Q&A for the Institutional Real Estate Asia Pacific (IREAP) journal. Written in December 2018 for an article published in May 2019. In the end, excerpts were published.
Q.1. Real estate asset prices are high across the Asia Pacific region. Where do you think we are in the market cycle right now? Are we due for a correction soon, and what could trigger the downturn?
It is a tale of different markets.
In Australia, where EG Funds Management is active, premium commercial is still strong; yields (which have fallen to 4.25% in some instances in premium with certain asset trading even sharper) are attractive relative to other established global real estate markets; we’ve seen a flood of money from global investors seeking diversification in Asia with Australia seen as an essential part of an Asian portfolio. Australia, Japan, and Singapore are valued for their market integrity, transparency, and liquidity.
But even so, managers are reporting a drop off in interest from offshore buyers as market conditions globally soften.
Elsewhere it is a mixed bag. Residential property growth has come off considerably. Auction clearance rates in Sydney have fallen from the low 70s to low 40s over the past 12 months, even in instances where residences have been priced to sell.
Retail has seen a big drop in confidence. It is not only the “Amazon effect” – the pick and click phenomenon of online shopping. Even neighbourhood shopping centres have considerably come off in value and interest. There are fewer bidders and a growing number of unsuccessful sales campaigns.
There is a lot of powder kept dry. Investors do not want to be catching a “falling knife”, thinking that a major correction could be just around the corner.
A lot of the uncertainty is due to fears about trade wars and related concerns about the underlying health of the Chinese economy.
As everyone knows, strong growth is hard to sustain forever. The Chinese economic experience since 1978 – the last 40 years – has seen the largest movement ever in any country of poor people moving to the middle class. Hundreds of millions have directly benefited. This is a wonderful instance of the idea that a rising tide lifts all boats. The global economy too has been fuelled by China’s growth.
But now there are question marks. President Xi is seen as a more controlling figure. Could this be stifling for entrepreneurship in China? William H. Overholt’s recent The Coming Crisis of China’s Success (2018) sets out why. I know. Every year there is a book published predicting a Chinese economic collapse. But Overholt is different – an academic with real market experience, including many decades in Asia as an important investment banker with Bankers Trust. His The Rise of China (1993) book predicted China as the next great economic super power. He has spent 25 years dismissing the critics of China’s growth projections. But now he is worried.
The market hates uncertainty.
Q. 2. Which, if any, Asia Pacific real estate markets and property types still appear attractive on a risk-adjusted return basis at this point of the cycle?
As uncertainty mounts in 2019, those markets reckoned to be stable and well regulated, governed by the rule of law, liquid, and with sophisticated investors, will benefit. There will be a flight to quality. Japan, Singapore, and Australia look attractive in such circumstances.
I like the strategy of repositioning core plus assets to core. I also like newly emerging sectors such as build to rent. Follow the data must be the motto. The true winners in property markets in the future are those who apply insights from big data into action.
I can talk more about that later.
Q. 3. What and where are the best investment opportunities for core, value-added and opportunistic investors, given current market conditions in the Asia Pacific region?
Given the earlier answer, the move of capital to mature, advanced markets, let me answer with reference to Australia.
The fall in the Aussie dollar (driven by trade and China uncertainty, in the main) in the latter half of calendar 2018 has caused some renewed focus on Australian real assets, now with a potential positive currency premium. But most sophisticated investors look to the fundamentals, not to currency movement.
The Australian economy is still growing; it has been around 3% annual growth in GDP since the global financial crisis. A return to surplus by the Australian government is around the corner. There are a myriad of factors. I expect a bumpy 2019, with buying opportunities mid year and stronger confidence returning at the end of 2019.
A personal view, if I may: By year’s end, we will be a year away from another US election. I used to think Trump would win again, also winning with a minority of the popular vote. (New York and California hate him, but they are not America). Now I am not sure. Usually it is never good to have a weak US President. The system needed a shake-up. But this guy is not the answer. That might be more obvious at year’s end. If I am right, if this is clearer that there is a likelihood of a one term President, I think this will be a robust factor to add to the equation.
Can I mention one other thing? There is a huge infrastructure investment in Australia. On the eastern seaboard, in Sydney, Melbourne, Brisbane, under construction are metro train lines, new road networks, and upgrades to transport networks generally that mean in each city there is an infrastructure spending boom. Similarly, in the last five years and the next five years, there has been – and will be strong investment in public and private hospital expenditure. Over a decade nearly every major hospital would have been rebuilt or massively upgraded. These investments will have a positive ‘network effect’ on related property markets.
Q. 4. Do public markets offer a better opportunity than private markets right now? Why or why not?
There is undoubtedly a more attractive premium placed on liquidity now that gives the listed markets an advantage. But volatility and complex ownership structures has caused some institutions to want to directly own assets.
Some value-add strategies are not well suited to listed-company market reporting.
To adapt Deng Xiaoping’s phrase, black or white, what matters is whether the cat catches the mice. Always look at the strategy, execution capability, and expertise, in looking at a particular investment approach.
Q. 5. How much lower do you believe office yields can go?
At present there is a spread of approximately 200bps between the 10-year bond rate and prime Sydney office. This remains above the long-term average of approximately 60bps, so in terms of mean reversion there is scope for further compression.
With Sydney Prime office at 4.25%, which is a historic low, this pricing creates caution with investors. In a building like the one I am in, Governor Phillip Tower in Sydney, it might go under 4%. It always turns on the counterparty risk. You need to look through to the tenancies, the blue and near blue chip renters. Beyond that, in B-plus and suburban, I can see yields needing to increase to attract buyers. That means prices will fall.
