The key factors driving global listed real estate investments
Disruption is the key investment theme of the decade and even fixed assets such as real estate are not immune.
The winds of change are buffeting all major investment classes in the sector, from office and commercial through to industrial and retail properties.
A recent briefing by senior managers of AEW Capital Management – underlying manager of the Pendal Global Property Securities Fund – highlighted the risks and opportunities thrown up by unprecedented market shifts occurring against a backdrop of one of the strongest runs by the sector in decades.
Like any sector, property moves in cycles – and globally the decline in interest rates has put a floor under the market.
The JLL Global Office Index – which tracks returns from commercial office assets – jumped 49 per cent from its 2004 low to 2008 peak. It’s still risen by about 32 per cent in the subsequent nine years – a more modest, but sustainable performance.
The changing valuation equation
Underpinning global property markets are negative yields on sovereign debt, coupled with a heightened risk of geopolitical uncertainty.
Against this backdrop, real estate remains an investment class that continues to offer sustainable yields along with diverse investment opportunities offering sustainable growth. But capturing that growth can be a challenge.
Large direct holdings of property assets can hamper an investor’s ability to quickly take advantage of market shifts, both locally and abroad.
That’s one reason real estate investment trusts have become an attractive investment option, says AEW director J.T. Straub.
“The returns screen has always been attractive,” he argues. “We see the returns of the past several years continuing. There are also attractive sub-sectors such as data centres.
“In addition, their liquidity gives us flexibility. So for example, we’re underweight Hong Kong, and use these types of environments to take advantage of situations.
“To go from a 6 per cent to 10 per cent property allocation takes time if you hold property directly”, Straub says. “But if you invest via a REIT, the flexibility means shifts in portfolio allocations can be achieved quickly and painlessly.
“The key is that the central banks are helping. Once one central bank cuts, others have to follow. It is likely the Fed will cut again and others will too,” says AEW’s Singapore-based Peter Ho. “As rates decline, valuations will go up.”
This will continue to drive demand for sustainable returns and keep real estate markets buoyant, he says.
“There is a lot of capital coming into the sector that can’t find a home,” says Ho. “To get into Australia, you need to know the REITs. It is the same in Singapore.”
AEW doesn’t take regional bets; rather it takes sectoral bets. It holds an overweight exposure to offices in Asia, for example, and underweight in other regions.
Looking broadly at the global market, AEW is underweight in areas of falling rent such as Hong Kong office and retail sectors, along with US shopping malls.
Similarly it is underweight retail in both Japan and Singapore, even though the decline in rents is slowing.
Areas of rising rents, such as US industrial and ‘other’ residential, along with UK and Australia industrial rents and data centres in Asia, has prompted it to take an ‘overweight’ investment stance.
New economy, new opportunities
Areas of the ‘new economy’ are throwing up both challenges and opportunities.
In the commercial office sector, flexible working operators such as WeWork have attracted a lot of attention, bringing both opportunity and threat. This sector alone accounts for an estimated 7 per cent of total stock.
“In Amsterdam, co-working is a large portion of the market, but it is still less than 15 per cent,” AEW’s Straub says.
“In London it is around 6 per cent. In Sydney and Melbourne, around 2 per cent.”
Straub argues growth in co-working has helped drive net absorptions in the office market globally – although the difficulties of WeWork’s IPO has focused attention on the downside potential.
“There is a liability mismatch,” he says. “Some see [flexible working] as being bad for REITs,” AEW’s Ho says. “If co-working continues its current trajectory, it will double the demand for space.”
“The challenge of the WeWork model is that since it is loss-making with a long-term lease, how much space do you want exposed?
“There is potential credit and liquidity risk. For example Regus has better credit quality.”
Environmental, Social and Governance impact
Listed property investors are also increasingly taking into consideration environmental, social and governance (ESG) factors, says AEW’s Ho.
ESG has gone from “nice-to-have to a need-to-have over the past decade”, he says. And there’s a range of data demonstrating a correlation between higher ESG scores and profitability.
Commercial properties in particular can be energy-intensive and tend to have environmental impacts —not only in construction but also through ongoing maintenance programs.
Industrial property revolution
Demand in the industrial real estate sector has also been driven by e-commerce.
As digital natives, Millennials are driving a wholesale shift in demand for industrial real estate.
“Increasingly a shed is not just a shed,” as AEW’s Straub puts it. Occupants are demanding automated storage systems, renewable energy and tracking systems spanning fleet management through to efficient truck-dock management.
“In Tokyo, there has been a lot of industrial supply,” AEW’s Ho says. “In three years there’s been a 50 per cent increase in industrial warehouses. Demand is so strong even with record absorption. And with [a low] 2.7 per cent vacancies, rents are rising.”
The strong underlying demand has AEW positive on the sector. The manager is overweight industrial assets in Asia, Europe and North America.
Data centres are an adjunct sector to new economy real estate. The rise in cloud computing is driving demand both for ‘last-mile’ centre operators located near client offices and data centres servicing a single client, which can be located in distant locations.
Either way, these centres are big energy users with ready access to electricity a prime driver of location.
Still, the longer the present market strength continues, the more investors will be asking how much longer can it go.
“We keep waiting for real estate to over-build,” AEW’s Straub said. “That’s how it ends.
“But the banks have been tightening lending restrictions – they’re not over-lending.
“There will come a time, but we’re not there yet.”