Listed property may have been the factor which has dragged down returns for many superannuation funds but, as Damon Taylor reports, some real opportunities are emerging for investors willing to take the plunge.
It seems a long time since the super industry had anything but bad news regarding investment returns.
Despite a March rally within equities markets, all asset classes continue to take big hits and there are very few brave souls willing to say that the end is in sight.
Yet the first rule of any downturn is that the investment opportunities are out there for those savvy enough to take advantage and, according to Ken Atchison, managing director of Atchison Consultants, property might have more than its share.
“Listed property, both international and domestic, has been taking an absolute hammering recently,” he said. “So does the sector represent value? Yes, it does.”
Atchison said that for institutional investors, the value and opportunities to be gained within listed property were based on the sector’s anticipation of some pretty savage revaluations of its underlying assets.
“Any listed property with high levels of debt is still going to have a limited upside,” he continued. “And that needs to be kept well in mind.
“But subject to that proviso and with distribution yields that are attractive compared to bonds, the sector looks appealing.”
According to Atchison, establishing the investment case for unlisted property reveals a similar story.
“It’s a similar story with a similar proviso,” he said. “The revaluations that have already been priced into listed markets are still happening within unlisted property.
“There’s still some downside,” continued Atchison. “But if we’re looking at an economy that’s starting to see the end of its dislocation, cap rate yields are at high single digits and fundamentals are relatively okay.
“One of the great qualities of property is its ability to provide income, and while that holds true, its investment still has a solid place in allocations.”
From the perspective of an institutional investor, David Hartley, chief investment officer for large industry fund SunSuper, said the fund was certainly underweight property with respect to its strategic allocation.
“But that reflects that we haven’t bought in a while and that we sold a property last year,” he said. “And at the moment, the listed side is problematic.”
Hartley said prior to 2004 listed property had been a fair surrogate to direct property and that funds had been able to invest in what he termed ‘look-through’ vehicles.
“There might have been a little bit of leverage but on the whole, they were pretty much straight look-through vehicles,” he said.
“Obviously that changed in 2003 and 2004 before going crazy in 2006. The market sent the message that it wanted more leveraged, more complex property investments, but in the wake of this financial crisis listed property trusts (LPTs) have come right down.
“They’re now tracking below net asset value and probably below fair value,” Hartley continued. “They’re a lot more volatile than the underlying properties and have been shown, effectively, to be just another equity.
“Direct property that is unleveraged, unlisted and conservatively geared is very different but right now, there’s no reason why listed property should be seen as anything other than equities.”
However, the impact felt by institutional property allocations has been more than a by-product of the global financial crisis surrounding all investment.
Twelve months ago many pundits pointed to property’s woes being as much a result of poor capital management as it was of poor investment performance and Atchison said that, to some extent, he saw that trend continuing.
“There’s almost been a sea change with respect to long-term investors becoming concerned with short-term liquidity,” he said. “And it will take some time to wash through.”
Jonathan Stagg, consultant at Frontier Investment Consulting, said 12 months ago the problems within the property sector could be isolated to capital market fundamentals.
“Rental growth and space demand were still strong but there was little available equity and debt for acquisitions,” he said.
“The situation 12 months on has been exacerbated by deteriorating space fundamentals which, with the global economic recession, is just as important an issue in terms of property values.”
Stagg added that capital structures continued to be a problem within property investment and that liquidity was set to be a prime focus for investors going forward.
“The banks want to reduce their exposure to the property sector as a whole,” he said. “And that places significant pressure for new equity from investors to support banking loan to value covenants and capital structures.
“Lower rental streams on lower levels of equity put pressure on income performance, with values falling further and impacting total returns.”
Stagg added that there had also been a renewed focus on liquidity from a whole of fund perspective.
“As with other asset classes, investors and fund managers have been hit by the rapid removal of liquidity from the property sector,” he said.
With respect to capital management and whether mistakes were still being made, Atchison said that many property structures had failed the stress tests generated by the global financial crisis.
“Unfortunately, there were some structures, including hybrid property funds, that pretended to be liquid and were proven not to be,” he said. “They weren’t built well enough to be liquid.
“Liquidity will continue to be a priority,” Atchison continued. “But moving forward, the hope is that super funds will work out a liquidity policy that doesn’t require 100 per cent liquid assets.
“That seems to be the fear at the moment.”
For Atchison, the big lesson to be learned from this period — beyond sector, beyond capital management and beyond liquidity concerns — is gearing.
