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Australian listed property still in the lead
A standout investment performer over the last decade has been Australian listed property trusts, with the sector outperforming all other asset classes. Index returns of 14.3 per cent a year (S&P/ASX 200 Property Index, 10 years to December, 2005) have occurred, with a standard deviation of 9.7 per cent a year over the same period.
Why has the Australian property sector done so well and what are the reasons for diversifying property exposure to include global allocations?
Structural shifts in Australian listed property
Macro theory would suggest that, over long periods, returns from the property sector should not be much greater than nominal gross domestic product (GDP), as property does not create wealth in the same way as a company in the real economy does. Evidently, this has not been the case over the last 10 years.
It is therefore important to ask whether there were any special factors that explain why a sector punches above its weight and whether these factors are sustainable. These factors tend to be structural and once an adjustment has been made the sector returns to more explainable levels.
For the Australian listed property sector, we would argue there has been a one off structural adjustment as the sector moved from low levels of securitisation to one of the highest levels in the world. With limited room to lift levels further, the scope for further strong gains in the capital component of returns is diminished and future expected returns are forecast to be much lower.
What about global property?
The global property sector hedged to Australian dollars has several desirable characteristics. First of all, the sector has produced high returns, 11.02 per cent a year over the last 10 years using the S&P/Citigroup BMI World Property Index Total Return Index hedged to Australian dollars. These higher returns, as investment theory would suggest, come with greater volatility; the sector’s standard deviation for the last 10 years is 17 per cent.
We project that these returns are sustainable over the next 10 years as levels of securitisation within the sector continue to rise and help boost the capital component of returns. This is in contrast with our expectation that returns from the Australian property sector will moderate.
Another desirable characteristic of the sector is its low correlation with Australian asset classes. We have calculated that over the 15 years ending December 2005, it has only a 0.205 correlation to Australian shares, 0.155 to Australian fixed interest and 0.072 to Australian cash. Even with Australian listed property trusts, the correlation was 0.250.
Combining lowly correlated asset classes is not only a diversification tool but can also improve the risk/reward characteristics of a portfolio.
Within the global property sector itself, correlation between sub sectors is also low, notwithstanding the high level of volatility of the overall sector. This reflects the fact that countries will be in different stages of the macro, demographic and GDP per capita cycles. Once again, taking a global approach in this asset class should lead to better diversification and reduced volatility (or risk) for a better overall level of return.
Not only is there greater opportunity for diversification across asset classes, but within countries and their economic cycles. Diversification benefits are also apparent in the underlying property itself. For example, Australian investors have limited choice in residential investments compared to a more expansive global range.
The countries themselves are also in different stages of securitising their property assets. Whereas Australia is the most securitised property market in the world, Citigroup’s global real estate investment trust (REIT) strategy report (January 2006) states that only 7 per cent of global commercial real estate is securitised into the listed markets. Of the total property assets in the US, Europe and Japan, Citigroup estimates that approximately 10 per cent or less are held in listed securitised structures. This is compared to the maturity of the Australian market — 36 per cent of investment grade property is securitised in the listed market.
In the last five years, France, Japan, Hong Kong and Singapore have launched REITs. With pending REIT legislation in the UK and Germany, as well as continuing property securitisation in other developed markets, we would expect the investible universe to grow beyond the over 300 stocks and market capitalisation of A$1 trillion currently available.
Once again, it is worthwhile to compare the global universe against the local and highly concentrated S&P/ASX 200 Property Index, with 25 stocks (of which Westfield makes up 31 per cent) and a market capitalisation of A$90 billion.
A continuous rate of securitisation and different valuation methods employed across countries also make the global property sector ripe for active investment management. Taking a global approach to the sector and normalising the financial statements gives an ‘apples to apples’ comparison of the securities, allowing investors to choose the security that will provide more alpha bang for their buck.
Stephen Hayes is managing director, Perennial Real Estate Investments.
AUTHOR
Mike Taylor
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