Looking to wider horizons
The idea that super funds need to consider a fresh perspective on property, and in particular global property, is still a new concept for many. “Property investors need to factor in the big picture and look beyond their own backyard for investment opportunities and trends,” says Stephen Girdis, head of Macquarie Property. How do they achieve that? The number of options is increasing – listed property trusts are a convenient method and their exposure to international investments has increased significantly as a proportion of the
average portfolio. But there are other options, including private equity vehicles, syndicates, wholesale and development funds or debt vehicles.
Queensland Investment Corporation (QIC) has some A$4.3bn (e2.5bn) in real estate assets under management but, as Matthew Strotton, property portfolio manager, says, “At present, our investments are limited to Australia, though we are not restricted to domestic investments and we regularly consider offshore investment options.” The investment is in town centre/sub-regional retail and central business district (CBD) office properties, in major cities and regional areas on the east coast. Strotton adds: “The portfolio’s asset type, mix and location is determined directly by our team. However, total allocations to real estate are determined by individual client asset allocations. As a direct real estate investment manager, QIC Real Estate deals with listed trusts only in the sense that they may compete for stock, and as such we actively monitor their activity, strategies and performance.”
QIC’s domestic focus is not uncommon and is at least partly attributable to a lack of suitable vehicles. But Australian institutions are making strides in allocating to overseas property. Recently, Funds SA chose US group Russell Real Estate Advisors to manage a A$35m portfolio to be invested in a real estate private equity fund of funds targeting European opportunities. Funds SA also has A$465m invested in Australian property, a mix of listed and unlisted. The fund’s other property managers include SG Hiscock, Macquarie Funds and Lend Lease Real Estate.
Australian fund promoters are still examining the overseas growth opportunities, although many have yet to market global property successfully to Australian investors. Notable exceptions would be AMP’s Global Property Securities Fund, which recently gained a A$50m mandate from Telstra Super and Colonial First State’s International Opportunistic Real Estate Fund, which is a direct property fund of funds.
The trend for institutions to consider not just direct and listed property but also property syndicates and actual developments is confirmed by Greg Paramor, managing director of James Fielding Group. In 2003, James Fielding was awarded a A$50m opportunistic and development mandate by the Australian Retirement Fund. Perth-based industry fund Westscheme has also co-invested with JF in development projects. The JF development division’s projects include a A$600m shopping centre in Queensland and the Bankstown airport site. Completed developments and properties can also be sold into the group’s unlisted property syndicate
division, JF Direct. The group also has a listed trust, JF Meridien and its finance division, JF Capital runs a A$120m mezzanine property debt mandate for the Government of Singapore Investment Corporation.
Westscheme and the motor trades industry super fund MTAA have both been supporters of mezzanine property debt funds managed by Gresham, the second of which was launched recently. Both super funds invested through their target return portfolios, which incorporate their unlisted and alternative investment assets. Deutsche Asset Management has picked up a mandate from Just Super for an Australian direct property portfolio, while the Western Australia Local Government Super Plan recently switched a A$36m listed property trust mandate from Macquarie to Credit Suisse because of dissatisfaction with performance.
Mergers among Australian property companies have more than tripled to A$35bn this year, according to Bloomberg data, as real estate trusts combined to cut costs and help pay for acquisitions. Westfield Group has recently been formed from the consolidation of Westfield Trust, Westfield America Trust and Westfield Holdings. The combined group, valued at around A$30bn, will provide a global platform for the shopping centre operator’s continuing international expansion. Lend Lease, Australia’s largest property developer, has bid for General Property Trust. And at the end of July, Deutsche Bank announced that it is to merge three of its Australian property funds to create the country’s third largest real estate investment trust, with A$4.5bn of assets. The move is primarily to deter takeovers and to protect fees, which totalled A$24m in fiscal 2003.
According to InvestorInfo, the listed property trusts sector is one of the fastest-growing in Australia, albeit from a low base. It accounts for just 2% of the total market funds under management of A$475bn. The category has shown explosive growth in the past four years, growing 228%, or an average of 14% per quarter.
This growth has been fuelled by wholesale investors, which hold around two-thirds of funds under management, which total around A$7bn. Net cash flows to the listed property fund category have been the primary driver of asset growth. There are 23 fund promoters participating in the listed property sector, although the bulk of funds under management is held by just a few. The largest group, Commonwealth/Colonial, has twice the funds under management of its nearest rivals, NAB/MLC, AMP and Vanguard. Together these four groups hold just over 50% of all public listed property fund assets.
Standard & Poor’s rates about 25% of the surveyed New Zealand and Australian real estate sector. The Australian sector represents about 7% of the total, compared with 70% in North America. Interestingly, the sector’s median rating in Australia is A – while it is only BBB in the US. This is partly because those Australian entities that are rated have stronger business profiles than the average listed property trust (LPT). However, the US sample is much broader, and the financial profile of the US entities is generally more aggressive.
