Chris Bedingfield

The Quay Global Real Estate Fund (Unhedged) Active ETF (ASX:QGRU) and the Quay Global Real Estate Fund (AUD Hedged) Active ETF (ASX:QGFH) are available for trading on the ASX from Monday 24 November.

Offering investors enhanced access to Quay Global Investors funds via the ASX is a significant milestone in the twelve year history of the highly-rated award-winning Quay Global Investors team lead by Justin Blaess and Chris Bedingfield. Demand for an ASX listed offering speaks to the strength of Quay’s proposition and their commitment to the preservation and creation of wealth through a differentiated approach to managing global real estate equity portfolios.

The new active ETFs provide ASX investors with access to a concentrated, high conviction portfolio of real estate securities listed on exchanges around the world. Unlike the Australian real estate market which primarily offers exposure to the retail, office and residential sectors, global real estate offers a much broader universe including aged care, student housing, data centres and storage facilities.

The objective of the ETFs is to provide investors with a total return (before fees and expenses) of the Australian Consumer Price Index (CPI) plus five per cent per annum measured over five years or more. The portfolio typically holds 20 to 40 securities, with most income derived from leases, rent and other real estate related income.

Gillian Larkin, chair of the Bennelong Funds Management Ltd Board said: “Quay are one of Bennelong’s strongest and fastest-growing investment partners. These two new active ETFs represent an important step in Bennelong’s strategy to enhance investor access to our leading investment solutions.”

Bennelong Funds Management CEO John Burke said: “Share market natives have limited options to build a high conviction index unaware allocation to global property, so making Quay’s popular proposition available via the ASX was a logical step.

“Active ETFs are an increasingly popular investment vehicle, and we are seeing retail investors seeking more sophisticated ETF offerings, which replicate those managed by experienced investment teams such as Quay Global Investors.” said Mr Burke.

Quay principal and portfolio manager Justin Blaess said: “The team is proud to reach this milestone. As specialists in listed real estate securities globally we believe an active exposure to global listed property can be a valuable inclusion in a truly diversified portfolio.”

Quay principal and portfolio manager Chris Bedingfield adds that the market conditions are supportive of global real estate investments.

“As investors we are observing deeply discounted valuations globally and consider them to be markedly disconnected from the sector’s robust fundamentals. As such, discounted valuations provide us with opportunity,” said Mr Bedingfield.

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Chris Bedingfield

Once seen as unstoppable, e-commerce may be hitting its limit with physical retail real estate making a quiet comeback, says Chris Bedingfield, portfolio manager at Quay Global Investors.

“During and in the aftermath of the COVID lockdowns it seemed e-commerce would devour the world, especially physical retailers. The rise in e-commerce benefited real estate assets like industrials from the over leasing and over development needed to support the demand. However four years on, and a new trend is emerging with a shift from online back to physical retail,” he says.

Online retail sales penetration appears to be peaking in Australia at or around 12 per cent of total retail sales, as the chart below shows.

This trend is not just local, says Mr Bedingfield. In the US, e-commerce’s share of retail sales peaked at 16.3 per cent in April 2020 and appears to be plateauing at this level.

“The implications of this shift for real estate are profound and two-fold. Firstly, the outlook for a reacceleration of industrial development and increase in demand for such real estate isn’t looking positive. At the same time, the fear and risks around physical retail, like shopping centres, continues to abate,” he says.

“When it comes to e-commerce, we believe that what was once a secular growth industry could now be morphing into a traditional cyclical industry. This is creating a real headwind for industrial assets.”

Investor confidence in both the direct and listed retail real estate markets is growing, and Mr Bedingfield says that the lack of any new recent supply of retail space should increase leasing tension as tenants look to stores as a new avenue for growth.

“We are already seeing some evidence of this with the transaction market beginning to thaw both in the US and in Australia. For example, Scentre Group recently announced a 25 per cent sale of Chermside Shopping Centre. This is the first sale for the group since 2019.”

Demand for additional warehouse space is also projected to once again decline in 2026, reflecting broader recognition that e-commerce share is reaching its peak.

“One of the largest e-commence tenants, Amazon, does not appear to be in growth mode. For industrial landlords, this is problematic. Unlike in previous years, Amazon’s future warehouse needs will be almost entirely self-built, with minimal third-party leasing. As the company continues to take market share from other e-commerce and third-part logistics providers there will be no positive offset from other sectors in terms of new leasing demand.

