The Australian core fund taking on Europe
A new manager has begun raising capital from Australian investors for its European core property fund. Florence Chong speaks to its CEO Tony McCormack
As the child of global infrastructure fund manager IFM Investors and Australian real estate fund manager ISPT, there are big expectations of the fledgling International Property Fund Management (IPFM).
IPFM has just launched what is believed to be the first Australia-based, pan-European open-ended diversified core property fund, the Central Places Fund–Pan Europe (CPF).
Tony McCormack, IPFM’s CEO, says: “We have been moving into a lower-for-longer environment for some time. Yields across most asset classes have compressed since the global financial crisis, giving rise to significant capital growth.
“[Assets today] offer very low yields and low inflation. I don’t believe investors expect future returns to be as high as they have been in the past.”
McCormack says Australia is a perfect case in point. Core commercial real estate in the country has typically produced total returns of 8-10%, with the ISPT’s core fund averaging returns of 9.8% since its inception 25 years ago.
With a huge influx of overseas capital, particularly from China, Australia’s historically high yields have been “bullied” down, according to McCormack. He says the yield premium over developed international property markets that once justified Australian investors’ domestic bias has all but disappeared.
Australian yields are typically quoted on a fully leased, face-rent basis, excluding transaction costs. European yields are typically quoted on a passing-rent basis, including transaction costs, and rental incentives are much lower.
“After adjusting Australian and European yields to a net effective basis so that they can be more fairly compared, it is apparent that effective yields in Australia are very similar to the major markets of Europe,” McCormack says.
However, on a risk-adjusted basis, taking account of market size and local bonds, IPFM believes many European markets offer superior risk-adjusted returns. “For this reason, IPFM is offering investors the opportunity to improve portfolio diversification, performance and liquidity by investing in the deeper, more liquid markets of the growth cities of Europe,” he says.
IPFM is targeting 6-8% total returns on its portfolio. “IPFM will emulate its parents in adopting an investor-first culture,” says McCormack. “We exist only to benefit members. We are not like other fund managers; fees will be set as low as possible to maximise the return to members.”
IFM and ISPT were born when a group of 27 Australian super funds, including AustralianSuper, Cbus and Hesta, decided to pool their financial resources and enter infrastructure and property-fund management over two decades ago.
IFM has A$117bn (€74.2bn) of assets under management through offices in seven offshore locations in Europe, Asia and the US. It has many global investors, including pension funds and sovereign wealth funds. ISPT, which manages almost A$17.5bn in funds and mandates, is one of Australia’s leading property fund managers.
“When ISPT and IFM discussed the possibility of the joint venture almost two years ago, the synergies of bringing together IFM’s expertise in global investing and ISPT’s successful record as a real estate fund manager were immediately obvious,” says McCormack.
The joint venture was formed in June 2017 and launched last April.
IPFM is a separate fund-management company with its own board. It will call on the in-house resources of its parents, including in the areas of treasury and finance, risk and compliance, IT and human resources.
“Being able to draw on the mature processes and procedures of its parents has allowed IPFM to accelerate its entry into markets and concentrate its energies on investment strategy and research,” says McCormack.
“IPFM is like the space capsule sitting on top of a rocket. IPFM’s team of international property investment professionals is supported by the power of 500 ISPT and IFM staff. We have assembled the best people both here and abroad. We have identified our first two in-market hires. They have impeccable credentials in capital transactions and asset management, and will bolster our capability in continental Europe and the UK.”
McCormack says IPFM’s European fund has begun raising capital, targeting A$800m from Australian institutions by June. “While CPF is a diversified fund that will invest in commercial, retail, logistics and residential assets, we believe the best risk-adjusted returns at this time are in the commercial and residential sectors,” he says.
The fund is intended to exercise a disciplined and patient investment approach. “There is no urgency,” McCormack says. “Ours is patient capital to be invested only when we identify assets that fit our investment criteria.”
He does see the uncertainty surrounding Brexit as a concern, but also notes that disruptive events can create opportunities. “While the market has slowed for some types of transaction, particularly in the retail sector, there are still buyers and sellers who clearly have different perspectives on the impact of Brexit and how they can manage the possible outcomes,” he says.
“It is an interesting time. We continue to monitor London, along with 34 other investment locations. We obviously consider the myriad of permutations and combinations and the ramifications of outcomes that could result in relation to how Brexit is finally resolved.”
