The duration of property cycles may not always pan out as expected. Most recently, the wave of fund expiries over 2013 to 2016 meant that many closed-ended property funds had to either exit investments when markets remained soft, or exit investments when market returns were in their initial stages of building momentum. In both cases, the returns on investments were underwhelming.
Given the slower economic growth outlook, full property cycles may last longer than the typically observed 10-year cycles. Depending on the entry point into counter-cyclical investments, a slower recovery may result in barely break-even returns, or even a loss, within the mandated seven to eight years of the fixed fund life – being early is the same as being wrong.
For counter-cyclical asset repositioning and development over a shorter property cycle, the property market may start to move back to down cycle before the asset repositioning, or developments, have been completed. In this case, for investors in fund structures that are based on a defined term, there is a high probability of asset write-downs for the investors.
In contrast, open-ended funds with longer time horizons allow more flexibility on exit timing. If the property market drags through its recovery cycle, or undergoes a prolonged property cycle, fund managers have the flexibility to exit at a more favorable time later in the cycle. In the case that property markets move quicker than expected, the fund manager may likely decide to exit over the next upcycle. Longer-term open-ended property funds are also able to allocate to counter-cyclical investments for certain market sectors undergoing major structural shifts, such as logistics and specialty sectors. For the closed-ended counterparts, the defined timeline to deploy and to return capital back to investors means limited market sectors for investment. There are opportunities to make such investments in Asia now.
Logistics in certain Japanese markets I think are good for short-term counter-cyclical investments. Among other factors, the structural shift of occupiers to upgrade to and expand into larger modern logistics facilities around Tokyo should mean accretive income and capital growth over the longer term.
Elsewhere, in select Australian cities, counter cyclical opportunities could arise in assets that have fully priced-in negative rental reversions. With effective office rents having adjusted downward by over 30 percent since the slowdown of the commodity sector in 2012, this market-segment is likely to be nearing a trough. The supply pipeline is also easing.
With relatively more flexibility on exit timing enabled by open-ended funds, going against the cycle is attractive because of the attractive pricing of overlooked market segments. Also, this strategy allows for intensive value-adding to asset management during the down-cycle to reposition the asset, as well as helping longer-term investments to capture structural shifts. When the market cycle turns in favor of the investor, these overlooked market-segments are likely to outperform comparable assets and benefit from more accretive capital value growth.
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