Property. Australians are obsessed. And it appears our unwavering fascination isn’t influenced by the time in the cycle; whether it’s rocketing skywards or, such is the case now, prices have peaked and values are well and truly heading south.
But the current picture painted by the domestic residential market shouldn’t deter investors from looking towards other property classes, with global property leading the charge.
As an asset class, real estate can deliver attractive, long-term, inflation-protected returns, and importantly, offers portfolio diversification. It can also offer investors both capital and income growth and, if a disciplined and well-researched approach is taken, risk can be managed effectively – for instance, by limiting exposure to developments.
One of the big advantages of real estate as an investment is that it’s based on real assets. As long as leverage is managed, real assets rarely lose all of their value. Even under a worst-case scenario, the rate of obsolescence for quality property is low.
Since 2000, global real estate has consistently outperformed both Australian and US equities. Even when performing relatively poorly, global real estate has made a strong recovery in the ensuing years.
Diversification remains key
For Australian investors, global real estate can provide as much diversification as global equities - with a better return track record. It’s therefore likely to provide much needed diversification even for investors who hold domestic property.
There’s a steep learning curve for investors as they move from a mindset focused on acquiring an investment property, to recognising other property sectors such as commercial or retail, to considering whether to invest directly or through unlisted or listed funds, and finally looking at opportunities outside the somewhat limited domestic market.
In order to access these opportunities, investors should look beyond the Australian property market to the global environment. Global real estate is a large and diverse industry offering access to many attractive themes that are often not readily available or of sufficient scale in Australia. As such, it can offer an attractive investment proposition regardless of any short-term risks to the market.
Australian investors who seek diversification by coupling Australian shares with domestic residential investment property may not be able to obtain the benefits they seek. With a significant proportion of the S&P/ASX 200 represented by banks and other financial institutions, and approximately 60 per cent of the banks’ assets in residential mortgages, the current decline in Australian property values may subsequently have a detrimental impact on the local sharemarket.
In extreme market environments – a time when diversification is perhaps most valuable – a portfolio of Australian residential property and shares may offer no real diversification at all as the two asset classes could turn out to be highly correlated.
Instead, a better option for property investors may be to diversify into global property exposure. An important aspect for portfolio construction is to allocate capital to uncorrelated asset classes while maintaining an overall return objective, making global property – with low correlation - an appropriate option.
Global real estate sectors abound
While Australian listed real estate is significant in size, it provides limited access to the sectors expected to benefit from some of the strongest real estate themes. For example, listed real estate entities investing in health, aged care, student housing and apartment (rental) sectors are very limited or non-existent in Australia.
Aged care is a prime example. While the issues and opportunities of an ageing population are relatively well understood in Australia, it may not be as well recognised how these same trends are playing out overseas. For instance, over 10,000 Americans are turning 65 every day and, as a result, demand for aged care facilities is expected to increase significantly over the next five to 10 years.
Internationally, there are property sectors that offer strong prospects to investors but either aren’t as readily available in Australia or don’t yet have the scale, including the following.
The demand for Western-style higher education is a theme prevalent around the world. With more and more people looking to study at educational facilities based primarily in developed markets such as the US and the UK, the demand for student housing is growing, and with it the opportunity for investors. While it’s also a theme in play in
Australia on a smaller scale, the opportunities for investors are much broader and stronger overseas. Student accommodation offers a reliable and non-cyclical cashflow.
This term is used primarily in the US to describe homes that are built in a factory and meet strict, federally-defined criteria. After being constructed in the factory, the homes are transferred to specific sites. Essentially, the home owner owns the house but not the site, where they instead pay a lease. Such approaches are rising in popularity in the US, where they allow retirees in particular to live in areas such as Florida or California, and generate extremely predictable cashflow.
Healthcare and aged care
This is a sector that has some local opportunities for investors but the size of the market is significantly bigger overseas. And while spending on healthcare assets has increased in the past decade, in the face of the demographic landslide we believe over time it will barely keep pace with demand.
Housing affordability remains a big issue in developed markets around the world. In Europe and North America, people tend to be more willing to rent, creating a groundswell demand for apartments. Different laws and regulations also make renting more attractive in many European countries, where tenancy is seen as a long-term option rather than a stepping stone before buying.
This sector is very strong almost everywhere including Europe, the US, the UK and Canada. From data storage facilities to warehouses for shipping products around the world, the demand for industrial property looks set to continue for some time. Undersupply continues to be a problem and in the UK, self-storage offers an attractive and defensive earnings outlook.
Despite the threat of e-commerce, best-in-class malls offer good opportunities for investors, particularly malls that focus on luxury and value-based retailers. Smaller shopping centres that meet local needs, focusing on groceries, services and pharmacy, will also continue to perform well.
Listed vs unlisted?
The arguments for investing in property can be readily understood, but appreciating why to invest in listed real estate rather than directly is more complicated.
For many investors, the main attraction of investing in property is that it’s a physical building they can visit, photograph, renovate and touch. However, there are several advantages to taking the listed rather than the direct or unlisted route, and these relate predominantly to liquidity and minimum investment.
Liquidity is a key attraction for investors. Being able to quickly and easily redeem any investment has become an important consideration, and direct or unlisted property is notoriously illiquid. Even unlisted pooled property funds, which may own several quality buildings, can have difficulties selling a property quickly in order to raise cash.
During a crisis or downturn, it is often the best assets that are sold while the poorer ones remain within the fund, impacting its quality and investor returns. This was the case during the global financial crisis, when many unlisted property funds were forced to hold ‘fire sales’ to dispose of assets, in order to raise money to pay out investors. Listed property funds, however, have much better liquidity and can respond to any investor withdrawals more easily.
Buying a property directly is an expensive business, and there are numerous tax and legislative requirements to consider. Even investing in an unlisted property fund can require a significant minimum investment of tens of thousands of dollars, which isn’t the case with listed real estate.
Chris Bedingfield is principal and portfolio manager at Quay Global Advisors.