Property that’s affordable and reliable
The daily diatribe on Australia’s residential property market from the media, economists and various lobby groups and calls of an impending slow down create a growing shadow over investment in the property sector. However, as Julia Forrest, co-Portfolio Manager of BT Investment Management’s Australian listed property funds suggests, there is a dearth of investment opportunities across the property sphere worth considering. One of the industry’s veterans in listed property investment shares her thoughts on where the risks and opportunities are today.
What is your role as a portfolio manager at BT Investment Management (BTIM)? What does it entail and what areas are you involved in?
I work in the Australian equities team at BTIM. My area manages the Australian Real Estate Investment Trust (A-REIT) funds, which means investments in property securities.
You’ve been working for BTIM for more than a decade and even longer within the industry. How has the Australian property sector evolved over that time?
I have been at BTIM and its former incarnation under BT Financial Group for 14 years and have been involved in researching and managing assets within the AREIT sector for 24 years. Listed property is a very dynamic asset class that performs differently at different stages of the business cycle, so it’s always changing, and always interesting. Like many industries, listed property has undergone its fair share of change and consolidation. When I started in the industry there were only a handful of property companies listed on the ASX; in the lead up to the GFC there were over 50 and today that number is down to 30 (in the S&P/ASX 200 Property index). Through this time there have been numerous opportunities to profit from merger and acquisition opportunities as they usually represent a premium to the prevailing share price for investors. Today we have the opportunity to invest in groups that have investments in residential property assets in addition to well-established operators in retail, office and industrial property. The property universe also includes assets such as childcare centres, storage facilities, petrol stations, retirement living and even healthcare property assets, so while the number of companies has reduced, the range of assets has expanded.
What type of residential property investments are available within the listed sector?
Property companies with exposure to residential developments include Mirvac, Stockland, Gateway Lifestyle, Villa World and Sunland. Many of these are involved in the development of land and dwelling construction which offer a diversified exposure to property across different geographies. Residential investments can also include tourist accommodation, retirement villages and even investments in many of our favourite local hotels. Many of these companies have been beneficiaries of the multi-year growth in Australian residential property, but unlike the typical investment in one or two single investment properties, investing in a listed property company provides much broader property exposure which significantly lowers the risks associated with investments in a single asset.
How strong is the Australian listed property sector right now and can you tell us what’s driving its growth. What is the outlook like for the rest of 2017?
The A-REIT sector has produced impressive 17% returns per annum for the past five years. The growth has been driven by falling cash and bond rates, as well as solid earnings growth across most of the property sectors. The outlook continues to be solid, although it would be difficult to continue producing those hefty annual returns. It’s worth noting that the listed property sector has lagged the broader share market over the last year as market earnings growth has recovered, particularly for resource stocks. At current pricing the sector offers a solid 4.7% yield with 3-4% earnings growth, but I would say that A-REIT prices and asset values are looking a little full relative to our valuations, so further growth beyond these total return expectations of around 8% in the short term may be limited.
How much longer can the booming Australian property market remain strong, in particular the level of commercial rents in Sydney? Are there risks in the listed property space that concern you, and where in commercial property do you think investors should be looking?
We have been very bullish on Sydney office property for the last two years, although it’s really only started to be reflected in A-REIT prices for the last year. We continue to believe the under supply of A/B office space in Sydney (office space has three levels; A, B and C, with A being the best and brightest, and B the mid-level) will see strong net effective rental growth until a supply response kicks in around 2020. Retail property like shopping centres are more difficult to predict as channel shifts continue to change the way we shop. The arrival of players like Amazon will change the market, for example, and there will be winners and losers.
How is global uncertainty affecting the way you invest right now? Is it something you have to consider when making financial predictions?
Global uncertainty has without doubt had an impact on bond yields but the good news is that low bond yields are very supportive for A-REITs. Naturally, it is very difficult to put a price on global uncertainty so we prefer to focus on where we can add value; through earnings and valuations. The Brexit vote in the UK, the Trump victory in the US and the recent upset for Theresa May in the UK election have certainly shown us that the market isn’t very good at pricing these risks anyway.
Given the global uncertainties and the challenges facing domestic retailers, isn’t there still a valid argument to maintain investments in the residential property market?