“This all suggests this is more than just a whipsaw adjustment,” says Mr Bedingfield.

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A very noisy month

April marked ’liberation month’: An attempt by the Trump administration to re-balance global trade back in favour of the US by imposing of a raft of new tariffs on trading partners friend and foe.

The month turned out to be quite chaotic, with the announced reciprocal tariffs postponed (for 90 days) while the US administration supposedly opened negotiations with individual countries. In addition, tariffs on Chinese imports were increased (up to) 145%.

Markets were understandably extremely volatile – and as markets do, goaded some commentators into making varied predictions ranging from a certain US recession, the end of the USD as a reserve currency and fears of a capital flight from the US.

Theme 1 – Real investment is at risk

Last month we wrote about the risk of a US recession with the imposition of tariffs. The fact we had to re-write and re-edit the paper three times in the week prior to publishing told us something about the wider economy. The sheer uncertainty of the current environment means long dated investment decisions are now at risk. If companies can no longer be certain of ’rules of the game’ we think it will make sense to just sit out of the game and preserve capital until the dust settles.

At this stage, no matter the compromises or announcements made, the hap-hazard manner in which tariff policy has been announced (and withdrawn and announced again) makes the investment world highly uncertain. How long would such a ‘grand plan’ remain in place given? What (if any) real investments can be made knowing in roughly 3 ½ years there will be a new administration (highlighting the inherent instability associated with policy via executive order).

Lower investment is not just a drag on GDP, but it also has significant implication on Theme 2 below.

Theme 2 – Increased risk around US company profits

Since the COVID recovery of 2021-2022, equity investors have gorged themselves on a steadily rising equity market, driven by a significant acceleration of company profits. According to the BEA, total company profits in the US now exceed USD $3.1 trillion, an increase of $1.0 trillion since 2019.

The profit boom may have come as a surprise to some, especially in the face of rising interest rates. However, by understanding the Kalecki-Levy profits equation, investors would note that company profits are an accounting identity that has very little to do with interest rates. At a macro level, company profits are generally driven by four factors: Investment, government deficits, household savings, and foreign savings.

As a refresher, the accounting identity is highlighted below.

This identity is not just theory – but supported by empirical data as seen by the chart below.

Since 2019, company profits have benefited from:

• a 28% increase in annual investment ($340bn)
• a 17% decline in annual household savings ($202bn) and
• a $650bn increase in annual federal deficits.

These factors alone added +$1.2T to US company profits since the pandemic.

Past tailwinds are now at risk as the investment environment becomes more uncertain (Theme 1), which in turn may lead to a more cautious consumer (and higher savings).

In the past, headwinds were overcome by expanding US deficits. For example, after the GFC US deficits increased by $1T – significantly offsetting the 60% or $0.5T collapse in investment (see chart above). While during COVID, the US deficit expanded to $2.8T. The concern for company profits today is no such reacceleration of government deficits appear to be forthcoming. To date net government spending is tracking the 2024 run rate – not disastrous, but not adding to growth. More worryingly, the Administration seems determined to reduce net government spending, and generating additional revenue via tariffs will certainly help in that regard.

These fresh profit headwinds (and lack of fiscal tailwinds) come at a time when profit expectations remain relatively high. At the time of writing, according to FactSet, 2025 US company profit expectations call for:

• earnings growth of 8.2% for Q2
• earnings growth of 10.6% for CY2025 and
• earnings growth of 14.2% for CY2026.

In the absence of any new fiscal impulse (ie: tax cuts), we see the risk to US corporate profit expectations is to the downside.

Theme 3 – New real estate supply is now less likely

While falling net investment is a headwind for the broader economy and company profits, it is a medium-term tailwind for real estate. In short, falling investment means less new supply, and for real estate that is a big deal.

Today, inadequate supply in sectors such as data storage and senior housing has already resulted in double digit revenue and net rental growth. Such rental growth may be a pre-cursor to what will emerge across other sectors as builders and developers ‘ice’ current projects due to tariff and leasing uncertainty.

Prior to April, we were consistently hearing from company management of our portfolio holdings that new supply is decelerating across multiple real estate sectors including office, multifamily, single family and self-storage.

