Macquarie Asset Management on unlocking hidden potential

Guiding the growth of specialist operators in sectors driven by global megatrends can add value for real estate investors, say Macquarie Asset Management’s Eric Wurtzebach and James Kemp.

This article is sponsored by Macquarie Asset Management

Real estate markets in the US and Asia-Pacific are behaving differently today, with potential dislocation in the former due to higher interest rates, and steadier fundamentals in the latter. However, the industrial and living sectors, as well as other niche real estate sectors, generally continue to have strong fundamentals thanks to long-term mega-trends.

Macquarie Asset Management, which continues to focus its opportunistic real estate strategy on investing in and alongside operating platforms, understands that helping local operators scale up in key sectors can offer an attractive investment opportunity for real estate investors, according to Eric Wurtzebach, global head of real estate, and James Kemp, head of real estate for Asia-Pacific.

Which real estate sectors and regions are most attractive at present?

Eric Wurtzebach

Eric Wurtzebach: Our sector preferences have not changed materially in the past 15 years. We maintain our focus on industrial, the living sector and niche sectors – those that are driven by demographics, technology and internet adoption. We believe these big thematic trends will drive better performance over the long term. In the US, we prefer markets which are business friendly from a tax and regulatory perspective. We prefer industrial nationally, living sectors in the South and other sectors based on specific, local supply and demand fundamentals. Decarbonization is also a key long-term thematic, and we are seeing this drive investment opportunities in Europe.

James Kemp

James Kemp: Those fundamental themes apply across Asia-Pacific, too. We remain focused on our core target sectors of living and logistics. However, how we are looking to play in those sectors does differ by country. We view Australia and Japan as highly investable with fundamentals and access to credit holding up, creating traditional equity-style investment opportunities.

We are seeing fundamentals in those sectors supporting asset performance in other countries as well, however there are a number of markets that are facing constraints on debt liquidity, especially for construction financing, and/or limited appetite from equity investors. This is presenting interesting investment opportunities. The ability to structure investments into such opportunities is providing a better risk-adjusted return than straight equity for the same underlying asset exposure.

Which investment strategies do you consider best suited to creating value in the current market?

EW: We prefer a top-down and bottom-up investment strategy. The top-down, research-driven approach helps identify the trends driving real estate and where to allocate. The bottom-up approach requires teams on the ground with local knowledge to identify opportunities. For Macquarie Asset Management, the differentiated piece to this is a preference for investing in and alongside real estate operating companies.

JK: Our ability to invest in real estate operating companies has been a point of difference through cycles and is proving to be a differentiated investment strategy for creating value in the current market. These operating companies are typically local sector specialists with strong real estate capabilities. They are typically sub-institutional scale at the time we find them but have a pipeline of opportunities often assembled off-market.

The typical structure is we invest in the operating company and directly fund their initial pipeline of real estate opportunities. To add value, we seek to help develop and grow those businesses, firstly for the management of our own capital but also to help that business scale and become an institutional fund manager.

In an environment where we are going to have increased competition, this approach can help access product with local teams that can differentiate relative risk-returns between submarkets. At the same time, we use our experience and capabilities to help create a valuable business, which adds alpha on top of the real estate returns for our fund investors.

What opportunities or trends are shaping the local markets?

EW: We are finally starting to see limited instances of true distress in the US. Right now, those opportunities are driven by operator or capital structure issues, and they are not widespread. However, we also believe the 10-year rate in the US could remain at current levels for the foreseeable future. That looks more and more like a true reset of the cost of borrowing.

With an estimated $1.5 trillion in commercial real estate loans maturing in a market where interest rates are going to be higher and lending is more conservative, we expect that distress will be accelerating. Therefore, there is a lot of value in being entrepreneurial and nimble. Specifically, we have seen opportunities to acquire completed or partially leased industrial assets from real estate investors who have construction loans maturing. In self-storage, there are quite a few competitors out of the market, which provides an opportunity to develop in select markets.

JK: In Asia-Pacific, we see opportunities in Japanese logistics, if you can access land at the right price. Despite the level of logistics construction in Japan over the past 20 years, the market is still undersupplied with modern logistics space. In addition, the “2024 Issue” that introduces new rules restricting truck driver hours is prompting tenant demand and leading the emergence of logistics hubs between Tokyo and Osaka.

In Australia, our underwriting of greenfield logistics development is not currently stacking up, primarily because land pricing has not reset sufficiently to account for the rise in construction costs and the slight softening in tenant demand that has slowed rental growth assumptions. However, due to the capital needs of REITs and diversified funds, there may be opportunities to acquire stabilized assets with a value-add angle where logistics assets are one of the limited sectors where vendors can find liquidity.

The living sector in Australia remains structurally undersupplied. There has been record immigration but a pullback in construction as for-sale developers are finding it hard to make projects commercially viable. Where these developers are long on land, we are seeing the opportunity to acquire land or structure deals for build-to-rent and land lease community projects. Outside of Japan and Australia, where there is generally less capital available, there are opportunities in specific submarkets through structured transactions.

Another approach to find value, especially through periods of dislocation, is finding ways to participate in listed market privatizations.

How can real estate investors identify and capitalize on opportunities others might overlook?

JK: When it comes to identifying operating companies, it is that bottom-up approach with our local teams meeting with operators in sectors we are looking to get exposure to. We typically prefer founder-led businesses with skills that are heavily on the real estate side and with access to land. These businesses tend to be working on a deal-by-deal basis, so we can add value by partnering, bringing an institutional mindset and scaling up that business.

Our goal is to grow out those internal capabilities as we execute the business plan. We can provide as much assistance in doing this as required, such that the founders and senior management can maximize the time they can focus on executing the real estate opportunities. We see this as the most efficient way to drive the value of the operating company.

EW: We have a hands-on asset management approach with all of these groups. This may include being represented on the investment committee and helping the board and management team structure products, raise capital, formulate leasing strategies and make key hires; we are not just sitting on the board waiting for reports.

How is the market likely to change over the next 12-24 months?

EW: In the US, I do not think there is going to be anything that significantly changes in 2024. Uncertainty leading up to the US presidential election should keep transaction volume low and investors generally on the sidelines. In the following 12 months, it is likely that the maturity backlog will eventually start to catch up to owners. This, in turn, may result in asset repricing, forced selling and banks taking back assets. If you are going to put equity to work today, you need to really understand the risk and be paid appropriately.

After the elections, when there is more of an understanding of long-term interest rates, I think we will see capital come back into favored sectors like logistics, living and niche sectors. And as a result, I think you could have an extremely quick snap back in valuations.

JK: I think there is going to be increased competition for the sectors and the geographies we have spoken about. Today, there are still many investors prepared to sit on their hands, but we are increasingly coming to a point in the interest rate cycle where you can take a longer-term view on asset pricing. As investor activity increases, we believe there will be a disproportionate focus on the living and logistics sectors, starting in Asia-Pacific with the developed markets of Australia and Japan. Those prepared to be bold, bring forward their entry timing, and be creative on entry structures have an opportunity to benefit.

What differences are you seeing between the US and Asia-Pacific markets?

JK: Overall, the US is currently a market that is opportunity-led in terms of dislocation, while Asia-Pacific is more about using the current market dynamics to find good entry points to those sectors with continued strong fundamentals. We believe these fundamentals will increasingly drive investor demand for these sectors as markets continue to stabilize and more capital returns.

EW: I think that the US market has quite a bit of global interest at the moment, much more than I have seen in the past 24 months, but we expect inflation and interest rates to remain high, which may give rise to distress. Asia is very different, country by country, but there are not the same debt challenges.