I can clearly remember a time when a house was just somewhere that you lived, not an investment in the way that everyone seems to see it now. I have owned investment properties in the past, but for now we just have our family home. Given the stratospheric current pricing of dwellings in Sydney, combined with record high household debt levels (thanks to the size of mortgages) and low wages growth which is unlikely to change for a long time, house prices should flat-line for the next six to seven years. It’s a possibility that people really need to factor in when considering investing in the residential market. While there are challenges and uncertainties facing sections of the A-REIT market, there are opportunities that can be identified through dissecting the businesses to gain a clear understanding of where the investment risks are and where the earnings growth will come from. These are not always reflected in the share price and this is where we seek to add value for our clients.
How many people are in your team to comprehensively research these opportunities?
We are a tight team of two people focused on the A-REIT sector and part of a larger team of 20 analysts and portfolio managers. We are one of the largest teams in the industry focused on Australian listed companies so we gain a tremendous amount of insight siting with the analysts who cover other sectors with links to the property sector, including banks, consumer-related, utilities and engineering and construction companies. Peter Davidson and I have worked together at BTIM for over a decade covering the A-REIT sector. The model works really well as being a core team of two, we get to cross check ideas, modelling assumptions, observations from meetings with company management, and reach decisions for our portfolios relatively quickly. We are not handicapped by ‘group think’ or committee-based decision making like some of our competitors who run considerably larger teams that include junior analysts, entry level portfolio managers and economists. It may work for other firms but we prefer to operate a two-person structure that allows Peter and me to focus our efforts on delivering the right outcomes for clients. Our key focus is to understand the outlook for earnings and the catalysts for change ahead of the market. .
Given your team’s focus on A-REITs, do you find the scope of opportunities limiting at times?
Some of our competitors operate their A-REIT investment strategies within global property teams which invest heavily in offshore property markets. Property is inherently a local asset class driven by many local factors so we argue that the focus needs to be on Australian fundamentals when considering A-REIT investments, while remaining cognisant of the global influences. We are in a world with growing divergence in interest rates and business cycles so we want to ensure our investment decisions are not diluted by over-emphasising offshore factors.
BTIM offers fund investments in A-REITs and in global REITs through our partnership with AEW Capital Management, so we cater for both investor appetites. That said, we do invest in offshore property companies and other companies that are not included in our benchmark and do so where the relative value is attractive.
What aspects of the global market are relevant to A-REITs and how do you keep abreast of these?
The A-REIT market is considered one of the most advanced and mature markets in the world. Australia was one of the first to establish the REIT structure in 1971 following similar legislative enactments in The Netherlands and the United States. Many countries have since followed with varying degrees of success. Although we focus on A-REITs, many of the large Australian companies like Westfield have significant operations and assets offshore. Westfield has 35 shopping centres across London, New York, San Francisco and Los Angeles and their performance is naturally influenced by the local economic environment. We maintain a close eye on these assets and travel regularly to visit individual sites to gain an appreciation of local market metrics and validate our conviction in the investment potential.
You have a diverse career background including appointments at the Federal Attorney-General’s Department and the National Crime Authority. What has this experience taught you about property?
This experience early in my career was invaluable and is reflected in a part of the process we use, which we call ‘cross check and verify. We critically assess details and don’t make assumptions, preferring to check sources. For example, we won’t just take what the CEO is saying at face value, we like to cross check with mid-level management as well as with staff on the ground (i.e. shopping centre managers). I have previously worked in insolvency law and have learned to look for the key signs before a company hits trouble. Like most things in life, there are risks and there are opportunities. Our job is to balance both while retaining a focus on preservation for our clients’ money.
After 24 years within the property sector, what are the key factors that maintain your interest?
Being a trusted fiduciary of Australians’ retirement savings is a big responsibility and is something I maintain a strong passion towards. The idea of guaranteed retirement income is well and truly extinct, but holding investments in companies that can offer a relatively stable yield of 4-5% and earnings growth of 3-4% over the cycle goes a long way towards meeting the income needs of retirees. And despite the rapid disruption facing many industries globally, I truly believe that value can always be generated from ‘bricks and mortar’ type investments.