The signs of lack of supply extends beyond anecdotal feedback. The AIA Architecture Billing Index (ABI) is a leading economic indicator of construction activity. It is produced by the American Institute of Architects (AIA) and reflects the approximate nine-to-twelve month lead time between architecture billings and construction spending1.

The ABI is based on a monthly survey of architecture firms that asks respondents to rate the level of their billings (or the amount of new design contracts) as either ’increase’, ’decrease’ or ’no change’ from the previous month. An index is compiled, where a score above 50 indicates a net increase in billings, and a score below 50 indicates a decrease in billings. The latest reading (for March) was 43.6, the 14th decline in monthly billings – a situation likely to get worse post ‘Liberation Day’.

The long lead times associated with most commercial real estate sectors means lack of new supply could be a theme which lasts for several years. In sectors where tenant demand remains somewhat stable, rental growth is possible even in a world where US profit growth stalls.

Theme 4 – Tenant demand will weaken but vary greatly across sectors

Real estate is not immune to the headwinds of weaker company profits and weaker GDP. So which sectors are more vulnerable?

In keeping with Theme 1, any sector where leasing reflects an investment – that is, leasing that commits a tenant to several years of obligation (i.e. long lease terms) are probably most at risk.

• Office
• Retail and
• Industrial.

Separately, the 10% fall in US inbound tourism2 will negatively impact hotels and sectors that benefit from tourist spending (such as coastal retail).

Real Estate business models that rely on transactions to generate income (developers, property managers etc) are also at significant risk. If the investment spigot is turned off, transactions will stall, and developer profits can fall substantially while balance sheets become bloated with unsold inventory.

Separately, we expect leasing demand for short duration and needs-based real estate to remain relatively steady, including:

• Senior housing
• Residential
• Self-storage and
• Manufactured housing.

Theme 5 – Don’t panic over the bond market

An emerging concern last month was the state of the US bond market. Specifically, that long-dated bond yields rose during significant market drawdowns led many investors to speculate ’something was broken’ in the US bond market. Theories included:

• capital flight from the US (no longer seen as a safe haven)
• foreign selling, forcing yields higher
• specific leveraged bets on US bonds unwinding (so called basis trade) and
• bond vigilantes fed-up with ever increasing deficits.

Our message here is simple. As the monopoly issuer of USD, the US Federal Reserve can always be in full control of US interest rates either indirectly (via cash rate and guidance) or directly (yield curve control). Over time, the long end bond yield will ultimately reflect long term interest rate expectations. And those expectations in turn are driven by Fed policy and guidance3.

In the short run, bond yields, like equities, can move on fear creating short term price inefficiencies. We believe care should be taken extrapolating short-term observations into assuming long term structural changes.

For more reading on this topic please refer to our November 2022 paper, Bond vigilantes don’t exist for a monetary sovereign.

Concluding thoughts

As most investment managers can attest, making long term investment decisions in the current environment is very challenging. Given the long lead times associated with real investment, this challenging environment is as true in the real economy as the financial one.

And that, in a nutshell, is the theme of 2025.

We believe current policy uncertainty may stall company investment decisions, which in turn will have the following knock-on effects:

1. Act as a headwind for macro company profits.
2. Slow overall economic growth, possibly resulting in households increasing savings.
3. Further diminish an already dwindling pipeline of future real estate supply.
4. Delay some leasing decisions – especially long-term multi-year leases.

We believe these themes are lasting, notwithstanding any near-term resolution on tariff policy since these themes are based on policy uncertainty – and the uncertainly is likely already baked into the cake.

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Chris Bedingfield

Fears of an imminent US economic downturn are premature given government spending will remain consistent with last year’s levels or even higher. According to Chris Bedingfield, principal and portfolio manager, Quay Global Investors, spending will support economic growth and company profits, while the expected hit to inflation from US tariffs is likely to be one-off.

“The US central bank will watch closely the impact of Trump’s tariffs on economic growth and it may even cut interest rates this year if activity slows too much, which could support the prices of listed real estate assets.

“In the absence of any other fiscal adjustment, tariffs will act as a fiscal drag, slowing the economy and reducing profits and potentially consumer spending. In what is perceived to be an over-heated economy, that may not be a bad thing and may provide scope for the US Federal Reserve to continue to lower interest rates, which would be positive for listed real estate assets as credit costs fall.

