Direct or listed property? Investors weigh up their options
Investors are flooding back to property, and as they do they might start asking whether direct or listed is the way to go – or perhaps even both. Freya Purnell writes.
Related: Getting the best performance from property investment
It’s been a tough five years to be in property, but the fortunes of this asset class are shifting. Investors were scared away from property during the GFC, and it has taken many quite a long time to forget.
With investors feeling cautious and cash and term deposits offering decent returns, property languished unloved.
Now the grieving process seems to be over for many of those who had bad experiences from 2009 to 2011.
But perhaps more compelling in the push back into property has been term deposit rates dropping to around 4 per cent, send investors looking further afield for yield.
Dinesh Pillutla, managing director of Property Investment Research, says given investors should be seeking around 70 to 80 per cent of their total return from income, property fits the bill, offering yields of around 7-8 per cent.
“With the hunt for yield, people are starting to realise that property is not a bad place to be, as long as you have good lease duration on the asset and you have bought the asset at good prices,” Pillutla says.
And the money has certainly started to move.
According to Damien Fitzpatrick, fund manager of the AMP Capital Core Property Fund (a listed/direct hybrid fund accessing both global and Australian real estate), retail investors’ reluctance to invest in property started to shift from around August last year, and the fund has seen its usual inflows double since then.
With investors getting back to basics, real estate investment trusts (REITs) and funds have moved to more conservative structures and gearing levels to regain their confidence, says Richard Stacker, CEO of Charter Hall Group.
“Property tends to be on leases that run for at least three years, and if you can get them for 10 to 15 years, you have a cashflow that provides certainty over a period of time.
“Commercial property also tends to have fixed annual increases coming through on the leases too, which provides a hedge against inflation,” he says.
On the unlisted side of the market, Jason Huljich, CEO of Centuria Property Funds, has also seen a huge pick-up in demand, particularly over the last six to 12 months, with its most recent capital raisings for unlisted single asset funds closing oversubscribed.
“Term deposit rates are a very big driver, so when people start getting less than 5 per cent on their term deposit, they really look to other asset classes for yield. Unlisted property is one of the few that could provide that,” Huljich says.
Centuria’s performance track record – providing average total returns of about 16 per cent per annum over the last 15 years – also probably helped to bring investors back.
The performance of listed property has not disappointed either. Both global and domestic indexes delivering “stunning” returns over the past 12 months, with the S&P/ASX 200 AREIT index up over 30 per cent, and the global index delivering similar returns, according to Louis Christopher, managing director of SQM Research. He attributes this to the global chase for yield.
“Investors are trying to find high yielding stable investments, and REITs have benefited from that new demand,” Christopher says.
Active managers have also been very strong performers in the property asset class, many outperforming the index over the last 12 months.
“It goes to show that active management really can deliver strong results. You can definitely beat the benchmark,” Christopher says.
“It certainly does pose some questions on some index products, which are quite expensive relatively speaking, and it certainly poses questions once again about how to deal with concentration issues, which so far the active managers have been doing a pretty good job on.”
Direct vs listed
With a wealth of direct and listed options on offer, investors have to weigh up the relative advantages of the different types of vehicles – single or multi-asset syndicates, closed-end or open-ended funds, and the listed REITs.
Listed property obviously carries the benefit of liquidity, which is highly valued in the market at present, and is more easily accessible via platforms.
While listed property also behaves much more like equities, which can be useful in the portfolio, its volatility can be something of a disincentive.
Christopher says although property is regarded as a fairly stable asset class, if investors want to invest in the AREIT market, they have to accept “they are going to have some volatile days”.
But perhaps a more important factor in the direct vs listed debate is that REITs are simply not delivering the value they once were.
“Listed property trusts have had a good run over the last 12 to 15 months, so the yields have been steadily decreasing,” Huljich said.
According to Pillutla, there is also an increasing disconnect between REIT prices and what the fundamentals of the market would suggest was a fair price.
“There’s quite a lot of money chasing yield at the moment, which is tending to push prices up quite quickly.
“If you look at the retail market, for example, the general view seems to be one where the fundamentals of the sector remain quite challenging in terms of generating sufficient sales to manage their occupancy cost.
“So there is quite a level of disconnect in the market,” says Pillutla, adding that PIR would prefer to see prices at least 15 to 20 per cent lower than they have been over the last couple of months.
The strong outperformance of the sector has meant that many AREITs are now trading a premium to their net tangible asset backing, with yields coming down as a result. This is driving investors into direct property for higher, consistent yields and distributions.
“There are some opportunities in the direct space now, where you can buy into certain unlisted property trusts or you can buy directly at basically net tangible asset backing,” says Christopher.
Direct commercial property offers the added benefit of being less correlated to the equities market, so if clients are looking to excise some of the volatility from their portfolios, it can be a good way to achieve this.
The demand in the market is also bringing more property syndications out of the woodwork, Stacker says – both at the smaller end of the market, with a single asset, and at the opposite end, with up to 10 assets, but a maximum size and defined investment criteria.
PIR estimates that since January 2012, unlisted property syndicates and retail funds have raised between $450-$500 million in equity, with newly launched syndicates often promising distribution yields of 8 per cent and above.
The new syndications on the market also offer a variety of lease lengths – while some carry leases of 10-years plus, others are higher up the risk curve with weighted average lease terms of between three and five years.
“Investors who understand property will understand the risks associated with having a short-term lease, and so the kind of clientele that are buying these funds probably have a better appetite for property, and can differentiate between a higher and lower risk opportunity, and therefore the risk/return difference that can be expected between the two as well,” Stacker says.
With the current market volatility, investors are typically gravitating to longer-leased assets with good covenants for the stability this provides.
“It’s not just the financial advisers and investors, it’s also the pension clients who are looking at property, and their preference at the moment is for longer-term leases,” Stacker says.
The strong performance from the sector has also prompted Centuria, which traditionally has dealt only in direct property, to make a foray into the listed market, with a new fund set to launch in the next few months.
Huljich says the company had to wait until the stars aligned for a listed launch.
“For the last four or five years, all the listed trusts have been trading at discounts to their net asset backings, which made it impossible for someone coming in with a new listing, because you’re coming in at par and everyone else is at discount,” he says.
“The first piece of the puzzle was the other listed groups coming up to parity with asset backing, and that’s happened, with a lot of them at premium. So when we had the right market conditions and the right person to run it, we decided to launch.”
Platforms’ role in accessing property
Direct property may now be attracting more attention from investors, but accessibility is still hampered by a lack of representation on platforms.
By having more unlisted property syndicates and funds available via platforms, direct property may move out of the realm of the ‘alternative’ investment and provide a different option for advisers looking to move funds out of cash or term deposits.
Platforms have been wary of adding property syndicates since the GFC, but as new funds begin to come to market to raise money in the unlisted retail fund market, Pillutla believes the time is right for platforms to reconsider this.
“Investors are looking at allocating more money into the direct equity market, rather than allocating a small proportion of their money into property funds, which we believe are of quite good quality and backed by really good managers,” says Pillutla.
“We’re getting good quality product, we’re getting really good yields in the unlisted/direct market and the platforms need to start to consider getting investors to invest in unlisted retail funds.”
Stacker agrees.
“I think the groups that do use platforms are looking for these types of products – [direct property] has a yield that investors are looking for currently, it tends to be on long-term leases, it tends to have a correlation which is a lot less than other asset classes to equities, and on that basis, it’s got a lot going for it that advisers want.”
But property managers should see having their products added to platforms as a two-way street, Stacker says.
Charter Hall has been successful in having its industrial funds added to wrap platforms by making them “wrap-friendly” – they are daily priced and have the right scale at $10 million-plus to make it worthwhile to administer.
“Product providers need to work alongside dealer groups and platform providers to ensure the structures of new products meet the needs of investors, but also the platforms, to help bring direct property investments into the mainstream financial planning space,” Stacker says.
Achieving diversification across the class
Australians’ love affair with residential property is well-documented, and most clients of advisers will probably hold a decent proportion of their wealth in residential property, either in their own home or an investment property.
When considering an investment in commercial property, particularly in less liquid direct property, investors need to think about how much of their wealth they already have tied up in property.
“You really need to look at what liquidity events are coming up. If you have too much in that property and then suddenly you need money for something or there is a taxation issue that changes, you might find you have to sell that one asset,” says Fitzpatrick.
Mark Pratt, head of property, mortgages and capital markets at Australian Unity Investments, says advisers should encourage investors to think about their risk/return profile and how the various types of property can add different characteristics to the portfolio.
Yields on commercial property, at around 7-8 per cent, are much higher than those offered by residential, at 3-4 per cent. In addition, depreciation on property can provide tax-deferred benefits.
“If people lift their heads, then there are some compelling reasons to potentially look more broadly than what they have been comfortable with in the past,” Pratt says.
To get the best of both worlds from property, a balanced allocation between listed property trusts and direct property funds is recommended, to balance liquidity with yield.
However, with REIT valuations high, investors must buy into these funds at a premium to book values, and this should be considered a very aggressive strategy, Pillutla says.
He argues that an allocation to direct property is warranted in the current environment to remove the volatility from returns.
“Now is the time to look for single asset syndicate exposures on direct property funds where liquidity could be an issue, but what you’re buying into is a very asset-specific strategy with a defined exit and a defined strategy to drive returns,” says Pillutla.
Hampering diversification in the local listed space are continuing concentration issues in the local AREIT index. Though this has lessened over the last five years, Westfield still dominates – albeit through two different stocks.
Christopher says managers are seeking to address these concentration issues with several different strategies – bringing in property securities from further afield geographically, such as Asia and New Zealand; bringing infrastructure securities into their property trusts for additional diversification; or by having a strict mandate to limit the maximum amount of holdings in one individual security.
“That means that they need to sort out their weightings into other index security funds, and maybe some ex-index security funds as well. We definitely approve of all three of those strategies,” Christopher says.
Danger zones
Despite the strong performance, there are still some danger zones for property.
While the recent market rally brought AREITs up to fair value, further outperformance could be problematic.
“There is still some space for it to continue to run, but if we were to see returns of 20 or 30 per cent again within 12 months, then we would see a significant risk of a correction, so our preference would be the same or moderate returns in the AREIT sector going forward,” Christopher says.
As the performance of property investments depends heavily on the quality of assets and how they are managed, investors and advisers should definitely do their due diligence before jumping in. This is especially true for direct funds holding only one or two assets.
“An investor coming in should look at the manager first – their track record and their size and scale. You want to look for a very well-located, quality asset, and finally you will look at the fund manager’s governance and voting structures, and make sure fee structures are performance-based,” Huljich says.
“Just because the price is good doesn’t mean that the returns will be equally good, because there’s a level of management overlay that needs to go through the asset, especially when you have a tough leasing environment, to maintain a high level of occupancy,” says Pillutla.
Conservatively geared funds and assets with longer leases will also reduce potential risks around interest rate rises and occupancy.
“Many retail investors are going to syndicates. But you really need to understand that if the underlying property has a lease coming up in seven years and the syndicate is eight years, you have a real leasing risk at that time. If it was leased to the Government for 15 years, and it’s a seven-year term of the syndicate, it’s fine. It’s just understanding what you’re investing in,” says Fitzpatrick.
To manage risk across the property portfolio, Pillutla recommends that investors have reasonable expectations for yield and growth over the long term, of around 7 to 10 per cent per annum in total returns.
“If you try and push this 10 per cent return to a higher number, inherently it has risks because you’re starting to either engineer the capital structure of the fund, or you’re taking on risks, for example, from the development perspective,” says Pillutla.
So investors should definitely choose their property investments carefully, but hanging back for too long may mean that investors miss out on value in the asset class, according to Stacker.
“We do expect over the next couple of years to see some good interest and growth in inflows into the sector, so investors probably want to have a look at it now rather than in a couple of years time, as values will start to move.”
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