He adds: “Whether we invest in a city or not is largely about long-term structural trends combined with shorter-term cyclical influences and whether there are opportunities we think represent good value.”
A focused strategy for Europe
IFPM has developed a research tool known as Market Intelligence System (MIS) to sort through the sea of information. MIS uses machine-learning and sophisticated statistical techniques to distil information to a series of indicators used to rate and rank cities forecast performance.
While many large investors are flocking to logistics, seeing opportunities from the exponential growth in online retailing, IPFM holds a different view. “It is a simple case of supply and demand,” McCormack says. “We think the factors that once benefited high-barrier-to-entry retail assets are now being spread across the whole of the low-barrier-to-entry logistics market.
“While there is and will continue to be more demand for logistics assets, lower barriers to entry to this sector ensure that supply can easily keep pace.
“The transfer of benefits from retail to logistics is spread so thinly across a much greater number of logistics assets that the impact on individual assets is negligible and generally does not justify the yield compression in the sector.”
McCormack believes that people today are overpaying for industrial and logistics real estate, and that valuations for retail assets have also not corrected enough. “We think the best core, risk-adjusted returns can generally be found in the commercial and residential sectors of Europe, although market and asset-specific issues need to be carefully considered,” he says.
IPFM narrowed its focus from more than 100 European cities to 35 it considers have the right attributes for long-term growth. It then used its MIS tool to come up with a list of five. This short-list is dynamic and can change with the market. “Structural and cyclical factors change over time, and correspondingly, so does our ranking of our top five cities,” McCormack says.
“Ultimately, managing an international fund is similar to managing a domestic fund. It is about rationing capital across competing markets and opportunities, and finding the best value for money”
“This disciplined top-down approach eliminates unnecessary noise and distraction, and ensures we remain focused on key markets. Europe has 10 times more transaction volume each year than Australia.
“While we analyse a lot of transactions, many do not make it past the first cut, based on portfolio construction considerations or required risk-return criteria. We have to turn over a lot of rocks to find the right assets exhibiting the right risk-and-return profile in the right markets. But that is fine – the team has never been scared of hard work.”
McCormack says the typical investment size is difficult to pin down. “It is market-specific, and the average transaction price varies significantly across Europe and between cities, based on building size, rental levels and yields.
“From a liquidity perspective, we do not want to own the largest property in a city. But from a returns perspective, nor do we want to compete at the lower end and own the smallest property either.”
McCormack adds that, because most commercial buildings in Europe are low-rise with lower price points than the large core properties in the Australian market, the fund should be able to achieve reasonable diversification quite quickly.
“Core transactions in Australia are large, running into many hundreds of millions of dollars. A good office building in German cities such as Stuttgart, Hamburg or Cologne can be found for around €80m,” McCormack says. In the larger cities, such as Berlin and Munich, the average price is about €130m.
Some buildings in the financial district of London or in the La Défense district of Paris come with big price tags, but there are many buildings sold in London and Paris for about £150m or €120m, respectively. “Ultimately, managing an international fund is similar to managing a domestic fund. It is about rationing capital across competing markets and opportunities, and finding the best value for money.”
In Australia, macroeconomic and sociopolitical issues tend to affect the real estate market uniformly, leaving fundamental market variables as the differentiator for investment decision making, he says.
However, investing across countries that are dealing with different economic and sociopolitical issues, and with real estate markets at different points in the cycle, comes with greater scope to capitalise on imperfectly-correlated markets.
For-rent residential is included in the remit of CPF. McCormack says it is an interesting sector due to its low correlation with the more traditional commercial, industrial and logistics sectors.
“It has exhibited less volatility through market cycles. While the sector is still in its infancy in Australia, it is a deep and mature market in various European countries, such as Germany and Switzerland.
“The residential-for-rent market requires specialised management, and we are in dialogue with a number of different operators to manage facilities on our behalf or form joint ventures with us.” IPFM will take the same approach that ISPT took as it built a portfolio of A$14.6bn in core office buildings in its main fund. ISPT also runs a number of smaller funds.
“The fundamentals of property investing are the same the world over,” says McCormack. “We invest for security of income and growth.”
IPFM expects to be in a position to deploy capital in Europe from the second half of this year. It will be the first small step in its ambition to become manager of a significant portfolio in Europe – providing the bridge for what will be a new market for many Australian superannuation funds.