“The bigger risk to the US economy is economic policy uncertainty – which could delay private investment, compounding the impacts of higher taxes or tariffs, resulting in a more meaningful slowdown in the US. At this point, however, the outcome is too early to call, but something to monitor closely.

“However, if companies do choose to delay investment decisions because of tariffs, such as the decision to renew leases, this in itself can become a drag on the economy and also work as a significant drag on company profits,” he said.

According to Mr Bedingfield, while tariffs on US imports may increase consumer prices, he does not believe sustained inflation will result. He expects more of a one-off hit to prices, with the biggest risk to economic activity.

“Over time, viewed correctly as a tax, tariffs may well be deflationary by slowing the economy. This view was recently supported by the US Federal Reserve in last month’s monetary policy statement stating that they were assuming that tariffs would cause a one-time jump in prices, rather than a more sustained increase, but it is also a hit to growth,” he said.

The US Federal Reserve (Fed) now expects inflation to stand at 2.7 per cent by the end of the year, up from the 2.5 per cent it had predicted in December. However, the Fed is also expecting economic growth in the US of just 1.7 per cent this year, down from the 2.1 per cent it had previously anticipated.

In terms of US government spending, Bedingfield is reasonably upbeat despite expectations of a huge crackdown on government spending. This follows after the second Trump administration introduced cost-cutting measures developed by the new Department of Government Efficiency (DOGE).

“Despite the concerns of government cuts and drive for government efficiency via ’DOGE’, there has been no deceleration of government spending or net deficit so far in the first quarter,” he said.

“In fact, relative to the same time in 2024, gross and net spending have increased. Further, despite calls for increased government efficiency via DOGE and the elimination of government waste, the recently passed stopgap funding bill known as a Continuing Resolution extended most current funding for the next six months, as well as increased spending on defence and border security.

“We have long argued that while macroeconomics is a hard beast to predict, investors have a better chance if focused on the fiscal pulse in the US, that is, net government spending, rather than an indirect credit pulse, monetary policy. And the data backs us up,” said Mr Bedingfield.

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Chris Bedingfield

Australian real estate is the quintessential “barbecue stopper”, especially if there are multi-generations attending. In a cost-of-living crisis the discussion has only been heating up.

But we believe that many of the reasons cited for Australia’s high property prices – and there is no denying the rapid escalation over recent years – are not necessarily true.

In a nutshell, this is an asset class that people desperately need an education on. While interest rates often drive the discussion around residential property prices, they are only one element – the cyclical element – of the cost of real estate.

The other element is the structural element, which means real estate prices itself around replacement costs over time. For example, if an office block costs $100 million to build today and in ten years’ time costs $200 million, office blocks in general will be priced around that $200 million mark, regardless of interest rate fluctuations in the meantime. Otherwise, there would be no reason for a developer to build any more office blocks ever again.

Myth 1: Population growth drives property prices

One of the most popular reasons cited for Australia’s residential housing crisis, or record high property performance, is population growth.

But by comparing Australia to a similar market, we can observe very different trends in property prices in the below charts.

Texas is the second largest state in the US and is a good comparison to Australia.  It has a comparable population to Australia – 20 million at the turn of the century. Both economies are supported by the resource and service sectors, both populations have increased by around 40 per cent over the past 23 years and most of that population growth is from external sources (immigration).

However, despite almost identical population sizes and growth profiles, the absolute value of house prices and rate of change is significantly higher in Australia, at 343 per cent since 2001compared to 196 per cent for Texas. We think this is conclusive evidence that population growth does not drive house prices. 

Myth 2: Capital gains tax policy has impacted property prices

On September 1999, the then-Howard government changed the capital gains tax law from allowing investors to index their cost base (to CPI), to effectively halve the capital gains rate for assets held for more than one year.

As the housing debate rages, many commentators point to this tax change as a core reason Australian residential prices have soared this century – yet we see no evidence it had any impact on assets that had a similar advantage to the changes – namely equities.

This tax change certainly has had advantages for Australians, and means the principal place of residence will be last tax free asset they have, but the chart above clearly busts the myth CGT changes altered the property market.

What’s really going on?

