Listed Property Strategy Update - November 2022
Investment Solutions | Market Insights

Paul Ashworth, Managing Partner

Our investment managers have been overseeing our listed property strategy since the early 1990s. As such, the strategy has operated through the ‘thick and thin’ of the Australian property market and economic conditions over the last 25 years. It has proven to be an important component of our client’s investment strategies, delivering attractive, stable inflation-indexed long-term income returns, capital growth, conservative capital profile, forward positioning in accordance with our economic strategy, and with individual trusts being ASX listed, providing efficient & low-cost liquidity and hence portfolio & asset allocation flexibility.
Posted 03 November 2022

We manage our property strategy to a defined set of policy attributes. These see: 

  • Liquidity through the ASX-listed property trust universe 

  • Assessed quality of underlying properties 

  • Property class positioning in accordance with our short and medium term economic strategy 

  • Leases to financially healthy firms, typically government & investment grade, with diversification of lessee exposure 

  • Weighted average lease expiry (WALE) > 5 years 

  • Distribution yields at a margin above the average 10-year bond rate  

  • Rent indexation or escalators combined with market reviews 

  • Geographical diversification 

  • Excellent debt management with gearing limited to 35% of assets with appropriate debt management 

  • Diligent, experienced through the cycle property management which is aligned to the listed trust 

  • No ‘blue-sky’ or build-to-sell property development  

  • An investment timeframe of 5 years 

The last 6 months has seen a sharp dichotomy in listed property operating performance compared with the listed price performance.  In summary, the operating performance of the underlying properties is healthy, but the prices for listed property trusts are being significantly impacted by the well-documented environment of higher long-term interest rates occasioned by inflation and short-term interest rate increases.     

At an operating performance level, our Listed Property Strategy, which is principally focussed on warehouse/logistics distribution assets, saw earnings per unit growth over the prior 12 months of 5% and we see that increasing 2.5% to 3.0% over the next 12 months with similar distribution uplift for a forecast cash yield of 6.95% per annum.   

For our existing property positions (particularly logistics property), CPI and fixed rent escalation are coming through operating cash flow. This is being modestly offset against higher finance costs for the unhedged components of debt due to increased interest rates.  For new(er), high-quality properties, similar capitalisation multiples to 12 months ago are being achieved with higher face rents and with that, yields. In summary, the forward medium-term operating environment is supportive of operating income and distributions.   

Importantly, the demand environment remains healthy with businesses moving inventory management from a just-in-time model to a resilience model post-COVID and China supply issues/concerns.  Equally, the supply environment remains supportive as there has not been an excessive build-up in supply. This is likely to remain the case as land values, financing and planning controls are restrictive.  

A significant medium term support is population growth through immigration. Recent ABS data suggests that the population has grown 1.0% over the last 12 months and the working-age population has grown 1.2% in the third quarter of this year. We view population growth via immigration as being a significant underpinning of economic growth in Australia going forward, and supportive of the demand side for both commercial and residential property.          

Overall, we assess that the warehouse & logistics property segment and supporting non-CBD office component for these regions, are well positioned over the next 3 to 5 years.  This we attribute to the combination of tight property supply, high replacement and new construction costs and goods demand backdrop supported by higher immigration and population growth. 

In terms of price performance, we note that listed property trust prices over the last 6 months have declined notwithstanding the relatively stable current and prospective operating environment.  This is made all the more confounding as the private commercial property transaction market for same-class properties has not experienced the same level of price decline. Prime properties are experiencing higher face rents, and often unchanged capitalisation rates.  On the whole though, values have fallen on average 4%, which contrasts the listed property trusts which have declined over 20%.  In a rising interest rate environment, it is right that property prices face some downward pressure (through increased capitalisation rates), but listed property prices have declined substantially move.  We would anticipate the transactional commercial property market might decline by up to 8% to 10% on the average, but still at a significant gap to the listed property market.

To us, there are two principal explanations, all of which we view will ease and dissipate through the course of 2023. They are:   

The Australian Clth 10-year bond rate has risen from 1.94% to 3.94% since 1 January 2022.  This sees the short-term relative attractiveness of bonds increase, which in turn requires listed property prices to fall to maintain the relative gap. We see longer-term interest rates in Australia stabilising and then moderating through 2023/24, which in turn will be supportive of listed property trust values.  

Our interest rate strategy sees central banks continuing to raise short-term rates until such time as inflation is materially tamed (most likely excessively raising if history is a guide).  In Australia, we on balance expect that the cash rate may reach 3.6% by April 2023.  With the lag effect of earlier rate increases ‘biting’, a 3.6% cash rate (translating to a 5.5% to 5.7% mortgage rate) will accelerate significant household wealth destruction and ‘snuff-out’ any inflation expectations. The corollary is that the 10-year bond rate will moderate and then lower. This in turn is broadly supportive of listed property capital values (when combined with a stable operating base).  

As we have already noted, private or non-listed property, particularly prime industrial property, is not experiencing the significant price movements that their ‘cousins’ in the listed property market are. Why then have listed property prices fallen when they hold the same underlying assets?  There are three primary reasons for exaggerated price movement, and they go to short-term market inefficiency: 

  • Liquidity – a great advantage of ASX listed property is that an investor can buy and sell on market fractionally and at will. It is highly cost-effective to transact on listed property compared with physical property, but when markets do sell-off, it tends to be a ‘throw the baby out with the bath water’ situation.  Also, being listed allows for directional short-term trading strategies by hedge funds not otherwise available in the private property market.   

  • Valuation – being listed property trusts, they are subject to daily valuation by the ‘mob of public opinion’ and mobs move by momentum +/-.  Whether property is held in an unlisted trust, Industry Superannuation Fund or ASX-listed trust, there is no difference in the underlying property assets. As such, there appears a large mismatch, and it looks like impatient investors are (unwisely) transferring this mismatch to patient investors. We assess the current mismatch to be a 20% variation for the same assets. 

  • Gearing – listed property has some gearing. For Cameron Harrison, this averages in the low 30% of gross assets. Whilst conservative in level, gearing can have an amplification effect for changes +/- in the underlying value of properties. This would justify some additional movement, but not where the physical market is transacting through discounts to net tangible assets of over 30%.     

In summary, we feel that listed property is well positioned within diversified wealth structures, noting the following: 

  • Lower 10-year bond rates supporting capital values – longer-term interest rates moderating as RBA cash rate rises take hold on demand (at current rate levels, the bite on demand will be severe once lag effects are incorporated, and worsen further as the RBA continues to raise the cash rate to an estimated 3.6% pa from the current 2.85% pa)     

  • Stable operating conditions supporting rents and cash flow - albeit noting that demand conditions will deteriorate over the next 12 months, the operating environment for logistics assets are supportive of distributions going forward, particularly when 10-year bond rates start to moderate 

  • Balance sheets well managed for this part of the cycle - through lower gearing and interest rate management through hedging 

  • Private market and ASX listed market gap – this is too large a gap, not justified by the operating environment or outlook. The listed market has priced for extreme, whereas the private market is likely on average to be 5-8% down.  

Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business. 

For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000. 

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