“That’s where a lot of property investment came unstuck,” he said. “And to fix the problem I’d advocate introducing risk budgets into property allocations.
“The experiences that many investors, both retail and institutional, have had in the last 12 months shouldn’t mean that they avoid highly geared property altogether,” Atchison continued. “They just have to budget for it.
“Don’t fall into the trap of having your entire property portfolio highly geared.”
According to Stagg, different investment strategies had the potential to support different levels of gearing.
“Ironically, at the moment gearing is quite accretive to yield,” he said.
“With interest rates lower than property yields, the proposition of higher levels of gearing in core funds could be quite attractive to equity returns once capital returns stabilise.
“But the problem is that the debt isn’t available and existing facilities are being reduced.”
Of course, despite liquidity concerns, direct property has traditionally been the first port-of-call for those funds looking to minimise return volatility without going to fixed interest allocations. And even in the midst of a financial crisis, Atchison believes it is continuing to play that role.
“In a diversification context, in terms of diversification away from listed property and listed equities, direct property is continuing to prove relatively sound,” he said. “But the key lesson has been around highly geared property.
“Highly geared property is an altogether different animal and it doesn’t provide that same degree of diversification.”
Looking at the property sector, Atchison said the tried and true formula for super funds investing in property, whether direct or listed, continued to be the retail, industry and office sectors.
“That hasn’t changed,” he said. “But interestingly, I’d say that office property has the potential to be among the riskiest sectors.
“It’s standing up well because the supply side isn’t storming the market,” Atchison continued. “Rents aren’t collapsing and provided we’re talking about a quality property with secure tenants, the sector is generating income and performing relatively well.”
Atchison said he had seen nibbles at alternative areas within property investment in retirement villages, hotels, serviced apartments, student housing, residential property and even agriculture.
“But there’s almost a feeling that no one wants to be the first or second or even third to try these new sectors,” he said. “And I think that reservation will always be there.
“The other lesson learned from this financial crisis has been the importance of a secure income stream,” Atchison continued.
“That’s fundamental. If the alternative sectors can prove they have a secured income stream, they will certainly emerge eventually.”
Hartley’s view on alternative property sectors was similar.
“It’s always useful to think outside the box,” he said. “When it comes to property, you’re really after the property fundamentals and expectations of a rental income stream.
“If an alternative property sector can provide a better return, and if funds are careful about how they tie themselves to these alternative businesses, why not go there?”
Stagg said he continued to see the big three property sectors retaining their position as the main focus.
“There have been one or two newer products trying to invest within the residential property sector,” he said.
“They’re getting some traction but not a significant amount as yet. It’s an interesting sector given that it accounts for such a large portion of the property assets across the country.
“We are keeping a close eye on those opportunities but have not invested yet.”
According to Stagg, the main difficulty is access.
“Access at a reasonable cost and scalability are the main difficulties,” he continued. “And there’s also a view that many members of super funds already have significant exposure to residential property returns via their own homes, so do they need to double up?”
Stagg said it was probably too early to tell which property sector had best weathered the storm because of continued and significant moves in valuations.
“Until the market frees up and we start to see transactions, it’s going to be hard to tell.
“But there should be some great opportunities in the main sectors in the not too distant future,” Stagg added.
“In the next 12 to 18 months, we’re probably going to see a number of distressed sales and that will represent significant opportunity for cashed up investors.”
At the end of the day, despite the challenges presented by a turbulent financial crisis, the reality is that superannuation is a long-term investment and that, for many funds, this financial crisis is unlikely to have had a significant impact on long-term strategic allocations.
But for Hartley, the biggest question posed in the last 12 months and one that could change property investment into the future lies in listed property.
“I think that’s the biggest question that’s arisen,” he said. “The role of listed property trusts as a separate allocation.
“As things stand, I think there’s very little justification to have an asset sub sector in what is effectively another equity,” Hartley continued.
“And it may be that listed property needs to get back to basics and become the look-through vehicle that it was initially.
“Because at the moment, listed property might as well be equities.”
For Atchison, liquidity and its impact upon property investment has been the most disturbing feature of the past 12 months.
“People have seen property as not liquid,” he said. “And their response has been a tendency to focus on just liquid investments.
“But property’s fundamental rules will flow through when sentiment returns,” Atchison continued. “And with baby boomers already entering retirement and wanting retirement income, the income generating qualities of property will again come to the fore.”