It seems like every investment manager has an opinion on property, whether that’s their area of expertise or not. Always be wary of people who are not experts in this field trying to scare you by talking up a housing bubble or a housing crash.

Unfortunately, we have made it extremely expensive to build in this country, with the cost of planning, government charges etc taking up close to 40c in the $1. As long as this remains the case, real estate prices are likely to remain high.

However, if you gear yourself carefully when buying property, and are patient, you’ll likely look back in 5- or 10-years’ time at a very solid investment.

By Chris Bedingfield, portfolio manager

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Chris Bedingfield

In financial markets, there’s always something to worry about.

For the better part of three years, markets have fretted about a 1970s-style inflation cycle. It seemed every inflation print mattered (sometimes to the nearest rounded second decimal point). Even more than other substantive issues, like how much profits companies were generating.

As the US inflation rate predictably normalises back to its pre-Covid levels, it seems the latest worry is now the possibility of a recession and fears the US Federal Reserve is now ‘behind the curve’ in terms of reducing interest rates^[1].

Focusing on the Sahm Rule

The US July employment report undershot expectations, posting a 110k job gain. This was soon followed by a rapid sell-off of the Nikkei Index (-15%), and a fall in the US market the following trading day. For a few days the markets were in turmoil and the fear of a looming US recession was to blame. Even the Federal Reserve has stated that the downside risk to employment has increased².

Although a positive job gain for any month would seem a pretty benign recession indicator, commentators are now highlighting the trigger of the so-called “Sahm Rule”.

Named after prominent economist and former section chief at the board of governors of the Federal Reserve, the Sahm Rule states the start of a recession occurs when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months.

The track record of this indicator has been impressive.

However, we’ve seen these ‘perfect indicators’ before. In 2022 another perfect indicator, ‘inverted yield curve’, was to be the harbinger of the next recession, which failed to materialise.

In December 2022, we questioned the predictive power of the inverted yield curve, recognising that the once-in-a-lifetime pandemic, and the fiscal response to it, probably altered the economy in such a way that many of the old economic rules no longer apply.

So, could the Sahm Rule be another false alarm?

There are other recession indicators that point to ‘no recession’

Another recession indicator is the size and direction of the US federal budget balance. Although not ‘perfect’, the historic pattern appears to be that whenever the US deficit is reducing, there appears to be risks that economy will either cool or enter a non-pandemic recession.

Alternatively, proactive deficit spending (that is, deficit spending not caused by an economic slow-down) is associated with sustained economic growth.

The reason is that unlike quantitative easing (QE), fiscal deficits actually reflect money printing.

This significant fiscal expansion in 2022 wrong-footed many commentators that overly relied on the impact of monetary policy (and the inverted yield curve).

The large reduction in deficit spending in 2021 and 2022 led to a surprise contraction for the US economy in the same period.

The lesson seems to be if one is worried about the state of the US economy, the fiscal balances of the government should be part of the calculus.

Deficits are important for investors

Sadly, there is still a widespread belief a sovereign currency issuer like the US (and Australia) will face a fiscal crisis³ due to increasing levels of government debt. An idea that we debunked in our Modern Monetary Theory article.

And for those who have abandoned their fiscal crisis rhetoric, they have simply replaced it with the equally discredited ‘deficits cause inflation⁴’ mantra.

But federal deficits are important (positive) for investors as the net spending adds to the financial assets of the non-government sector, supporting incomes and company profits.

The impact of this ‘macro accounting’ is best visualised via the sectoral balances depicted in the chart below. In short, one person’s spending is another’s income. And one entity’s deficit is another’s surplus.

The recent data (Q1 2024) points to a fiscal deficit of -7.5% of GDP resulting in net savings to domestic companies (+2.7%), foreign savers (+3.0%) and households (+1.7%).

And while household savings are well down from the Covid peak (+21.1% of GDP) the accumulated savings since 2013 (+$35 trillion) have resulted in a household sector that is in ’rude health’. As per our previously published research, these accumulated savings are acting as a buffer against potential recessions, signalled by either the inverted yield curves or the Sahm Rule.

Meanwhile, company savings (as a % of GDP) has accelerated from 0.9% of GDP (Q4 2022) to +2.7% (Q1 2024). Is it any wonder why the US share market is booming? Thank the deficit.

More broadly, with a US deficit tracking at 7.5% of GDP – neither accelerating nor decelerating – it suggests an economy muddling through.  And with US politicians focused on the November vote, it is unlikely this cadence will change any time soon.  Based on this factor, it seems the odds of a US recession are pretty low.

What about Australia?

The economic reality of ‘one person’s spending is another’s income’ is universal and applied equally to Australia. But unlike the US, the consolidated fiscal deficit (federal and state) is contracting and, as of March 2024, stood at 1.4% of GDP.

Source: ABS Cat. 5232.0, Quay Global Investors

Despite the start of the ‘stage three tax cuts’ in fiscal 2024, the forecast federal deficit is expected to remain around 1% of GPD over the next two years. And for those that suggest this is somehow inflationary, they would have to come up with some rationale why the US deficit (7x larger) is resulting in lower inflation.

The result of an absurdly small deficit in Australia is already resulting in weak economic performance, with real per capita GDP growth posting negative growth for the last five quarters.⁵ Given the lack of political will to run deficits necessary to meet the savings desires of the household sector, the structurally low fiscal deficits will inevitably lead to structurally lower interest rates as detailed in our article, Aussie interest rates are heading for zero (again).

Concluding thoughts

So, is the US headed for recession? Based on recent fiscal flows, the odds seem low. Using the same framework for Australia, the outlook is far less sanguine. As a caveat, we note that recessions are notoriously hard to predict.

At Quay, we are firm believers in the adage that it’s better to build an ark than try to forecast the weather.

In that vein, we maintain a portfolio tilted toward recession-proof of sectors such as senior housing, affordable accommodation and self-storage with companies supported by great management teams and solid balance sheets while benefiting from structural tailwinds.

By Chris Bedingfield, principal and portfolio manager 

———-

Sources:
[1] https://www.wsj.com/finance/investing/federal-reserve-behind-curve-1357e515
[2] https://www.federalreserve.gov/newsevents/speech/powell20240823a.htm
[3] https://siepr.stanford.edu/news/fiscal-instability-behind-ticking-time-bomb-us-debt
[4] Debunked as US deficits increased in 2022 and into 2024, coinciding with falling inflation
[5] https://www.brokernews.com.au/news/breaking-news/australias-per-capita-recession-continues-for-fifth-quarter-284864.aspx

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Chris Bedingfield

Quay Global Investors, a Bennelong boutique, has celebrated its 10-year fund anniversary, returning 10.05 per cent per annum* since inception to investors in its Quay Global Real Estate Fund (Unhedged). 

The active listed global real estate manager has outperformed its index* by 3.81 per cent since inception.

The 10-year milestone also saw Quay reach $1 billion in funds under management.

Co-principal and portfolio managers Justin Blaess and Chris Bedingfield attributed the success of the business to its outstanding investment team, unique investment philosophy, as well as the ongoing support of Bennelong Funds Management.

“Reaching our tenth anniversary, as well as $1 billion in funds under management, is a great achievement. Our success reflects the trust investors place in our team’s expertise and dedication.

“We continue to see strong opportunities for investors in global real estate, particularly off the back of renewed expectations of interest rate cuts in the US, and look forward to another decade of success for our investors.

“It’s been great working alongside the talented team at Bennelong to reach this milestone,” Mr Bedingfield says.

Quay partnered with Bennelong Funds Management in 2015.

Bennelong CEO, John Burke, said that co-founders Chris Bedingfield and Justin Blaess have led the business to outstanding success over the past decade.

“Quay has consistently grown while providing investors with solid returns and access to a diverse range of listed real estate opportunities across the globe, at a time of continuous change in markets.

“Thank you to the investors who have joined us on Quay’s journey. We’re proud of the team’s accomplishments and look forward to many more years of successful partnership.”

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Most of the world’s data centres are in the US, where there are over 5,000 centres, with a combined capacity of over 7,000 megawatts (MW) – more than the combined capacity of the next four largest countries of China, Japan, UK and Germany.

Leasing demand for data centres is derived from two broad sources: hyperscale tenants or very large technology companies like Amazon, Google, and Microsoft, and smaller retail tenants such as banks, companies, and government.

“The demand from AI is being led by hyperscale tenants, or the large US technology companies. The combined annual capital expenditure of Amazon, Microsoft, Google, and Meta has increased by 26 per cent from 2020 to 2023, with forecasts projecting a further 33 per cent increase by 2025,” he said.