An attractive, sensibly focused strategy in that context, is to look at core plus to core strategies. That’s a nice angle. We have developed at EG a fund just for that.
Q. 6. Have we passed peak negative sentiment toward the retail sector? Should the retail sector be avoided until the dust settles on this particular stage of restructuring of the markets, or are there opportunities lurking in the retail markets that can be identified and exploited? If so, what are some of the opportunities?
I think there is more retail property pain to come in 2019 for certain sub-sectors of the market. But I am thinking counter-cyclically. There are buying opportunities even now. With some healthily yielding property I am seeing that the market has become too spooked. Look at the fundamentals. Always think where value might be taken.
In the past few decades, a common answer to retail has been to put more anchor tenants in the mix. Maybe we need less. And sometimes there is surplus land in and around a retail centre. There are mixed use options available.
The smart opportunities are for those who deeply know the changing retail markets and who can also figure ways of creating options with repositioning and alternative uses.
Even with modest leverage, I can see 9% yields ahead. Snap them up.
Q. 7. Have logistics assets become overbought due to high investor demand? What are the current supply-and-demand dynamics for the logistics sector across the Asia Pacific region? And what implications does the slowdown in international trade, resulting from trade wars, have for the logistics sector?
This is a really interesting question, and it is complicated to answer, because logistics and industrial assets are not homogenous product.
In Australia, Goodman International, a REIT I was on the Board of in its earlier manifestation, has become an almost dominant player; but there is more competition coming into the market. Goodman actually see Amazon as their friend, their future tenant. There are shakeups occurring, but I see warehousing and logistics as good places to be. It depends on the counter party. Many goods are of course endogenous, food and perishables for example, and often better placed to resist overseas competition (including in an island country like Australia, with quarantine issues; though there is a very open market; Australia is amongst the most liberal in light tariff and associated restrictions in the OECD). There are interesting and growing niche manufacturing companies. The Australian economy is becoming more diversified.
We all sometimes commit the sin of “gigantism’, thinking that the giants are the market; they are not. They will have a big impact, but if you know this space, you will see the opportunities.
In Australia there is strong, continuing growth in the sector; some of this is due to reinvesting – technology making operations more efficient.
But also, the changing complexion of our cities, including the new transport infrastructure spend, has caused some big companies to move where there are better road and freight connections. That is the biggest – and ongoing – story in logistics.
The potential of trade wars is a complicating and still uncertain in its implications. You have got to worry about dumb US trade policy, even if thieving of technology IP and other bad behaviour of China are legitimate concerns.
The Trans-Pacific Partnership (TPP) trade treaty was there for the signing in 2016. Free trade is good for world economies. President Obama could not sell it. President Trump tore it up. But this was the most liberal, creative answer to American complaints about trade in services and intellectual property being rigorously covered in a trade treaty. All Asia, excluding China, wanted to be “in”. Australia did its part to get neighbours to commit. It was a significant American initiative. But when everyone was lined up to sign, America declined. The TPP is now a free trade agreement (FTA) between Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, Peru, New Zealand, Singapore, and Vietnam – and open one day for America to join.
In years to come we will see this story as one of the biggest own goals in American trade diplomacy.
Q. 8. What niche sectors should investors currently consider attractive, such as data centres, co-living, medical office, student housing, senior housing, etc? Please explain.
Over the last 5 to 6 years, as value was perceived as fully, or at least strongly, priced in some property sub-sectors, there has been a search for value in alternatives. For example, in Australia over the last decade, there has been a boom in investment in student living. Around 25% of university students are international students and a lot of student housing on and near campuses was built. There is more to come here, and university administrators talk about a student accommodation “shortfall”. But many of the obvious pickings have been taken.
It best to follow the demographic and market trends and devise investment strategies accordingly.
Let us take two big examples: aged care and residential rental accommodation.
With age care, we know the baby boomers are ageing, they are the wealthiest generation ever to retire. Australia’s $2.7Billion in pensions or superannuation savings is part of that story. Yet a lot of the accommodation stock is poor and unimaginatively configured.
I know smart investors are devising ideas to enter and add to this market. Is it propco and opco? A combination? A new way of doing things through inspiring a community feel? And the fit with mixed uses? These are the questions worth asking.
Incidentally, in Australia there is a Royal Commission (an independent, government-sponsored inquiry, headed by a retired or judge and independent experts) into this sector this year.
I imagine some horror stories ahead. I see opportunity, but it is a complicated sector.
Build to rent, on the other hand, is a well-established market in most OECD countries. But in Australia, institutional investment is miniscule. Yet with housing affordability as important in Australia as anywhere else (arguably more so, with Sydney’s and Melbourne’s skyrocketed increases in housing prices over the past decade) and as mobile millennials are not as interested as their parents in owning a dwelling, and want a community feel to their living, relaxing and working environments, I see opportunity. It is not a matter of building a block of apartments and renting them out. Of course, it is that, but also how you present and actually create something vibrant and interesting. The winners will be those who know residential like the back of their hand and can marry that with hotel-like community living. Wish I had more time!
Q. 9. Anything else you want to add?
Yes. I referenced before big data and insights from technology applications. In everything I am doing in property, whether mapping land use change, risk analysis or in new technology to design and manage buildings, this is the future. A few years ago, McKinsey did a report that commented that the property sector, broadly defined, was amongst the most backward in the application of technology to their sector. I see a revolution ahead. We are on the cusp of vast change in our industry.
Postscript (2019)
In the end my comments were used for an article by James Dunn, ‘Market Timing. Even in a Toppy Market, Capital is Waiting to be Placed’, Institutional Real Estate Asia Pacific (IREAP) Journal, March 2019, pp. 23-26.
Article by Dunn:
