“Recent research* shows that a diversified growth portfolio with no exposure to direct property has an approximately 18 percent chance of experiencing negative total returns, whereas one that contains a standard allocation of 10 percent to direct property has an approximately 14 percent chance of negative total returns.

“And the more direct property held within a portfolio, the lower the chance of negative total returns due to the stabilising effect of rental income.

“It is noteworthy that the same does not hold true of listed property, or Australian Real Estate Investment Trusts (AREITs), due to the high correlation of an AREITs share price with the broader share market.”

Mr Banting said that as well as reducing total volatility, direct property can contribute to higher income returns within a portfolio. (See Chart A.)

“Direct property has generated consistently high income returns with lower absolute volatility than even cash and fixed interest, in contrast to AREITs, over the last 25 years.

“The reason for this is that direct property income returns are directly correlated with the property’s rental profile.  This has resulted in less volatile income returns than AREITs, which have historically had a higher exposure to property developments, overseas markets and other volatile investments.

“As well as providing stable income returns of around 7 to 8 percent, direct property also provides the opportunity for capital growth in the long term as rents are often inflation linked, resulting in increases to capital value.

“As part of portfolio construction, having unlisted retail funds with a longer investment horizon will be able to help boost yield for the portfolio as a whole,” Mr Banting said.

He added that investors hoping interest from overseas investors in Australian property will start to wane, causing prices to come down, are likely to be disappointed.

“The stability of the Australian market, high yields, and transparency, mean that Australia will continue to be an attractive destination for overseas investments, even if the interest rate gap between Australia and the rest of the world starts to close.

“Australian investors who are considering investing in property shouldn’t hold off in the expectation that the flow of capital internationally will dry up,” he said.

Chart A

 Source: Atchison Consulting, S&P/ASX, MSCI, REIA, CBA, UBS, RBA, PCA/IPD

* Property Funds Association Investment Report, Property Performance Research, by Atchinson Consultants – February 2014

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Office property is seeing a high level of interest: Australian Unity Real Estate Investment.

While foreign investors continue to be attracted to all property sectors, office property is seeing a particularly high level of interest, driving up asset valuations in some locations, says Mark Lumby, head of property funds – retail at Australian Unity Real Estate Investment.

But outside of the traditional CBD markets, there are good opportunities for investors seeking an investment in office property, he says.

“Over the last five years, foreign investors’ appetite for Australian office property has gone from being a relatively small component of their overall property allocation in Australia, to being by far the largest sector – almost three times bigger than retail property, which was historically the most attractive.

“More than 60 percent of foreign capital going into Australian property has been directed to office investments since 2005. In addition, a number of overseas residential developers are buying old office buildings and converting them to residential properties.

“On top of this, AREITs are now trading at a premium to their net asset value once again – eight percent as at 31 August 2014. Coupled with strong interest from private syndicates in a low interest rate environment, these factors are all creating competitive tension and increasing asset valuations in some locations.

“This has resulted in high transaction volumes and pricing for office property in some CBD locations to the point where investment returns are too low for some investors, such as institutional investors, to meet their investment objectives. Typically, these return objectives are CPI plus five percent.

“As a result, these investors are now turning to the ‘secondary’ office market, such as in Sydney and Melbourne fringe areas, which contain excellent investment opportunities.

“For example, Parramatta in Sydney, and St Kilda in Melbourne, have both been delivering good stable returns for investors.  We have seen a number of superannuation funds investing in these areas as they offer the potential to better achieve the kinds of property returns they require.”Mr Lumby said that the stable returns for investors in Sydney and Melbourne office property are likely to continue for some time.

“There continues to be reasonable leasing demand for office space in these cities.  Even though the development pipeline is strong – for example, the Barangaroo development in Sydney’s CBD which, on completion, will represent approximately five percent of Sydney’s CBD office space – there are a number of office buildings being converted to residential or hotel use which, when coupled with the moderate levels of tenant demand, should keep a lid on vacancies.