“In recent months, global leasing activity has surged, achieving record-breaking levels in each of the past four quarters to 31 March 2024.”

Mr Truong says that remarkably, more megawatts have been leased in this twelve-month period than in the preceding three and a half years.

“Hyperscalers are rapidly absorbing available space and power. Consequently, rents are growing. This looks likely to continue as current power capacity is absorbed and future supply can’t keep up with such strong demand.

The chart below shows the soaring demand for global data centres.

According to Mr Truong, supply is responding to this surge in the need for space and power in data centres. Capacity under construction in the US has grown to just over 3,000MW at the end of 2023. However over 80 per cent of current construction is already pre-leased, compared to around 50 per cent in prior years.

“This significantly decreases the risk of oversupply. Power constraints will also restrict the supply response. Generative AI requires a tremendous amount of power compared to conventional uses. Difficulty sourcing power and procuring generators and transformers are adding multi-year delays to the development timeline of data centres,” he said.

Mr Truong suggests that the potential investment returns are appealing. “With development profits of 40 per-cent-plus and stabilised net operating income yields of more than 9 per cent, developments are proving to be lucrative which may suggest supply could accelerate from here.

“However, due to the long duration (10-15 year) nature of hyperscale leases, strong rental growth does not quickly translate to outsized earnings growth. A significant portion of current rental rolls were signed back when leasing environments were less favourable. Landlords are trying to speed up this process by divesting ‘low growth’ data centres and reinvesting capital into new developments. Nevertheless, it will take time to play out, however the trend is positive.

“Globally there are just five listed pure-play data centre REITs, with exposure to developed markets. Only one of these is listed in Australia and, in our view, it is priced at a premium compared to global peers. At Quay, we have the ability to invest in better opportunities globally.”

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Chris Bedingfield

Households are facing significant pressure on their balance sheets, however this is not a function of ‘the cost-of-living pressures’ or interest rates.

The squeeze on households is coming from deliberate government fiscal policy in Canberra according to Chris Bedingfield, principal and portfolio manager of Quay Global Investors.

“One of the biggest macroeconomic lessons learned from the Global Financial Crisis (GFC) is investors tend to overestimate the impact of monetary policy and underestimate fiscal policy. Even today, the amount of time dedicated to the impact of fiscal balances pales in comparison to the scrutiny dedicated to central bank actions.

“Yet the evidence suggests this focus is misdirected.

“Following the global financial crisis (GFC), the response was largely based on monetary policy to stimulate the economy. As we now know, the economic recovery after the GFC was very slow and inflation consistently remained below target, despite zero interest rate policy in the US and Europe.

“During the COVID-19 pandemic, however, the policy approach reflected a significant shift toward greater fiscal support (via deficits). The massive fiscal response during the pandemic resulted in a speedier recovery compared to the post-GFC era in terms of jobs and overall economic growth. The aggressive fiscal policy was mirrored in other developed economies, including Australia, with similar results,” he said.

However, Mr Bedingfield now expects the Australian economy to continue to slow – largely due to the current tight fiscal policy from Canberra.

In recognising the accounting identity that requires one entity’s savings is derived from another’s deficit, Bedingfield points out the pursuit of a fiscal surplus will continue to harm the local economy.

“By law, the federal government requires employees and households to save while simultaneously depriving these households of the net financial assets required to support such savings.

“If households are required to run a fiscal surplus (save) equal to roughly 10 per cent of income, and the federal government refuses to run a fiscal deficit, one of two scenarios play out:

1. The household sector borrows the 10 per cent difference to maintain consumption, or
2. Households can only spend 90 per cent of income in any one period resulting in a decline in economic activity from one period to the next.

“The first option can sustain economic growth for a while, but at the cost of rising household debt. This is something that occurred during the Budget surplus years of the Howard Costello government (which required households to run large deficits). However, at some point, as debt balances swell, the appetite for additional household credit wanes, spending will slow and the economy sheds jobs,” Mr Bedingfield said.

As they did prior to the pandemic, households will turn to credit to maintain consumption. And like they did prior to the pandemic, the RBA will accommodate this need via monetary policy. In the absence of a change in fiscal policy, this consumer and policy cycle will repeat until we approach zero (again). The only uncertainty is the timing.

