Global real estate investors have long seen Australia as being home to attractive and low risk markets for commercial real estate. In more recent times, the country has further benefited from the drop in the Australian dollar, from a 2011 peak of A$1: US$1.10 or so to the current level of around A$1: US$0.75. In falling, the Australian dollar has provided a shock absorber against the impact of the softness in the global economy.
Generally, we analyze four sources of real estate market risk. One is liquidity – the ability to sell an office block, a shopping center or an industrial property at any point in the real estate cycle. Another is the transparency of the local real estate market. Income security – which is reflected in the length of a standard lease and the presence of international occupiers – is the third source of risk. Volatility of income is the fourth source.
Australia scores well in relation to each of these four facets, and when one takes into account a fifth key variable that has an influence on commercial real estate valuations – the yield on a 10-year Australian government bond – the markets here are ‘in the middle of the pack’ relative to other developed countries.
The global economic slowdown, volatility of financial markets and the slippage in the Australian dollar through 2015 had little impact on this. Jones Lang LaSalle notes that transaction volumes in the Australian office markets last year surpassed A$15bn for the second year in a row. Offshore investors accounted for 54 percent of transaction volumes.
Interestingly, 2015 was also a record year for divestment of Australian office properties by offshore investors: many of these were players who were realizing gains that they had made from counter-cyclical purchases, in the wake of the global financial crisis.
Those investors who bought Australian commercial real estate at that time may well have made a profit on the movement of the currency – which would have boosted the gains that they would have made from the general fall in cap rates and rise in capital values.
Of course, the risk of a loss over time through adverse currency movements – a sustained fall in the Australian dollar relative to the US dollar and other currencies – is something that institutional investors can control. They can do this through use of currency forwards or derivatives – or reducing risk via funding the acquisition by borrowing in Australian dollars.
Given the significant devaluation of the Australian dollar, we are finding that investors are re-considering their approach to Australian dollar currency management. For those investors who have traditionally fully hedged the currency, the cost of continuing to fully hedge has decreased in recent months from a US dollar perspective. Equally, some investors may consider a partially hedged position where income continues to be fully hedged yet the capital value is unhedged, particularly if a long term investment of, for example, 10 years is envisaged.
Consequently, differing currency management strategies have costs attached that need to be considered when underwriting investments. This range in costs will depend on the currency pair, and timing required of the hedge, along with the level of hedging strategy being undertaken, which can influence market competitiveness and required returns being achieved.
At TH Real Estate, we keep our investors well-informed and up to date with full transparency on any currency policy. In our experience, it is important to have any investment mandate discussion with clients up front to help determine where the currency decision resides, and this sets clear ‘rules of engagement’ before implementing an investment strategy.
If the risk of a loss on the Australian dollar is something that can be mitigated – or eliminated – then the general fall in the currency since early 2013 is something that global real estate investors see as a positive. The attractive Australian markets have arguably become better value on this basis.