like Boston, New York and Washington with strong prospects for both population growth and economic expansion are the SWF's priorities. The NBIM executive wants areas where there is a lack of real estate supply, "...though he acknowledged that staying in that tight-knit pocket of markets could have the fund missing out on activity in other hot markets like Dallas or San Francisco."

Like all disciplined and selective investors, the SWF of Norway knows that it'll probably miss some great deals in those hot markets, "...but we're OK with that," the executive said. That's the way some of the largest REITs in the U.S. operate as well.

Examples include Vornado Realty Trust ( VNO), a New York-based REIT that specializes in mainly commercial property. VNO has a market cap of $14.75 billion and a dividend yield of around 3.5% with a payout ratio of 93%. The chart below shows its one-year price and free cash flow history. VNO trades at a forward PE of 15.54. VNO Chart VNO data by YCharts

A very unique way to participate in the office REIT space is with Government Properties Income Trust ( GOV), an office REIT with about $1.7 billion of office properties in 31 states and Washington D.C. As its name implies, it likes to rent properties to government tenants. In fact 71% of GOV's annualized rental income comes from the federal government.

GOV pays a generous 7.4% dividend representing a payout of 158%. Its total debt in the most recent quarter ending Sept. 30 was a staggering $610.71 million, which is high for a REIT with an operating cash flow (TTM) of $99.28 million.

Its revolving credit line is approximately $550 million. You can visit its informative Web site to see the latest quarterly earnings results and GOV's credit rating. Oftentimes a higher yield and payout ratio means that the credit rating will be lower than a more conservative REIT like VNO, which only yields 3.5%.

Getting back to the Norwegian SWF, before it expands to areas like Asia it will scour the U.S. market for the best real estate deals. The SWF is "looking for partners with a long timetable as well as deep pockets. The fund is set up to hold investments for decades if need be," meaning it may hold a piece of property through a number of boom-and-bust cycles, according to the Journal article.

Another potential partner with "deep pockets" may be SL Green Realty ( SLG), another New York-based REIT with a $6.9 billion market cap and a forward PE ratio of around 15.43.

Like VNO, its shares offer a much lower dividend payout (current yield-to-price of around 1.74%) and a more modest payout ratio of 67%. At $76 per share the REIT trades well below its Sept. 17 52-week high of $85.74. One year ago (Dec. 29, 2011) its 52-week low of $65.08 was established.

The Norwegian SWF must believe Federal Reserve Chairman Ben Bernanke, who stated emphatically the Fed will keep interest rates near zero until 2015, which should be good for established REITs with long-standing lines of credit. The SWFs of the world want income with slow and steady growth. The U.S. real estate apparently meets those requirements to a "T."

At the time of publication the author had a position in GOV.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

DISCLOSURE: As of the time of publication the author is only long shares of GOV.

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