Where are the property winners and losers?

Property has been undoubtedly one of the most hotly-debated asset class for Australians for many years. So the big question is how the market has performed over the last 12 months, what has changed and, most importantly, where should investors go from here to maximise their investments across the commercial real estate space?

Should investors keep putting their money into shiny office buildings in the central business districts (CBDs) or maybe they should look further into suburban markets where new logistics centres are springing up around the main Australian cities?

According to fund managers, the market looked incredibly healthy for investors engaged in the real estate investment trusts (REITs) over the last few months as the whole sector performed quite strongly, helped by an ongoing reduction in bond yields and stability offered through its sustainable income streams.

“The world is in uncertainty so things were making the market a bit jittery whereas REITs typically have a far more predictable or sustainable income streams so they are appealing from that perspective,” Stuart Cartledge, managing director at Phoenix Portfolios, said.

According to Chris Bedingfield, principal and portfolio manager at Quay Global Investors, what investors experienced recently was just the continuation of the trend which had clearly favoured office and industrial over retail, and this trend had been just exacerbated now. 

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“It’s really just a continuation of the trend that’s been going on for several years now. I don’t think that’s going to be anything too different. There has been a lot of money that has been raised in the marketplace because some of these companies are taking advantage of the very, very strong share prices.”

At the same time, not all segments of the real estate sector delivered similarly strong performance, with the consensus being the office and industrial markets were doing much better than retail or residential.

Some fund managers said the sector was looking expensive and because of that investors should focus even more on actively managing their portfolios in order to avoid paying for securities which might be overvalued in this period of time.

“There has been strong buying and interest in the market in the office and industrial sectors. But we think that they are looking a little bit overdone in terms of valuations,” Zurich Investments' senior investment strategist, Patrick Noble, said.

“I don’t think these trends are looking to change anytime soon but we are just cautious whether these trends are your friend. We think valuations or the relative value in the market is definitely not worth where the trends are at the moment, particularly in retail, and some retail investors should probably have a look and see what they think versus where the momentum really is.”

RETAIL

So the main question remains: at this point in time is retail a value opportunity or a value trap? The short answer to which would be the retail sector, which represents roughly 50% of the REIT sector by market capitalisation, was a trap over the last few months. But this is only one part of the equation, the experts said.

According to managers, the other key reason was that people believed in what they had seen was a structural change, which was further underpinned by changing consumer trends and a continued shift towards online shopping.

Also, there was an expectation that the retail valuation will come under further pressure, but at the same time, investors were forgetting that the growth numbers were just a part of the economic cycle, they said.

On top of that, the shift towards the online consumption left landlords with a necessity to reconfigure the space, which when combined with less favourite macroeconomic trends, added extra pressure.

“We think people are ignoring that retail has cycles and the stocks look cheap,” Noble said.

“This comes back to my point about how retail is reflecting a realistic situation which is the economy is not that great,” Quay’s Bedingfield stressed.

“Obviously bond yields have come down a lot over the last 12 months, and I think for those initiating or those who are not sophisticated investors it’s easy to say – because interest rates are so low I should buy real estate but that isn’t really a right way to look at it. The way we look and the way we think you should look at it is what is the bond market telling you about the wider economy?”

Also, the negative sentiment across the retail sector was more of a global tendency, with the majority of developed markets seeing retail as a massive underperformer over the last few months. This held true for markets such as the UK, Europe and the US.

“It’s happening globally in the UK and in Europe – it’s been a massive underperformer, if you look at retail in the US, retail property has been a massive underperformer, so it’s struggling in the developed markets but there are pockets of outperformance as well,” Bedingfield noted.

OFFICE/ INDUSTRIAL

On the other hand, managers were more optimistic when it came to office and industrial assets, which were supported by the recent financial results announcements from the leading groups which proved they had delivered a sound growth.

The industrial sector was one of the winners benefitting greatly from the recent change in consumers’ preference towards the online shopping and thanks to which the sector saw improvement in rental growth.

“The other thing that probably has assisted industrials to some extent has been space that used to be industrial has been converted to residential particularly in areas like South Sydney,” Cartledge said.

As far as the office space was concerned, one future risk was the current condition of the financial sector which has survived another yet difficult period, coming under extra pressure from the fallout of the Royal Commission. This might 
be the bad news for investors as the financial sector may be forced to ‘start trimming’ in order to grow its profits again.

Bedingfield said: “Roughly 5,000 people occupy a building of 60,000 to 70,000 sqm so for the bank to lay off 5,000 people that’s an equivalent of the new office building, being delivered to the market.”

So where investors should look for gains?

One manager, that operates in the unlisted property market, said investors should not limit their options to big shiny core CBD buildings and look further at the fringe and suburban markets with high-quality tenants.

“Our most recent acquisition for example was in Mascot in Sydney,” Hamish Wehl, head of retail funds management at Cromwell, said.

“What attracted us to Mascot is the market rents in Mascot are substantially lower than those in the city and we can’t just help to see it given its proximity and given its good transport connectivity.

“We don’t necessary try to buy these big shiny core CBD buildings, we are happy to buy CBD fringe buildings and suburban buildings with high-quality tenants that can still deliver a secure income stream to investors.”

Moreover, the other key tailwind towards unlisted property funds was growth in the self-managed super funds (SMSFs) space which currently have about $715 billion in net assets and of that $171 billion is within cash and term deposits.

“Given that huge cash balance is generating a small return, unlisted property funds becomes attractive” Hamish said.

OUTLOOK - BE CAREFUL AND PROCEED WITH CAUTION

Although the commercial real estate sector managed to attract investors in the last few months thanks to its defensive characteristics, moving forward the sector might look somewhat expensive at the aggregate level. 

Noble warned that investors coming to that market, appealed by its defensive characteristics, need to remember what they are paying for these assets.

“I guess in terms of what we’re doing – you know, gearing is not an issue like it was a decade ago, supply is picking up particularly in the office market so again, there’s a strong demand for office that we’ve seen particularly in Sydney and Melbourne where supply is coming along and if economic conditions do weaken then that could make those type of office stocks weak moving forward.

“We understand that people will need that type of investment in their portfolios so what we are trying to do is to make sure that we’ve got good valuations in there hence why we tend to be underweight in industrials and the office sector at the moment, and overweight retail. And we have some residentials in the portfolio as well but we’ve been sellers of that,” Noble said.

Bedingfield said his approach is to start from the point of view of looking for good total returns and trying to find the companies that will give those total returns no matter where they are based.

However, having said that, he added: “It’s really the companies and investment opportunities that come first. But when you look around the world, we probably tend to have more in the North America than we do anywhere else because that’s where the economy is the strongest at the moment, but that really is just a function of our stockpicking process, rather than wanting to allocate to one country”.

Bedingfield warned that there was still a lot of hype in one sector and much pessimism in another and therefore investors should be super cautious when it comes to picking stocks.

“You’ve got to be so careful. Because when you look at the index and its total – there is going to be big differentiation of returns going forward. There’s going to be some big winners but there is going to be some big losers.”