Finding yield with unlisted property trusts
Published in Switzer Daily on Tuesday, July 12, 2016
It’s the old conundrum; if it sounds too good to be true, it probably is. Higher risk can mean higher returns, but it also means higher risk! At the same time, low risk means lower returns. In an economic environment of near-zero interest rates, many low-risk assets just can’t give investors the income stream they need – let alone the possibility of growth in the future. Let’s take a look at unlisted property trusts and see whether they fit the bill in challenging times.
Global growth is improving, but the views of the world’s leading economists remain cautious in the extreme. The US Federal Reserve Chair, Janet Yellen, acknowledged this month that she could not rule out the possibility that slow productivity growth will continue into the future. This is despite the fact that she has argued for years that the headwinds to economic growth would fade, allowing growth to pick up and interest rates to rise.
For advisers and their investors seeking a yield they can live on, this kind of rhetoric is unlikely to raise their spirits. But it does signal a need to carefully assess investment and asset allocation decisions. Traditional glide paths which saw investors (in particular those approaching retirement) shift out of so-called growth assets like property and shares, into fixed interest and cash, must now be approached with caution.
So where should advisers and investors be looking?
Unlisted property trusts are one option
The right unlisted property trusts can provide investors with a yield they can live on and the possibility of capital growth in the future. Many invest in high-quality commercial office property, which individual investors would not otherwise be able to access, and active asset management can increase both income yield and potential sale price in the future. On the other side of the coin, most unlisted trusts last for between five to seven years, during which time it can be difficult to exit. But for investors looking for yield, rates of between seven and eight per cent are very appealing.
But not all unlisted property trusts are created equal. Investors can be faced with a difficult conundrum when assessing their options. In property, as in any investment, the more you move up the risk curve (or down the quality curve) in the expectation of a higher return, the more danger. And we only have to look back at the experience of unlisted property trusts in the global financial crisis (GFC) to see where that can lead. In that instance, a heady mix of high gearing, poor asset quality, inadequate disclosure and a lack of transparency from management saw many investors get burnt.
The trick is to get the balance right – too little risk can leave investors unable to live, but too much can be even more catastrophic.
Look carefully at the manager
One way of mitigating potential risk is to choose an unlisted property manager carefully. If there was one good thing to come out of the GFC, it’s that some of the less scrupulous managers were weeded out. However, despite the fact that the industry has made significant improvements in relation to disclosure, fund structures and fees, it is still of utmost importance to look at a manager’s track record. How long they have been managing unlisted trusts, how have their funds performed over time, and what level of transparency and communication an investor can expect.
Unlisted property trusts closely mimic the performance of their underlying assets, much more than their listed counterparts, A-REITs, which tend to move in line with equity markets. Because an unlisted trust is not priced daily by the market, it is very important that the manager is transparent about how properties are valued, and how the fund’s net tangible assets (NTA) are calculated. There are strict rules governing how assets are priced, the disclosure of borrowings, as well as fees and charges, and a good manager should automatically disclose this information.
Active versus passive asset management
Because returns from an unlisted property trust are so closely based on the performance of the underlying properties, understanding the quality (or otherwise) of the property and its tenants is crucial. A good manager should explain his or her reasoning in this regard.
There are also a number of key figures and ratios which an investor should consider carefully. Some of these relate to the likely income from the property, and others to the potential for capital value. In both cases, the ongoing actions of the manager can make a significant difference to overall returns.
For example, on the income side, the weighted average lease expiry (WALE) of a property is very important. The WALE measures the average time period in which all leases in a property will expire. Given the leases in a commercial building provide the income streams which make up the yield, the length of the leases clearly underpin income returns. Generally speaking, the longer the WALE, the more secure the income stream, and potentially the higher the price of the property when it comes to sale.
Also important is the quality of the tenants in the building, and whether or not there are opportunities to improve the property and increase rental levels. This is where an active manager can play an important role. We have a dedicated in-house asset management team whose job it is to identify ways of managing our portfolio of properties and identifying possible improvement. Upgrading foyers and lifts, improving air-conditioning and even undertaking ‘spec’ fitouts in order to attract smaller tenants, can all improve a property’s profile.
Never has the ability to identify an appropriate risk/return relationship been more important. Too much risk can lead to disastrous results, but in a world where term deposits can’t put food on the table, investment options which provide a liveable yield are in demand. While every investor’s situation is different and asset allocation decisions must take into account individual risk profiles and investment horizons, there are many reasons why advisers and investors might consider adding unlisted property trusts to the mix.