Real estate – foundation garment or fashion victim?

September 5, 2011 / By

Some people think that the real estate sector is slow-moving, lacking the adrenalin boost of other asset classes. And, certainly, real estate does not experience the day-to-day trading volatility of equity, bond and foreign exchange markets.

But the reputation of real estate as a staid sector is undeserved.

Consider Australian REITs. Over the past twenty years A-REITs have twice re-invented themselves, changing from diversified portfolio managers to specialists in specific sectors (office, industrial, retail) in the 1990s, then re-emerging again as diversified investment vehicles. Right now they seem to be back on a specialisation track. At times A-REITs sought to invest in the local market; at other times offshore investment has been aggressively pursued. Debt levels have gone from low to high and back to low again. At different times core and non-core real estate assets have been at the top of the acquisition agenda. After 2000 a focus on high yield investment strategies gave way to a race for capital growth. Then, since 2007, high yield has returned to fashion.

Management of A-REITs has veered between external and internal arrangement arrangements, with passionate advocates of both in public debate. In the run up to 2007 stapled structures were popular whereby a REIT was twinned with an operating company engaged in development, funds management or tourism. These arrangements are now being unwound and it’s back to a vanilla REIT structure once again. A measure of the pace of change in the A-REIT sector is that of the 30 A-REITs publicly listed in 1990, only three are identifiable in 2011.

So, what’s hot on the cat-walk right now? To catch the eye of the discerning A-REIT investor you need to display:

  • Low levels of debt
  • A domestic portfolio focus
  • Yield rather than capital growth
  • A portfolio of prime core real estate assets
  • A focus on specific sectors (e.g. industrial assets) or markets (e.g. Brisbane)
  • A plan to divest non-core activities such as offshore or tourism assets

Of course this list of desirable, if conservative, attributes is a hang-over from the shock of the global financial crisis. It is very unlikely that the revolving wheel of fashion has stopped, though the pace may have slowed somewhat. For example, domestic investment is flavour of this month, but with rising funds under management and a small local market Australian investors will have to go offshore sooner rather than later if they are to maintain their portfolio weighting to institutional grade real estate assets.

The A-REIT sector may be an extreme example, but it is not alone in its history of vigorous restructuring as market conditions and investor preferences change. With A-REITs now often trading at a discount to underlying asset values, funds are flowing into unlisted wholesale funds. Unlisted syndicated investment funds have come and gone. Right now they are re-emerging, albeit in a different form than previously.

Unfortunately, all these ups and downs of the real estate hemline have not always delivered good results for investors, though they may have created a useful fee flow for corporate advisers and financiers.

The key message for investors is that the fashion roundabout of the real estate funds management sector does not change the underlying nature of commercial real estate assets. Stripped of the grease-paint and away from the spotlights, commercial real estate portfolios typically offer low capital growth but high distribution yield. They are low beta assets that deliver a reasonably stable investment return through the market cycle.

Fashions can create illusions but commercial real estate is resistant to cosmetic changes. Nothing is worse than being all dressed up with nowhere to go.

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