“It’s a different story in Perth and Brisbane, however.  As the mining industry transitions from the construction to the production phase, many big mining corporations are reducing their office space requirements in these cities.  At the same time, there are some major new developments coming online, such as Kings Square and Elizabeth Quay in Perth.

“This is creating a huge amount of supply on the market, and there simply isn’t the demand over the short or medium term.  As a result, we expect vacancies to increase in the short-term in both Perth and Brisbane from their current levels of 11.8 percent and 14.7 percent respectively” Mr Lumby said.

Another positive sign for investors in office property is that business conditions have been improving over the course of the year.

“Office tenant demand tends to lag business conditions by about one year.  At a reading of +4 index points, the latest NAB Monthly Business Survey[1] shows business conditions at close to the highest they have been for four years, so the outlook is pointing towards improved tenant demand.

“And when focusing on secondary office properties, a comparison of industry conditions for SMEs and larger sized firms, taken from NAB’s Quarterly Business Survey[2], suggests that smaller firms are performing better than their larger counterparts in a number of industries – as well as reporting better conditions overall.  This evidence supports the low vacancy rate in many suburban office markets like Parramatta where the vacancy rate is 6.7 percent compared to Sydney’s CBD which is at 8.4 percent,” he said.

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Patrick Noble

Zurich Financial Services Australia (Zurich) contests recent commentary on the merits of active management in the increasingly buoyant Australian Real Estate Investment Trusts (AREITs) market, instead believing that the uneven performances seen within individual sectors of the economy add a level of risk to a passive approach.

Mr. Patrick Noble, Senior Investment Strategist within Zurich’s Life and Investments business likens the passive approach to buying a whole street.

“In simple residential property terms, why buy the whole street when really what you want is to selectively choose a property in the right location, priced at a discount to your expert market valuation, and which can be moved in and out of quickly?” he said.

“We have a positive outlook for the AREIT market but the opportunities are not uniform in our view.

“For example, we have a preference for REITs with an exposure to residential but are more cautious for securities with exposure to the office market. Residential is benefitting from both recovering markets and improving margins whereas office to us is struggling under high vacancy rates and new construction which is adding to supply.

“Under researched and under owned small cap property securities are also offering some good opportunities,” he added.

The sector has demonstrated strong returns over the past 5 years and yields also remain appealing for investors.

“But simply taking a passive position belies our strong conviction that there will be a wide dispersion of future returns in the listed property sector.  Investors should consider the argument for highly active, nimble management alongside the appeal of the AREIT market,” said Mr. Noble.

One fund utilising such an approach is Zurich’s Australian Property Securities Fund, recently commended by Morningstar Australia in recognition of its “track record for serving unit holders well.”*

Mr. Noble said the fund was highly regarded by other independent research houses including Lonsec and Zenith and has recently been included in the model portfolio for a major listed institution’s private wealth investment lineup.

“The strong message for investors is to seek out active managers with a proven track record as the market requires specialist skills now more than ever,” he said.
Fund wins Model Portfolio Listing

The Zurich Australian Property Securities Fund has recently won a position on the model portfolios offered to clients of Perpetual Limited-owned licensee Perpetual Private Wealth.

Mr Philip Kewin, General Manager Retail for Zurich’s Life and Investments business said it was pleasing to see further uptake of the Zurich Investments’ model to develop strategic partnerships with best-of-breed investment specialists.

“Renaissance has been a strong partner to Zurich and our customers since 2005. As we forge new business partnerships with a strategic, long-term focus in mind it is very encouraging to see investors and their advisers rewarded by the diligence we bring to our manager line-up,” he said.

Mr Kewin said listed property investment was the traditional domain of investors seeking reliable income and some capital growth over the long term.

“Australian investors can access a Fund that has convincingly reminded us that a disciplined, rigorous investment approach together with highly active market capability can help to achieve such outcomes”.

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