Adam Murchie

Current market dynamics are creating an interesting opportunity set says boutique property fund manager, Forza Capital. Established in 2010 by Adam Murchie and Ashley Wain, Forza Capital has developed into a business known for its savvy investment positions, with investors averaging IRR’s of 29% per annum net of fees based upon exited investments.

A credit squeeze on both residential purchasers and developers has significantly impacted the short-term supply/demand dynamics, but it is unlikely to change the overall long-term market trajectory.

According to director Adam Murchie, the availability of credit for both residential purchasers and residential developers has been seriously curtailed.

“This has seen demand for residential property fall at the same time supply has decreased, as residential developers can no longer get their stock to market.”

“Short term, this is providing a ‘sweet spot’ for purchasers who want to upgrade their residence opportunistically.”

Adam Murchie believes these banking changes are not actually changing demand, rather, they’re simply deferring it.

“Current purchasers who cannot get finance will still want to purchase in the future, however the future residential stock supply pipeline has been squarely curtailed.”

“This will take time to mobilise again and it is going to create a supply bottleneck. Eventually this will see prices increase,” he said.

Co-director Ashley Wain believes this dynamic will worsen affordability; because rental vacancy is very low (see Chart 1), this supply squeeze will eventually put serious upwards pressure on rents (refer Chart 2).”

“Essentially, the affordability crisis is going to be relocated from owners to renters short term,” he said.

“Add in population growth that’s not tapering to the same degree as supply, in future years we are going to see some real pressure on housing supply and demand as evidenced in Charts 3 and 4.”

Forza Capital is known for its ability to find value in turbulent markets and it sees the current market dynamics as presenting some interesting reference points.

“Developers are unable to finance and develop sites and yet we have very strong long-term population growth. In Melbourne alone, we have witnessed an average of 145,000 new residents per annum over the last two years,” said Adam Murchie.

“Looking forward, we see a real need for future supply; over the last 20 years, 53% of this growth has been accommodated on the fringe, however infrastructure constraints will become an impediment to future significant growth on the fringe.”

Ashley Wain believes the ‘middle ring’ will be ‘tapped on the shoulder’ to accommodate the bulk of this growth.

“There are only so many new train lines, hospitals and schools that Governments can build on the fringe; as such, Governments will look to locate people where this infrastructure already exists.

“Large format land holdings in strategic locations with public transport and social amenity nearby will become highly sought after,” he said.

“For Forza Capital, the holy grail is securing income producing, large scale land holdings.

“With time, the investment performance of such sites can often be exponential and generally with reduced risk as you always have a fall-back position – they are very hard to find but are worth the wait”.

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Adam Murchie

Rising land values, population growth and constrained supply of new office accommodation is expected to put upwards pressure on Melbourne office rents in the near future says boutique property fund manager, Forza Capital.

Ashley Wain, co-director of Forza Capital says, “Over the past five-six years, the tightening of capitalisation rates – which have generally tracked bond rates – have helped keep downward pressure on rents.

“This is due to the fact that asset value growth, and not rental value growth, made feasibilities stack up.

“However, with bond yields now trending upwards, higher rents will be needed to justify new development.”

One of the key drivers of the increased cost in delivering new office stock in CBD and surrounding inner city locations has been the growth in land values. For the past 15 years, Melbourne’s new office construction has been driven by major developments in areas such as Docklands and the western end of the CBD, where cheap land values allowed developers to attract major tenants to new buildings at competitive rents.

Over 1,000,000m² of new office supply was introduced to the market in the past 12 years alone.

Forza Capital co Director Adam Murchie said “We have witnessed CBD development land values increase five to seven-fold over the last decade.

“This means higher rents are necessary to justify new supply and we therefore expect to see upwards rental movement on existing stock until such time as economic rents support the supply of new space.”

The following three examples of land transactions for major office developments (on a per developable metre basis) illustrate the price increases, from $454m² in 2006 to almost $3,000m² in 2018.

The current vacancy rate is 3.6%, the lowest level in 10 years. The Melbourne CBD office market is now approximately 4,500,000m² and with a new supply pipeline of 540,000m², is expected to exceed 5,000,000m² by late 2019.

Ashley Wain continued, “Melbourne’s population is currently growing at a rate of 2.7% per annum or 145,000 new residents each year, which is resulting in a fundamental alteration in long term annual office absorption forecasts.

“Essentially, the commercial office market can absorb annually almost double the amount of space it could a decade ago; we expect this will result in a supply shortfall and an increase in rents.”

“In addition,” said Adam Murchie, “space compression through hot desking and open plan accommodation has kept a lid on rental increases, but its impact is abating.

“Over the last 10-15 years office densities have reduced significantly from one person per 20m² to something closer to 1:12m².

“Our view is the ability to further compress workspace densities is limited and thus it will increase pressure on future rental uplift.”

Forza Capital expects to see reasonable rental growth for existing office space before meaningful new supply is developed.

Ashley Wain said, “Interestingly, we see office vacancy risk as a real opportunity at the moment.

“Financiers are not supporting transactions with significant vacancy; hence they have negative cap rate pressure on them.

“It’s our view that the right assets can be positively positioned to capture both rental growth and cap rate re-rating, which could potentially create significant value.”

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Adam Murchie

The introduction of the National Disability Insurance Scheme, together with an increased desire for thematic and impact investments, is creating the opportunity for the development of a disability housing investment framework says boutique property fund manager, Forza Capital.

Adam Murchie, co-director of Forza Capital says, “Disability housing is at a crisis point, a little like aged care was decades ago.

“Disabled people are either in aged care or remaining with parents or carers because they literally have nowhere to go.

“Government appears unable to provide the necessary supply, and we think there is a real opportunity for quality disabled housing supply to be delivered by the private sector.”

Forza Capital was recently involved in delivering a number of disability compliant apartments in its Supply Co development.

Forza Capital co Director Ashley Wain said, “We were approached by Guardian Living, a private company focused on providing apartment style Specialist Disability Accommodation (SDA) for those with complex physical and cognitive disabilities who are registered NDIA clients.

“We worked closely with Guardian Living on delivery of the apartments and through this process, our eyes were opened to both the need, and opportunity, for the delivery of quality disabled accommodation.”

Adam Murchie continued, “We loved the concept of integrating this sort of accommodation into our Supply Co project.

“It completely aligned with our ESG principles and we think we can use our skills in funds management and property to build an impact investment vehicle in this space.

“We are working with a few other well credentialled groups on this concept at the moment and we believe there is scope to deliver a high-quality outcome for disabled occupants while providing investors a fair return on capital.”

At Supply Co, to meet Guardian Living’s requirements apartments were developed to LHA (Liveable Housing Australia) “platinum plus” standards which required features such as level changes for easy wheelchair access, adjustable bathroom vanity units and kitchen work areas, assistive technology (lighting control, electrically operated doors and windows, smart appliances) and high quality finishes with a high resistance rating.

Stephen Vick, the Development Manager of Guardian Living said, “Guardian Living has a strong philosophy on design, tenant selection, building quality and relationships with the overall goal to facilitate people with disabilities to leave hospitals, nursing homes, ageing parents and group homes, and to support them to live independently in their “own” apartment.

“For many of the tenants moving into an SDA apartment, it will be one of the most significant and challenging times of their lives.

“They will be leaving a group or nursing home, or even a family home, with structured care and very little emphasis on independent living; this is a massive step and we want to get it right.

“To deliver this, we need to partner with projects that are well connected to the community, with apartments of a sufficient floor area and a developer who both shares our vision and takes the time to understand the process.”

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“Rental growth is driven by simple economics and we are seeing demand outstrip supply,” says founding Director Adam Murchie.

Forza Capital says the market rent for new office accommodation is generally determined by the terminal value of building a new project. Over the past five to six years the tightening of investment yields, which have generally tracked bond rates, have helped keep downward pressure on rents as office developers were obtaining their margin from yield compression, and not growing rents.

“With bond yields now trending upwards, the market can no longer look to yield compression to keep rents constrained,” commented Mr Murchie.

“Instead, softening investment yields are anticipated to put upward pressure on rents as new supply will not be economically feasible until the softening in cap rates is offset by substantial rental growth.”

One of the key drivers of the increased cost of delivering new office stock in CBD and surrounding inner city locations has been the stratospheric growth in land values.

“In the past decade we have seen CBD development land values increasing five to seven-fold; at the same time, the cost of construction has increased at nowhere near this rate,” Mr Murchie said.

“As a result, the overall cost of delivering new office stock has increased dramatically, which means higher rents are necessary to justify new supply.

“Typically, you see upward rental movement on existing stock until such time as economic rents support the supply of new space”.

Interestingly, the primary driver for increasing land values has been the repurposing of office development sites to residential developments. Supply side constraints are being further exacerbated by demand side drivers.

The current vacancy rate is 3.8%, the lowest level in nine years and net population growth is as strong as it has ever been. The Melbourne CBD office market is now approximately 4,500,000m2 and with a new supply pipeline of 540,000m2, is expected to exceed 5,000,000m2 by late 2019.

There are three dynamics Forza believes will drive an increase in office rents:

1.     Melbourne’s population is currently growing at a rate of 2.7% per annum or 125,000 new residents each year, which has resulted in a fundamental alteration in long term annual office absorption forecasts. Essentially, the commercial office market can absorb annually almost double the amount of space it could a decade ago. We expect this will result in a supply shortfall and an increase in rents.

2.     The move to open plan accommodation, followed by the concept of hot desking, has seen average office densities reduce significantly from 1 person per 20m2 to approximately 1:12m2. Forza Capital’s view is that the ability to further compress workspace densities is limited and thus will increase pressure on future rental uplift.

3.     The war for talent is leading businesses to continually upgrade their office accommodation to make it relevant to the new and evolving workforce. To attract the best human capital, a key element is the quality of the office accommodation, in addition to location relative to social amenity such as cafés, restaurants, bars, gyms and public transport.

“We are witnessing a combination of low vacancy, modest supply delivery, significant increases in land value, increasing construction costs, record population growth, investment yields that have reached the bottom of the cycle and a growing number of Gen Y employees that demand higher quality accommodation,” said Mr Murchie.

“All of these factors combined suggest rents for new office stock will be trending upwards in the near future.”

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Adam Murchie

There’s been a marked uptick in commentary about market cycles, market pricing and the risk of correction. Pricing and valuations are heightened across many asset classes, bringing into play the threat of downside risk. Given this scenario, how can investors’ portfolios be best positioned to withstand a downturn?

One aspect rarely addressed is the impact investment structure can have on investment performance.

The liquidity conundrum

Adam Murchie, director of Forza Capital commented: “Many investment operatives are fixated on the need for liquidity, that is, the ability to enter and exit an investment when you want.

“Without doubt, liquidity and the ‘easy’ strategy of picking an index as opposed to specific stocks has given to the rise and rise of ETFs.

“However, just as the ETF’s have risen in value off the back of their own momentum, what happens when the pendulum swings the other way?”

Liquid markets rely on rational investor behaviour to operate efficiently. However, as history proves, in falling markets investor behaviour becomes irrational and thus market movements are often magnified.

The liquidity and structure of ETF’s amplifies this even further, much in the way gearing affects an investment outcome – as such, this is something that needs to be considered when assessing a portfolio for risk.

Illiquid investment structures

“In property, which is our area of expertise, we have the luxury of having well established, well informed listed (liquid) and unlisted markets,” said Mr Murchie.

“As such, property is an exemplar for highlighting how a different investment structure can result in materially different outcomes.”

Figure one illustrates the returns from listed property and unlisted (core) property for the three years pre and post the GFC and is, therefore, is a strong representation of the impact of the cycle.

The post Tips for protecting investments through a market cycle appeared first on AdviserVoice.

Adam Murchie

The recent news that ASIC has commenced legal action against AMP is not surprising. The fallout that has resulted from the Banking Royal Commission, along with ASIC’s announcement that its financial services reforms has enshrined conflicts of interest within vertically integrated advice and product providers, have not come as a surprise to many long term independent service providers in the investment sector.

Forza Capital, a property investment provider to independent financial advisers and family office clients, saw danger signs when the Financial Services Reform (FSR) Act was first introduced. The regulations and compliance, especially for retail service providers, were so significant and so all-encompassing that the only real outcome was the merger and consolidation of many smaller operators that could no longer efficiently provide services.

“In effect, this was when we saw the first real wave of vertical integration occurring,” said Adam Murchie, a founding director of Forza Capital.

“Many smaller firms either sold out or rolled into a larger licensee. Under these bigger dealer groups, they were then driven by Approved Product Lists, white labelled products developed by their licensee and attractive commissions driven by business (or advice) volume.

“In effect, the changes removed competition and made it harder for the independent product providers to get distribution.”

The FSR changes were so significant they ultimately led to a range of unintended consequences for investors; a reduction in available products, stifled competition and innovation, and a focus on fees/commissions as opposed to advice outcomes.

The GFC then resulted in another round of huge changes to the advice industry via the Future of Financial Advice (FOFA) regime. The FOFA changes, while welcomed and required, significantly changed the business model of the advice sector; it impacted the ways advice was provided, and thus resulted in further consolidation and vertical integration.

“The FOFA changes were necessary because the reality is, the commission on advice model did not work,” said Mr Murchie.

“We have seen the very real ramifications of conflicted commission models laid bare before the Royal Commission and the truth is ugly.

“When FOFA was introduced, it further enshrined vertical integration while the sector worked out how to deal with the complexity of the changes they were now governed by.”

As the FOFA regime became more established, and advisers digested what being part of a vertically integrated model entailed, many started to see the issues, primarily conflicts of interest, that vertical integration bought to the advice dynamic.

“Water started to find its level,” Mr Murchie said.

“We saw a distinct shift with many advisers obtaining their own AFSL, establishing their own truly independent business models and going to a full fee for service offering.

“This shift has been a massive benefit for independent product providers as we find these independent advisory groups actively scour the marketplace looking for the best of breed investment providers.”

Having struggled with the integrity of the commission-based model, Forza’s directors designed their business around a zero-commission model. As a result, Forza only deals with fee for service advisory groups; when the business first launched in 2010, there were few such advisory firms, so it was a somewhat pioneering approach. Over the last five years, Forza has seen a massive shift in the advice sector to fee for service pricing and a shift in the willingness of independent advisers to engage.

One of the key differences noticed was that these independent, self-licensed advisory groups do their own due diligence and are therefore invested in the process and better understand the offer. One such firm is Providence Wealth, an independent advisory group underpinned by a single principle – to provide advice aligned only to clients’ best interests. This principle has served Providence Wealth, and its clients, well for nearly 20 years.

“We believe there is an inherent conflict in the manufacture of product and financial/investment advisory, as has been clearly demonstrated during the Royal Commission” said Grant Patterson, Managing Director of Providence Wealth.

“Being truly independent means we have no constraints when it comes to investment selection and the managers we trust and partner with; this results in the freedom to find the best opportunities, which in turn drives a better potential outcome for our clients.

“Being unfettered by institutional ownership or product manufacturing, independent practices are able to provide advice that’s honest, professional and unbiased.”

“Independent advisory businesses such as Providence Wealth don’t hide behind an APL or research house,” said Mr Murchie.

“Their advice is as good as the due diligence they have done. It is their name attached to the recommendation and it has bought a greater discipline where there is no conflict by way of commissions.

“We see this as a great outcome for investors. It has made advisers more invested in the process and more receptive to innovative ideas and opportunities as a way to create value for their clients.

“For this reason, high-quality operators were not dragged through the mud before the Royal Commission.”

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Adam Murchie

At Forza Capital, the team spends a lot of time speaking to both real estate agents and investors. There is no substitute for being at the ‘coal face’ for eliciting information that often precedes cycles or opportunities (or both).

For some time, these discussions have been uncovering a subtle pivot in asset allocation, in particular an increasing allocation to cash and a reduction in assets that are seen to have reached their cyclical peak.

According to the Capgemini Asia Pacific Wealth Report 2017, there have been several changes to the 2017 asset allocation of Australian High Net Wealth (HNW) investors when compared to their previous years’ report, as illustrated in figure one.

“While we are not suggesting a correction in property or bonds near term, there is a distinct investment link between the two,” said Adam Murchie, Director of Forza Capital.

“Given upwards pressure on bond yields, it is natural to see investors dialling back risk in both sectors.

“We have seen a number of clients exit investments where they feel the value adding has been completed.”

Mr Murchie continued, “The consensus has been that holding the investment for an extended period exposed them to greater risk than the future return profile would support, therefore they were better to convert to cash, sit tight and wait for future opportunities.”

Broadly, Forza tends to share the view of the HNW investors and is keeping an eye on bond pricing and property capitalisation rates in certain parts of the market. Debt can’t be priced at these levels forever and any mean reversion will hurt assets on very tight capitalisation rates.

“Notwithstanding this commentary, there are several areas where we identify opportunity, although it’s necessary to be prudent to ensure than any acquisition is robust enough to withstand any market shocks,” said Mr Murchie.

HNW versus retail asset allocation

The HNW asset allocation data presented in figure one differs considerably from traditional asset allocation for retail clients, which is illustrated in figure two.

Clearly, HNW investors have a much higher allocation to property and cash, which is consistent with Forza’s experience. This is further supported by the BRW Rich 200 List where asset allocation to property featured heavily; of the list, 80 people (40%) either made their wealth in property or use it as a major store of their wealth. On the same basis, property was a primary asset class for 47.55% of the Rich List wealth.

“This demarcation between the investment allocation of the wealthy and that applied to retail investors has always interested us,” said Mr Murchie.

“We often wonder why retail investment allocation is not more closely aligned to those who have had immense investment success.

“These statistics support what we see with our clients; many have a high cash weighting at the moment and are more comfortable with less liquid investments than retail investors.

“This liquidity element is interesting to us; when we speak to people about the need for liquidity, it is safety mechanism allowing them to exit an investment if they need to. If you drill down further, most have no intention to liquidate, and if they did so, it would likely be at an inopportune time as they respond to market cues.”

Interestingly, for a traditional retail investor’s portfolio, 90% of their portfolio volatility comes from their 60% allocation to equities. It is no wonder then that HNW investors favour more illiquid assets, property in particular, to mitigate portfolio fluctuations and risk.

We only wonder why more people in the investment sector don’t take notice.

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Adam Murchie

Over the last few weeks there has been an increased number of headlines in the major mastheads noting that many HNW investors believe current commercial property prices are “crazy” and “insane”.

This sentiment has been supported by a number of wealthy investors selling property assets which they feel are fully priced as the cycle reaches its peak.

The headlines accord with the feedback boutique property fund manager Forza Capital (Forza) has obtained directly from its HNW clients over the past nine months. Interestingly, Forza has been made aware that often these sale proceeds are being retained as cash rather than reinvested back into the property sector.

“In late 2016, we started to receive more and more feedback from our family office and HNW clients, that they felt the cycle was very toppy,” said Forza director Adam Murchie.

“Many of them advised that their cash holdings were at the highest proportion of their asset mix for some time; however, they indicated they were comfortable with this because it gave them firepower when the next cycle presents.”

As a result of this feedback, Forza has spent time researching its investor base to see if this dynamic was limited to a select few clients, or it was representative of the majority.

“From the many discussions we have had, there is a general consensus that the cycle is fully priced; increasingly, our investors are extending their cash holdings,” said Mr Murchie.

“HNW investors are still motivated to acquire strategic assets, but the investment needs to meet very strict criteria, otherwise the default position is to sit on their hands.

“In one instance, a client advised the gap between mandates approved by their clients, and the actual investments made, was as wide as they had ever seen.”

Traditionally, HNW investors have been at the forefront of market cycles, quite accurately picking the high and low points and making their investment decisions accordingly.

Mr Murchie said, “These investors do not feel a need, nor do they have a requirement, to be fully invested at all times. As such, they remain patient and use investment fundamentals as their guiding light for investment decisions.”

“The recent headlines come as no surprise to us – this feedback on market pricing has come direct from our clients for some time now”.

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In a stable market such as that we are currently experiencing, the divergence between the listed and unlisted sectors is somewhat insignificant. However, in a turbulent or correcting market there are often substantial pricing differentials which are intriguing given both markets are represented by the same underlying asset base.

This has been of immense interest to us as the performance differential can be attributed almost solely to ownership structure. Before we proceed any further, Forza Capital does not imply one investment medium is better than the alternative. What we do wish to identify and bring to the attention of advisers is this structural pricing differential given it has an important role to play in the formulation of a client’s investment portfolio.

For a long time now the investment market has priced an illiquidity premium into unlisted property investments relative to their liquid peers. Historically this premium has been between 200 and 400 bps over its listed alternative and is seen as recompense for a loss of control, not being able to transact in a timely manner and for being locked into an investment (often) for a fixed time period.

Whilst the logic behind the illiquidity premium is sound, what actually transpired in the market seems to challenge this. In a stable market, the liquidity of listed property investments acts as they should allowing investors to enter and exit positions in a timely manner with low transaction costs. Conversely, in the unlisted sector there are no effective secondary trading markets, entering and existing an investment has far lower liquidity and there are far higher entry and exit costs. On this basis an illiquidity premium can be justified.

However, this does not address what occurs during correcting markets. Typically such periods of turbulence or correction see liquid markets haemorrhage capital with the fall in the share price often far exceeding the actual fall in value of the underlying asset(s). Certainly this is highlighted by the divergent performance between the listed and unlisted property sectors during the GFC which saw peak to trough the unlisted space fall 20% whilst the listed sector fell 60%.

Based on the above, the “real” assets fell 20% but the liquidity of the listed investments magnified this negative outcome two fold as investors ran for the door. This is not a topic we have seen much discussion on, however the pricing impact on investors was huge.

Over and above the pricing outcome there is another important aspect to consider – the very time capital stability is required to manage the investment and ride out the cycle is the very time it is flowing out the door. Many funds learnt this the hard way during the GFC and were forced to raise additional capital at a massive discount to NTA, thereby diluting existing investors and further exacerbating their already significant losses.

Herein lies the question not often asked nor answered – how important is the liquidity and at what cost are investors prepared to retain it? Within this answer one must also consider the role investors want property property to play in their portfolio.

Classical portfolio allocation typically sees property as a defensive hedge against equity risk. Now consider that listed property performance is closely (almost perfectly) correlated to broader equity performance. On this basis the hedge is eliminated. For advisers this is important to consider and address as the changing nature of markets may mean portfolio construction needs to be reviewed.

Certainly there is an argument to suggest the liquid property markets should offer a return premium to compensate for the volatility and the reduction in the defensive portfolio hedge but the reality is there is no perfect answer to the listed versus unlisted property value proposition.

Each has an important role to play in investment portfolios, but the nature of each is shifting. Advisers need to ensure they are across the changing facets of property market structure/performance and consider whether portfolio theory and a client’s property exposures need to be reviewed and/or adjusted to reflect these changes.

By Adam Murchie, Forza Capital

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Forza Capital Pty Ltd holds Australian Financial Services Licence number 345 929. This article is general in nature only and does not constitute specific investment advice.

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