Australian LPT managers have traditionally adopted more conservative financial policies; debt to assets tracks in the 25-45% range across the rated portfolio. In the US the weighted average debt to capital (book value) is about 55% and the average based on implied market value is 42%. To diversify their debt funding, various LPTs have placed debt offers in overseas markets. For example, Stockland Trust Group issued US$350m in notes with various maturities from 2011 to 2018 and Westfield Trust issued A$850m of exchangeable floating rate bonds due 2009 to Deutsche Bank
As a result of their stable and recurring rental income, the rated Australian LPTs have increased their average debt usage to 31%, from about 17% in 1996. The outlook for credit quality is generally stable, with 10% carrying a negative outlook and 5% positive. Australian retail landlords have the most favourable near-term prospects, with office-oriented trusts likely to spend another year aggressively competing for tenants.
According to S&P, although the financial ratios for the rated Australian property trusts are readily comparable with other markets, the increase in the number of stapled property groups (which combine a REIT structure with a corporate structure) will make future comparisons more difficult. Moreover, a number of Australian entities are increasing their exposure to property development to enhance returns and capture profit on developing new assets.
The consolidation of Westfield’s operation and the new vehicle linking Lend Lease and General Property Trust LPTs has the industry’s fund managers debating what should be done with Australia’s listed property index, since the combined groups will represent more than half the index, arguably making the benchmark fairly meaningless for active managers. However, Citigroup’s director of property Stuart Cartledge believes a reduction in the number of LPTs has been more than compensated for by the increased diversity in their underlying businesses. The offshore exposure of the sector has gone from 6% in 1996 to 24% today, encompassing the US regional mall market (Westfield America) and the US industrial market (Macquarie Prologis). Australian LPTs have thus become a proxy for global exposure.
Australia is not headed for a massive, widespread property crash, says Rod Cornish, head of Macquarie Property Research. “Australia’s economic cycle is shifting from housing-driven activity to business-driven activity and the property markets are responding accordingly. Housing prices peaked in the past year and overshot in all capital cities. While the market will be more volatile and diverse, we expect a soft landing relative to other cycles. The most important triggers for a major crash are not in place and are not expected to be in place over the next year. It would take a major increase in interest rates, high unemployment, a severe economic downturn and a massive slump in underlying demand – conditions where people are forced to sell their houses – to trigger a crash in the market,” says Cornish.
The influence of the global economy on Australia’s property markets is likely to be significant in the next 12–24 months as the global economy recovers. Non-residential sectors are the most affected by business activity and global drivers and this is where Macquarie expects opportunities to emerge over the next year. Cornish says: “Office markets should recover by mid-2005 with rents and values set to rise, particularly in the Sydney CBD. However, in the short term because of the lag between leading indicators and leasing demand, we expect things will get worse before they get better.”
For astute property investors, pockets of opportunities still exist. Cornish expects an increasing shift from residential to indirect investment in non-residential property through LPTs and office syndicates in preparation for an office market upswing commencing late 2004/early 2005.
“The industrial property sector is in an expansionary phase and opportunities are still expected to be near new and emerging infrastructure, for example, the Western Sydney orbital road and the proposed Scoresby freeway in Melbourne,” says Cornish.
The popular areas for migration such as south-east Queensland will continue to experience strong fundamental demand. But even in Australia’s strongest housing market, price growth will not match the strong gains recently experienced. While total migration numbers will remain strong, the rate of growth of inward migration has peaked.
On the commercial property side, Macquarie believes a number of office markets around Australia are set for a solid recovery commencing late this year. While current leasing demand is weak, research suggests the strengthening domestic and global economies will increase demand for white collar workers late this year – fuelling demand for office space, particularly in Sydney. “This scenario should lead to increased capital growth and rental growth in that market commencing early next year, providing significant gains for investors mid-decade. This is the time to consider taking a position. But note that we refer to significant buildings in prime locations, particularly in the Sydney CBD – for most investors the only opportunity is by way of indirect investment through listed property trusts or syndicates,” says Macquarie.
It continues: “Sectors of the industrial property market will outperform, predominantly where there are constraints on land or where improvements to infrastructure are planned. With new supply an issue in some locations, though, there are risks. As industrial companies increase their focus on emerging locations with access to infrastructure, properties in secondary locations will suffer.”
According to Ange Montalti, economist at ANZ, forward indicators of building activity have edged down, turnover has fallen sharply and price growth stalled in the early part of 2004. Yet, underpinned by very strong underlying demand and dwelling shortages, construction activity should recover solidly in 2005 and 2006 following a shallow dip this year. “While our fair-value analysis suggests house prices are over-valued by around 20%, correction of this over-valuation will be gradual.”
On the commercial side, the office vacancy rate for state capital city CBDs increased to 9.5% in the six months to January 2004. The Melbourne market suffered the most and, given the substantial amount of new space in the pipeline, further rises in its vacancy rate can be expected. Continued growth in white -collar jobs will be needed to stabilise other CBD markets. Construction of industrial premises has been on an improving trend since 2001. Economic and interest rate fundamentals remain in place to support a moderate pace of industrial construction over the near term. Shop building is likely to continue to grow at a healthy pace with activity centred on shopping centre development and the construction of bulky goods stores and homemaker centres. The prospect of a strong pick-up in international arrivals bodes well for the tourist accommodation market. However, growth in domestic travel would be stronger if not for a recovery in outbound travel.