Most new unlisted property fund vehicles raising funds in the market are providing ‘back-to-basics’ closed-ended syndicates with a single asset and quality tenant and a long weighted average lease expiry says the report “Direct Property Funds Sector Review” by Lonsec Research Pty Ltd.

The report also highlights that pre-tax yields for these vehicles range from 7.5%-10% and that gearing levels are now in the range 40%-55%, down from 55-65%.

Jason Huljich, CEO of Centuria Property Funds Ltd and recently elected President of the Property Funds Association of Australia (PFA), welcomed the report saying, “It is good to see the analysis of what we have known for a while now, that the unlisted property fund sector is in recovery and investors are back in the market supporting managers with quality offerings”.

The report gives an update on the status of funds and managers which have had difficulties but also notes the emergence of new boutique fund managers.  Mr Huljich commented, “It is always a good sign of confidence when new fund managers start to emerge, both in the value of the underlying property markets and in the appetite of investors to reinvest in the sector.”

Results from the Unlisted Retail Property Fund Index, released by IPD, an MSCI Brand, and sponsored by the PFA reinforce the Lonsec Report’s findings that the sector has come a long way from the depths of the property market crisis in 2009.  Total returns over the last 12 months have stayed around 7%-8%, with the latest quarterly result indicating a 7.2% total return for the year to March 2013.

Mr Huljich said, “The PFA is pleased to support rigorous analysis of the unlisted property fund sector, both at the retail and wholesale level.  With these figures, our fund managers can properly benchmark their performance, and we look forward to seeing the results as the sector continues to improve.”

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In the current market, Retirees are becoming increasingly concerned with the substantial and sharp reduction in their capital base, which is primarily the result of  exposure to highly liquid investments. 

In a typical portfolio theory, the total allocation to property is 11% and of this allocation, 73% comprises listed property exposure[1]. Due to the close correlation of listed property to equities (currently about 0.7, whilst unlisted property is -0.2), PFA believes that portfolio theory may need to be revised so that listed property forms part of the equities allocation, and property allocation comprises predominantly unlisted, syndicated (or direct) property investments. 

PFA President Robert Olde, said; “Despite  the noise surrounding the property sector and funds that have incurred capital losses in recent years, Unlisted Property and Syndicates remain the strongest performing core asset class inAustralia over the last decade. They have outperformed the Australian equities market by 2.2%pa, but with much lower volatility.  In fact, the volatility is closer to that that experienced by bond investors, providing further proof of the defensive nature of direct real estate investment.” 

“On this basis, one must ask why the investment industry continues to back  lowallocations to unlisted/direct property investments when it appears to be a superior  asset class for long term superannuation investors, especially as the investments trade on fundamentals, not sentiment,” he said.

 Mr Olde said data obtained from Mercer Investment Consulting’s performance surveys also supported a change in thinking in property allocations.  “Results showed that as a defensive component of a portfolio, Unlisted Real Estate provides growth returns with defensive characteristics and Unlisted Property has provided the same Risk/Reward Contribution to a Portfolio than Australian Bonds but with significantly higher returns.” 

Results from Mercer showed that over the 10 years to 30 June 2011:

• Cash returned 5.4% pa
• Australian Bonds returned 6.2%pa, with a 2.9%standard deviation (a risk-reward ratio of 2.1)
• Unlisted Property returned 9.4%pa, with a 4.4% standard deviation (a risk-reward ratio of 2.1)
• Australian Shares returned 7.2%pa, with a 13.3% standard deviation (a risk-reward ratio of 0.5)
• Australian REITs returned 2.2%pa, with a standard deviation of 17.6% (a risk-reward ratio of 0.125).

Mr Olde added, “The current allocations are also particularly interesting when you consider that High Net Worth and Ultra High Net Worth investors hold up to 35-50% of their portfolio in property[2]. Property is seen not only as a way to preserve wealth, but to also augment it and this is particularly relevant when you consider that property investment in most cases is an inflation hedge, given the structure of leasing arrangements. If the sophisticated investors are so heavily weighted to property, why is it that a similar approach is not adequate for the typical Australian retail investor?”

“Australian retail investors simply have too much exposure to listed markets and they should have higher allocations to unlisted real estate.  Historic evidenceover both the short and long term indicates the benefits of having a portion of one’s portfolio allocated to unlisted real estate funds.” 

