Europe has become the most attractive foreign real estate region for superannuation schemes, according to a recent investor forum. Erling Sorenson and Jamie Nemtsas explain
The attractiveness of the Australian real estate market in the minds of both foreign and domestic investors has continued to increase over the past 12 months. This was evident at The Centre for Investor Education (CIE)'s real estate investment forum, which took place in Queensland, Australia in early July. CIE's polls revealed that 51% of attendees viewed Australia as the region with most compelling investment opportunities, up from 36% a year ago.
Demographic shifts, urbanisation, technological innovation, increased regulation and environmental trends, coupled with a world of low GDP growth and exceptionally low interest rates, provide a challenge for institutional investors globally. It therefore comes as no great surprise that, despite the strength and volatility of the Australian dollar, the shift in the economic centre of gravity towards Asia has led to an increase in foreign investments in the Australian real estate market of A$3bn over the past 12 months (according to DTZ research). In particular, sovereign wealth funds, which have the size and scale to move markets, have demonstrated increased interest in Australian real estate.
It seems the attraction of Australian core real estate, which was also discussed at last year's Real Estate forum, remains intact for foreign investors, including sovereign wealth funds, drawn to the yield and stability offered by those assets.
According to a recent report by CBRE that measured the total occupancy cost of office property, the major capital cities of Australia are still considered inexpensive relative to their global peers. Sydney, the most expensive in Australia, is still only at 53% of the cost of the most expensive city in the world (central Hong Kong). Therefore, while subsequent pricing pressures are not yet reflected in cap rates, investors should be prepared for more competitive property auctions, especially in high quality, prime CBD locations in Sydney and Melbourne, if the trend of increased foreign interest persists in the coming years. In line with this, there was a broad expectation among attendees at the CIE real estate investment forum that cap rates for core real estate will continue to compress. Furthermore, 77% of CIE's attendees indicated some concern that core Australian real estate is already at fair value or maybe even overvalued, which brings to mind the words of Sir John Maynard Keynes: "Markets can remain irrational a lot longer than you and I can remain solvent."
With demand high and credit restraints limiting development, it is logical to start questioning how far cap rates will compress. This, in turn, provides an imperative for institutional investors to seek out investments abroad. A CIE poll revealed that 21% of attendees viewed developed Europe as the best real estate investment destination outside of Australia, followed by the US (18%).
Asia remains a region of interest to investors seeking opportunities across multiple asset classes, with 32% of attendees deeming it attractive over the next 12 months and 48% over the next five years. However, looking closer at specific asset classes, there was a marked change in sentiment towards real estate with just 7% identifying Asia as attractive compared with 12 months ago when 30% saw appealing real estate opportunities in the region.
Singled out as the key contributing factors to this significant change in attitude were a lack of transparency and asset valuations. Lack of transparency, in particular, has consistently been identified over the past few years, by some 75%, as a key challenge. At the recent CIE real estate investment forum, there was agreement that building trust and possessing local knowledge was crucial when entering a new investment destination, with attendees citing information asymmetry as the biggest challenge when accessing foreign markets.
Perhaps the most resonant takeaway of this year's property forum was the acknowledgement that if funds are to effectively implement global real estate in the future, preparation must be completed now by devising the right investment policies to maintain the appropriate levels of control, allow flexibility, minimise foreign exchange risk and implement tax-efficient structures.
While Australian institutional investors might not be yet prepared to commit a sizeable portion of capital to global markets, there is a need to undertake due diligence, equip trustees with the tools to make the right investment decisions, and install the necessary investment infrastructure. In addition, to reflect the increasing need of local partners, joint ventures and co-investments may begin to present an attractive method of accessing property returns. Both allow for risk to be spread among partners and provide the parties with local expertise and more bargaining power, especially for larger deals.
Looking ahead, as members are now requiring greater choice and additional products, one of the key challenges many funds face in the current volatile environment is an increasingly active member base. More frequent switching by members requires greater liquidity and presents a challenge for managers of real estate allocations.
There is also a need for new product designs to accommodate liquidity needs in the pre and post-retirement phase. Product design is partly responsible for real estate accounting for only 10% of institutional allocations, on average, in Australia, according to CIE data. Real estate is subject to the same illiquidity budget along with investments in hedge funds, private equity, infrastructure and other real assets. It is interesting to consider this in the scope of global institutional allocations to illiquid assets. With many investors in Japan and Korea dedicating a larger proportion to alternatives and hedge funds recently, it is interesting to see to what impact Asian institutional capital will have on Australian property markets in the coming years.
The CIE Investor Sentiment index, a proprietary measure that tracks the sentiment of decision-makers of institutional capital allocation, revealed that the allocators of real estate capital expect to face an increasingly challenging environment over the medium term. This was highlighted by attendees' general view that, domestically, interest rates and growth are likely to fall and inflation and unemployment are likely to rise over the next 12 months. As a function of this, equipping trustees and investment staff with the necessary tools to effectively fulfil their fiduciary duties will become ever more important for real estate and other asset classes alike.
Erling Sorenson and Jamie Nemtsas are co-owners at Centre for Investor Education