“Recent data suggests the RBA may soon change tack and cut interest rates, beginning the march towards zero interest rate – not because of high inflation, but due to a weakening Australian economy.

“In our view, the industry most vulnerable to a sharp rise in near-term unemployment is the construction sector. New dwelling starts are at or near 2013 levels, and the construction industry currently employs 350,000 more workers today compared to what was required to meet the 2013 construction cycle. This means the construction industry has significant excess capacity relative to forward workflow. This is meaningful, as one in 10 Australians are directly employed in construction so the job cuts could be significant,” said Mr Bedingfield.

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“If history is any guide, and central banks begin to reduce interest rates, the global REIT sector is due for a bounce, supported by the relatively robust macroeconomic environment. From a timing perspective, global real estate begins to generate outsized returns to investors in the lead-up to, and after, the first interest rate cut by the US central bank,” Mr Bedingfield said.

Source: Quay Global Investors, Bloomberg, FTSE EPRA NAREIT Index. Based on first federal reserve (US) interest rate cuts average of June 1995, Dec 2000, July 2019 (Excludes GFC / COVID)

“Long-term real estate security prices follow earnings, and earnings, in turn, are driven by rents and cashflows. For investors looking to take advantage of these opportunities, the global listed property market provides more diversification and access to these sectors that are not readily available in markets such as Australia,” he said.

“With this in mind, we are seeing promising opportunities in several sectors, including residential rental properties driven by a global housing shortage. Senior housing is another area where we see potentially strong growth along with shopping malls, as landlords mark rents up to better reflect economic reality and the strong inflation we’ve experienced in recent times.”

According to Mr Bedingfield, central bank actions designed to curb inflation has sent a signal to builders to stop building.  And globally they have listened.  Meanwhile populations continue to grow creating a significant demand and supply imbalance.  Of course, we see this real time here in Australia, but this phenomenon is happening in other developed markets too such as the US, Canada and Europe.  The best part is the listed REITs that own these types of assets are trading well below where is its feasible to build new supply – giving investors great downside protection which offering medium term upside gains.

Elsewhere, as populations age, seniors housing accommodation is becoming more important. “The sector is needs-based and relatively immune to economic conditions. And despite an expected surge in demand, net new supply is at a cyclical low due to high construction costs. We expect a rise in occupancies, enhanced pricing power and ultimately, more robust earnings growth from experienced leading senior housing providers,” he said.

Another area where Mr Bedingfield sees upside is in the retail sector. “Since COVID, the recovery in in-store retail sales remains well above the prior pandemic trend, with in-place rents still largely reflecting a pre-COVID world. As landlords continue to mark rents back up to economic reality where inflation is higher and foot traffic in malls remains robust, we expect good financial results from the best malls in 2024,” he said.

Over the longer term, global REITs have delivered handsome returns to investors, and are likely to continue to do so, according to Mr Bedingfield. “Importantly, REITs offer investors earnings defensive qualities as they achieve a high proportion of their returns from income sourced from rents, which provides a regular income stream to investors. Rents too are typically linked to inflation, a link which bonds and term deposits mostly lack. Listed property also has a low correlation of returns with those of other equities and fixed income investments over the long term.

“Reflecting this, global REITs have performed strongly for investors so far this century, as global real estate ranks in the top three asset classes nine times versus global equities (five times), and Australian equities (eight times), as the chart below shows, ” he said.

Source: Bloomberg, Robert Schiller http://www.econ.yale.edu/~shiller/data.htm, NAREIT

Mr Bedingfield is cautious on industrial property, which has benefited from more tailwinds in recent times including the secular growth in e-commerce, COVID and lockdowns; these headwinds are now diminishing as the world has returned to more normal times. “Industrial investment success is a double-edge sword, as with investment demand comes the incentive to build a new supply. We have seen substantial new supply and although landlords currently believe this pipeline is manageable, the greater supply could put downward pressure on rents,” he said.

More broadly, given the huge diversity of property assets on offer globally, investors need to note the advantage of global REITs over Australian REITs. “While the Australian listed property market is dominated by a few big property trusts, the global listed property market is more diversified and includes some sectors that are not readily available in Australia such residential rental properties and senior accommodation providers.”

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