Recent PFA research also shows that the totalreturns of direct property on an after-tax basis exceeded A-REIT returns over all examined periods. Tax, fees and other costs had a minimal impact on relative total returns from direct and listed property. 

Cumulative returns of direct property and listed property over 25 years also showed direct property supplied higher returns than A-REIT’s, with substantially lower volatility due to the lower level of liquidity, which is inherent in real estate investment.

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PFA Vice President and member of the Sustainability Committee, Adam Murchie, said while there is a significant opportunity for property to play a part in reducing emissions, the Government needs to ensure the scheme does not favour replacement of buildings over upgrades. 

“Commercial and residential buildings contribute over one fifth of emissions in Australia. Given the inputs into property (steel, cement, aluminium, glass, gas, electricity, etc), building owners and occupiers are likely to experience cost increases should a carbon tax be introduced,” he said.

“As a carbon price will place a greater focus on energy usage and the total cost of occupancy, it could inadvertently accelerate building obsolescence where owners are unable to fund upgrades so that their buildings remain competitive.  It is likely that anything other than premium grade real estate will need support to remain competitive.”

Mr Murchie said the PFA firmly believes that a Carbon Incentivisation Scheme for real estate is required to ensure the continued feasibility of existing stock and to avoid having a major gulf between old and new stock across Australia.  

“The carbon scheme, although environmentally sound, is a very real threat to the competitiveness of existing real estate and theiroccupants if the cost of upgrading buildings is left unaddressed.  In particular, it is imperative to address the existing stock as retrofitting existing buildings, given their embodied energy and existing use of resources, is far more sustainable thanbuilding new premises.  If this is not addressed, the negative impact, particularly for secondary grade buildings that make up the majority of the stock, could certainly be a burden on the industry in five years time.  This will affect both property investment as well as business competitiveness and will hurt the smaller investors more than the larger institutional players.”

Mr Murchie added that a transition process needs to be developed now in partnership with the Government.  “The property industry is already a leader in sustainability, but it will need support to react appropriately to the changing economic environment that the Carbon Scheme, as proposed, may bring.  Without support, a potential outcome of the changes could be significantly higher rents for non-residential premises to offset the cost of building upgrades or the rise in outgoings.  With business profitability already at low levels, an added impost could send many businesses to the wall.”

“It’s the occupants of those buildings requiring upgrades who will be forced into higher rents to offset the cost of the carbon price.   This will reduce the competiveness of many businesses.  Alternatively, the outcome could be accelerated obsolescence for existing building stock, which may force values down and in turn, restrict capital investment across the sector.  I’m sure that it’s not the intention of the government to reduce the attractiveness of real estate investment, given its importance to the Australian economy.   A partnership on this issue could in fact achieve quite the opposite, especially as some of the greatest gains, at the lowestcost, are possible from the property sector.”          

Mr Murchie said technology has already been developed that can significantly reduce emissions.  If the government provides support programs that promote the upgrade to low emission technology, this would not only stimulate economic activity, but potentially lead to Australia having the greenest building stock in the world, in addition to a relatively easy and cost-effective way to reduce carbon emissions.” 

“The $10bn Clean Energy fund will support the deployment and commercialisation of renewable energy, low emissions intensity and energy efficient technologies.  Given the potential property has to reduce emissions, the PFA believes that a fair share of these incentives should be directed to property, particularly given the long term life cycle of real estate.”

In addition, the PFA believes the government needs to implement more direct action for property under programs like the Green Building Fund, and deliver on tax incentives under the green tax breaks program. This will help reduce emissions faster and bring other benefits such as increased employment and the development of exportable skills and technologies.

To this end, the PFA has been working for over three years to prepare its members for the inherent changes in the property and investment sector which will be bought about byclimate change.  A dedicated Sustainability Committee has been addressing the risks and rewards of the impact of climate change on property and has been arming its members with tools so they can take meaningful steps to transition. 

“This is about knowledge” says Murchie, “and armed with the right information we hope our members can make the right decisions. Like the Target 155 program or the Green Star ratings tool, whenarmed with relevant information and a benchmark to aspire to, the market typically tends to change its behaviour for the better.”

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