The real deal
24 December 2013
By David Macfarlane
Asia has come of age in the last two decades. And its real estate markets have matured significantly and opened up to international capital.
Institutional investment in Asian real estate really only began in the mid-1990s with the raising of the early generation of closed-end Asia funds. According to Scott Girard, CEO and CIO, Asia real estate at M&G Real Estate, Asia now comprises around 34% of the global real estate investable universe and it is growing, on average by 11% per annum – far quicker than other regions.
“Asia is now firmly part of the global portfolio allocation decisions made by institutional investors both with respect to core open-ended and value-added investment strategies,” he says. “The opening up of China to foreign investors has certainly been a key element in attracting capital to the region. The creation of China specialist businesses has also been a significant catalyst in attracting capital from overseas.”
When the first edition of Asia Asset Management was published 18 years ago, commercial real estate was in the midst of a dramatic shift from the private sector to public markets – a shift that has resulted in the massive expansion of the global real estate securities market.
Vince Childers, senior vice president and portfolio manager of Cohen & Steers’ real assets strategy, says the catalyst at the time was the emergence of the modern real estate investment trust (REIT) structure in the US in the early 1990s: “Even though REITs had been around since 1960, new legislation made it easier for companies to operate and put public shareholders on a level playing field with private real estate investors. The success of this model led to the adoption of similar legislation in other countries,” he explains.
Today, 22 countries have adopted the REIT structure, while legislation is in progress or under consideration in another 15, he adds. REITs are quite prevalent in Asia Pacific now, particularly in Australia. However, the region continues to see a broad emphasis on real estate development due to the shortage of quality housing in China, Singapore, Hong Kong and India. Retail development is also popular, providing a means of tapping into the growing disposable incomes of the expanding middle classes.
Due in large part to global REIT adoption, the global real estate securities market has tripled in size since 2000, and is now valued at approximately US$1.5 trillion. This has significantly increased the ability of investors to participate in commercial property investment through global allocations to listed real estate.
Role of real estate
Real estate, and in particular unlisted real estate, is recognised as an important cornerstone in a balanced portfolio, both for the stability it provides and the consistent income it can deliver.
Tim Nation, head of real estate capital at AMP Capital, points out that the weight of money during the last three years or so has been almost exclusively directed towards core/prime real estate, again on the basis that it proved during the global financial crisis (GFC) to be very defensive and, in some cases, fairly liquid (albeit at a price). “We have seen global institutions increase their strategic allocations to real estate for these reasons during the last few years,” he says.
There are numerous ways of using real estate within a multi-asset portfolio. However, property’s primary role is to generate income with an underlying expectation for income to rise with rentals. Mr. Girard notes that rental agreements, in some markets, are frequently inflation linked, which offers the investor an inherent inflation protection mechanism. “For this reason,” he says, “real estate is seen as an integral part of their multi-asset portfolio by institutional investors with inflation-linked liabilities, such as pension funds and insurance companies.”
For these investors, with longer-dated liabilities, real estate is considered to offer an attractive illiquidity premium at different stages of the investment cycle. In addition, it is a key diversifier with both bond and equity attributes, and it mitigates the negative impact of inflation on inflation-linked liabilities. Mr. Girard observes that many portfolios include direct and unlisted real estate to generate income, provide enhanced liquidity and diversify risk.
“If you feed property risk/return metrics into a mean-variance optimiser programme, the system would generally overweight property, such is the potential quality of returns provided by core real estate with solid rental covenants. Higher allocations to real estate make sense for institutional investors with longer-term liabilities,” he says.
So where are the best opportunities in the real estate market now and how do they fit into a broader portfolio context?
Mr. Childers says: “We are currently finding attractive opportunities throughout the global investment landscape. Accordingly, we continue to recommend a globally diversified allocation to real estate securities as being the most attractive and efficient means of investing in real estate. On a geographic basis, we have become more positive about Europe and the US, while scaling back in Asia Pacific.
“However,” he continues, “we continue to have a favourable view of Australia’s property market and take an increasingly constructive view of Japan. We particularly like companies focussed on London, many of which are trading below the value of their underlying assets. In China, we believe residential developers stand to benefit from a more moderate GDP growth rate, as this has reduced the risk of additional policies to restrain housing prices.
The last few years have seen an insatiable appetite for core real estate in major gateway markets globally. In a number of markets this weight of money has seen yields compress to such a point that the investment rationale can be little more than wealth preservation rather than meaningful investment returns. This is also off the back of some fairly benign occupational markets.
“At this point,” says Mr. Nation, “while there has been significant investment in Australia from both domestic and offshore players, yields have mostly gone sideways for an extended period, although still offering income yields in excess of 7%.
“Core-plus real estate (or core real estate in secondary markets) is the next logical opportunity for global capital, and potentially where mis-pricing currently exists due to it being largely ignored by equity and debt investors during and since the GFC.”
Private investment capital continues to flow into Asia Pacific, particularly to Australia and Hong Kong. However, the liquidity afforded by publicly traded real estate securities enables fund managers to be more opportunistic about their allocations than they could be with direct real estate investments: “For example, we have recently adjusted our positioning in Hong Kong and Singapore due to the increased supply outlook and the potential negative impact of higher US Treasury yields on property values in these countries,” says Mr. Childers.
According to Mr. Girard, European investors have been actively viewing Asian real estate as it offers the prospects of growth relative to their domestic markets plus significant diversification. He says there is also growing interest in US markets on the back of impending economic growth. At the same time, investing in the US can be relatively complex due to taxation (e.g. FIRPTA) and onerous reporting requirements that can be imposed at both federal and state levels.
Mr. Nation points out that Australia has seen unprecedented interest and investment from global institutional investors during the last few years across all three sectors: office, retail and industrial. “The robust macro-economic environment and sound property fundamentals have provided a lot of comfort to global investors spooked by the turmoil and uncertainty experienced elsewhere. In an investment environment where a high value is put on sustainable income over speculative capital returns, Australia has continued to deliver.”
He continues: “Global pension and sovereign investors from North America, the Middle East, Europe and Asia have all been active resulting in the strongest capital inflows ever recorded by JLL Research in 2012. While occupational markets in Australia are also soft, cap rates have remained at a point where investors can still be comfortable that any downside risk is already priced in.”
Asian cross border investment has largely been outside of the region, Chinese real estate investment being a notable exception. Korean, Malaysian and Chinese SWFs and insurance companies have been very active investors in the UK, the US and Australia and are now moving beyond the English-speaking countries, says Mr. Girard. “Investment has been mainly in direct deals rather than fund investments. As of now, it is insurance and SWFs that are the primary sources of capital – pension funds, beyond NPS, EPF and KWAP have been slower to diversify offshore,” he notes.
Mr. Nation says current pension fund weightings to real estate across Asia Pacific vary widely, from less than 2% in Japan to typically 8% – 10% in Australia.
Furthermore, he elaborates, Asia-Pacific pension funds tend to be very heavily biased to their home markets, even in Australia where the portfolio weighting is one of the highest across the region.
“In some markets, pension funds have only recently begun an offshore investment programme, for example Japan and South Korea,” says Mr. Nation. “South Korean pension funds in particular have been some of the most active globally in 2013 and are likely to continue to be so. Japanese pension funds are ramping up offshore strategies and Australian pension funds are very slowly starting to consider offshore strategies once again, largely driven by the shortage of core opportunities in their domestic market. Strategies range from investment in direct assets, joint ventures, unlisted funds or global real estate investment trusts.”
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