Seeking greater stability in volatile times?

3 May 2017

Author: Centuria
Date: 3 May 2017

Seeking greater stability in volatile times?

Unlisted property could be the answer.

According to Jason Huljich, CEO of Unlisted Property Funds for Centuria, a key feature of direct property investment is that it is not as susceptible to changing market sentiment that can cause volatility in listed investments.  Here, Jason asks whether unstable times call for investors to consider  less volatile investments.

A recent global survey of institutional investors[1] revealed that their number one concern is market volatility. And it’s fair to say that recent movements in fixed interest and equity markets have validated this view. When prices move erratically, both up and down, investment managers struggle to provide medium, let alone long-term, forecasts. This can be unsettling for investors, particularly those who rely on the returns from their investments to live. At the same time, volatility is the price investors pay for liquidity.  Depending on the investor’s goals and time horizon, there may be no choice but to accept volatility – those who need access to their money at a moment’s notice may find listed investments the best option.

 

Unlisted property funds are different.

Listed property, in the form of AREITs, offer property exposure with the benefit of liquidity, but they are also heavily correlated with equity markets and hence can be volatile. Investors looking for a more direct property investment may find that AREITs do not fit the bill.

Unlisted property offers a more direct exposure to the market (usually commercial property markets), without the multi-million dollar price tag, but also without the liquidity. Whilst each property or property fund will have different characteristics and risks, if selected well, property can provide the opportunity for strong and stable yields where the tenancy profile includes long term leases to high quality tenants such as the government or AAA rated companies, combined with the possibility of longer-term capital gains.

Most funds will tie an investor’s money up for between 5-7 years, during which time it can be difficult to exit the trust. The trade-off is the potential for a stable income stream (when supported by long team leases), and insulation from constantly changing market sentiment.  The value of properties in unlisted funds is generally set by independent valuers every year, rather than the market on a daily basis.

 

Interest rates affect listed property more than direct property markets

But what of interest rates? With so much talk of the US Federal Reserve starting to raise rates, and opinion divided on what is likely to happen locally, it’s important to understand how interest rates impact property markets.

When rates are low, as they are now, it’s easier to service debt, and therefore more attractive to purchase. Ongoing low rates are one of the reasons that weak office markets, like Perth, are not in a state of free fall. Given the demise of the mining boom and its effect on office demand, vacancy rates are rising, yet with rates as low as they are, owners can continue to service their debt while they wait for a recovery.

At the same time, the correlation between property prices in the direct market and movements in interest rates is not particularly strong, whereas the opposite is true of listed property. Movements in interest rates can affect REITs sentiment significantly – so taking a view on where rates are going is more important for investors in REITs.

 

Unlisted funds vary significantly – in structure and assets.

Unlisted funds will generally have similar structures, they are unit trusts which hold direct property assets. However, they are not all the same, and if you are considering an investment, it’s important to think carefully about what you hope to achieve by investing in an unlisted property fund.

Firstly, it’s always crucial to look closely at the track-record of the manager, and at the quality of the assets in the trust. Quality commercial property may offer the potential for stable yields, due to the locked-in nature of leases, but be sure to look closely at the quality of the tenants.

One way of assessing the quality of the yields on offer from an unlisted trust is to look at the WALE, or weighted average lease expiry. Investors looking for long-term, stable and forecastable yields will prefer a longer WALE. A shorter WALE may not necessarily be a negative, however. At Centuria, for example, our ability to actively manage our property assets has been key to our success. In other words, and depending on the fund, we seek to identify and purchase properties where there is scope to add value and improve overall rents and returns, by upgrading facilities for example. For this kind of strategy – a shorter WALE may be more appropriate – if it means that the tenancy profile of the property can be improved. Again, it is important that you research you fund and understand the risks to investing.

 

Unlisted funds can be attractive from a total return perspective

Our property in Chatswood, the Zenith, is a good example. In this case, the property was acquired based on our view that there was the potential to increase rents as a result of a building refurbishment and other factors. This means that Zenith has been most appealing to investors looking for a total return type fund.

 

Or may be more attractive from a yield perspective

Investors more interested in yield, on the other hand, may wish to consider property funds with the potential for yield rather than total return. An example of this type of fund is Centuria’s current offering, the Sandgate Road Fund . Sandgate Road has yields that are underpinned by long-term Government leases. It has a long WALE of 9.4 years, and over 80% of its comes from Queensland state government owned tenants. The fund is geared at 44% and forecast yields are strong – 6.5% in financial year 2018, rising to 7% in financial year 2019.

 

Office markets across Australia continue to be a mixed bag – but demand is strong

We are finding that demand for quality office property in Australian markets continues to be strong – from domestic as well as offshore buyers. Tighter controls from the government on currency flows out of China has seen a small slowdown from this sector, but the flows from Singapore, Hong Kong and the United States mean overall demand hasn’t dropped.

The commercial markets of most interest to us continue to be Sydney and Melbourne where we see the strongest fundamentals looking forward. Brisbane is improving, but Perth still has some way to go.

However, buying well in any of the stronger markets is proving challenging. In our view, risk is not being completely priced into the market. Buyers are paying prices we find difficult to justify, for properties with significant risk either in terms of vacancy profile or the need for refurbishment. It is partly for this reason that our Sandgate property appealed – if the risk is already priced in, then a property with locked-in yields on the back of quality tenants on long term leases is an attractive proposition.

Ultimately, like all investments, unlisted property trusts are not without risk, and over the course of the 5-7 years they run, all does not always go to plan. However, for investors interested in the potential for attractive yields without the volatility that may come with listed AREITS, unlisted funds are certainly worth considering.

 

[1] Natixis Global Asset Management, 2016 Global Survey of Institutional Investors <http://durableportfolios.com/docs/897/60/WP124-1216%20Institutional%20Outlook_trifold_F.pdf

* Forecasts not guaranteed and subject to assumptions in the PDS which will be available of Centuria’s website from mid May 2017. Investment in the Fund involves risk including loss of income and capital. This article contains general information. No consideration is given to your personal circumstances or objectives. Centuria Property Funds Limited ACN 086 553 639 (AFSL 231149) is the responsible entity of the Fund and receives fees for managing the Fund.

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