Seeking drivers of real estate investment
There are compelling avenues to invest across various real estate sectors, including office, industrial and logistics, retail, student housing, healthcare, social and affordable housing, and disability accommodation.
There are often emerging categories to monitor as well, such as multi-family housing. Investment opportunities in real estate are closely correlated to societal and economic trends, so marrying knowledge of real estate’s performance drivers with the macro environment and structural shifts is crucial.
For example, the shift in demand from bricks and mortar stores to online shopping experienced a surge during 2020, rapidly accelerating a trend that is already underway. This had negative impacts on retail, with foot traffic plummeting, but saw demand of industrial and logistics spike as retailers suddenly required significantly more warehouse space and distribution facilities. This trend also means that the more traditional retail sector is going through repositioning of some assets in terms of its offering. We now see more major shopping centres including a variety of tenants outside fashion retail such as medical centres, day care centres, and gyms in an attempt to attract more customers and keep their footfall increasing.
FIVE FACTORS TO TAKE INTO ACCOUNT
1) The macroeconomic environment
The state of the economy is an important barometer for real estate, as it impacts the spending and investing power of corporations and individuals. Factors to take into consideration include unemployment levels, gross domestic product (GDP) growth, inflation, interest rate, infrastructure spend, income percentage change, consumer confidence and trade dynamics.
By assessing these factors, we can build a forecast model which helps predict with a reasonable level of probability how important elements of a real estate investment, like rental growth, might be impacted.
2) The state of the market
Real estate, like any other asset class, has its own cycle. Identifying where the cycle is at is important for performance, generating returns and determining sustainability. We take into account yield/capitalisation rates, current rents, levels of incentives, vacancy rates, catchment area and quality of tenants.
For example, the office sector in Australia was experiencing strong performance prior to the pandemic, but workforces moving to a work from home environment during and post-lockdown has been a significant challenge for the sector.
Now, we see that the assets are still expensive, but their return potential has decreased – rents are falling, the provision of incentives (such as rent-free periods or discounted rent) has increased and demand has weakened. When the cycle shifts, and prices start dropping to below their historic levels, there may be a compelling investment opportunity.
3) Societal trends
Real estate is designed for social use, so of course, it is highly impacted and influenced by social trends. Large-scale trends, like demographic shifts, give indications of where demand will intensify and equally, where it will weaken.
One of the examples includes flexible office space – this was considered an emerging trend just three years ago and is now a well-recognised concept (think about companies such as WeWork, Regus, WOTSO Workspace and others). Last year, there was a surge in companies offering flexible office space to tenants like tech companies, start-ups and venture capital. We constantly monitor those trends and look at the fundamentals – the key is to find a trend which has long-term tailwinds given the illiquid nature of this asset class.
4) Investment characteristics
There are a number of attractive investment characteristics for real estate, particularly diversification benefits. Traditionally, real estate has low correlation to equity markets and bond markets, meaning they do not typically move in the same cycles.
However, real estate can be positively correlated to inflation, meaning it has the potential to act as an inflation hedge. Rents are often linked to the consumer price index (CPI) especially in sectors like healthcare, creating the potential for positive returns during periods of rising inflation.
5) Implementation
Implementation routes vary depending on the size of the investment, risk appetite and the level of governance. Real estate investments can be implemented via: investing in pooled funds, with minimum ticket sizes usually between $5 million and $20 million; investing in direct deals and co-investing, which requires a significant amount of capital; and setting up separate mandates, which requires strong governance and scale.
As such, retail investors often find it challenging to get access to investments due to large minimum ticket size requirements and complexity. Investors can gain access to real estate exposure through listed investment companies and real estate securities, and should be wary of factors like concentration risk – that is, exposure to one or few assets – when making a selection.
ANALYSIS IN ACTION
Our assessment of real estate in the healthcare sector is an example of where understanding the various dynamics at play can spotlight an opportunity.
The healthcare sector has attractive characteristics – for one, it is less correlated to economic growth, GDP and unemployment levels compared to sectors like office, industrial and retail. This translates into growing rents (albeit at a gradual pace) with either fixed annual increases or CPI linked, high occupancy rates and long lease contracts of more than 10 years. Leases are often structured as triple net leases where tax, insurance and maintenance cost is all covered by a tenant.
There are other social trends which indicate a long-term opportunity in the healthcare sector. Populations in developed countries worldwide, including Australia, face longevity risk in their ageing populations. This contributes to a strong demand for healthcare related assets, while the current supply is limited.
From the valuation perspective, this sector appears attractive, and there is a good potential for further capital appreciation. The key for investors in this sector is to have the right network of contacts in order to source deals, given the restricted supply, and then the skill to manage those assets and the relationships with tenants.
Understanding what drives performance and valuation in real estate is critical to securing a compelling investment, especially at a point in history where social, structural and economic change is fuelling a unique opportunity set.
Dania Zinurova is portfolio manager at Wilson Asset Management.
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