From his office in Melbourne on the south coast of Australia, Michael Seton, chief executive of the Australian Government Employees Superannuation Trust (AGEST), manages A$2.5 billion ($2 billion; €1.5 billion) of retirement plan money for 165,0000 public sector workers.
As such, he is a member of a 300,000-strong industry with A$1 trillion of funds between them that control up to 70 percent of Australia's real estate, according to estimates.
With the majority of his 15 percent allocation to property locked up in lower-risk core assets, Seton has watched returns come in at 15 percent to 16 percent in the last financial year— topping the long-term trend of 8 percent to 12 percent.
But recognition in the industry that cap rates cannot continue to drive returns forever is leading folks like Seton to consider branching out into more value-added and opportunistic strategies in Australia, and even casting an eye overseas.
“Returns from core property have been pretty good,” Seton says. “But in the property market, people are saying we are not necessarily going to get that strong capital growth every year, so we are starting to look at a few other strategies both here and overseas.”
“We are just starting off,” he adds.
Seton explains that two years ago, AGEST invested with two Australian fund managers, both of which target core property. One is managed by the Industry Super Property Trust (ISPT), which charges fees commensurate with its not-for-profit status, and the other by RREEF. However, acknowledging that returns from core property will surely settle back down to more normal levels, Seton's fund has recently made small commitments to two overseas funds, both targeting US real estate. The first is with Boston-based AEW's Value Investors Fund II, which targets value-added opportunities in all the traditional sectors in the US, plus hotels and senior housing. The second is with another US investment house, Franklin Templeton.
Though there is undoubtedly a gear change by Australian superannuation funds towards investing overseas, the funds are still happy to align with firms pursuing opportunities in their own backyard. This is in part because of the strong economy and historical returns. But it also because tax leakage considerations are checking some of the enthusiasm for offshore investing.
“You might find a very good manager getting a 15 percent return, but if you are going to lose 15 percent to 30 percent of it in tax, we might as well stay in Australia,” Seton says.
This attitude is commonplace among the superannuation funds, which are not to be regarded as exhibiting a herd mentality. Briar Dowsett, the director responsible for origination, structuring and equity finance transactions at nabCapital, part of National Australia Bank, says: “They are a long way from being dumb investors. They generally won't go offshore for diversification sake. They will do it at least to get the same returns as they are getting here and preferably better.”
Though real estate pros do not suggest that Australia's supers are massively shifting allocation to value-add and opportunistic deals in the country, which some say account for 20 percent to 30 percent of their indirect property holdings, these investors certainly have a growing number of choices among fund managers and strategies.
It is not only the early movers in the private equity real estate space such as AMP, Charter Hall, Lend Lease and Macquarie that are tapping investor demand. One of the most interesting recent trends is that the listed property trusts—Australian REITs— are creating fund management businesses by transferring assets off balance sheet into wholesale funds to recycle capital and generate high multiple fee incomes. While the majority of funds under management created in the last 12 months are core in nature, the majority of funds by number have been of the highly managed core-plus and value add variety.
“There is no doubt investors in Australia have quite a lot of choice in this space today,” says Dale Phillips, head of real estate private equity at Sydney-based AMP Capital. “When we started out 10 years ago there was not a lot of track record or thinking about it by asset allocators.”
In 1997 when AMP launched the first institutional-type opportunity fund in Australia in partnership with developer Charter Hall, superannuation funds were for the first time looking to diversify into higher-risk, higher-return vehicles and had noted the structure of the highly leveraged overseas private equity funds.
Commensurate with investors' increasing sophistication, some of the fund sizes operated by the early fund managers have since grown larger as a function of superfunds' growth. AMP's first fund raised A$61 million, but it latest independent vehicle, Select Property Portfolio No.2, raised A$201 million in 2006, at the time a record for a private equity real estate fund in Australia.
Such firms have invested in a wide variety of sectors such as underperforming hotel groups, motels, offices with leasing risk, retirement living and mezzanine debt on behalf of the supers.
However, there is no masking the fact that there continues to be a strong bias towards development among many of the value-add and opportunistic funds, which seemingly jostle for position with dedicated development vehicles.
There is an historic reason for this, as well as a market explanation. According to Rob Hattersley, global chief investment officer at Lend Lease Investment Management, in the 1980 s developers typically sold completed projects into funds and generated management fees from the funds they had created. “Today those interests have become more aligned, with investors wishing to take more risk in their portfolios,” he says.
Throughout the real estate boom of the 1980s, development firms created products that were sold to investors via financial advisors. However, the whole unlisted sector unravelled by the early 1990s when development oversupply and higher interest rates led to a run on the unlisted funds. The debacle led to the rapid expansion of the quoted property sector which exploded through the decade—and led investors to question why fees were being paid to advisors. In response, some funds split from their parent groups leading to the expansion of the internalized management model.
The other reason why the opportunity funds have tended to gravitate towards development is scarcity of product. By some estimates, some three quarters of Australia's A$223 billion of real estate has been securitized and is therefore locked up. According to the Property Council of Australia, superannuation funds own 70 percent, so it is little wonder that fund managers believe they should be creating product, rather than buying it.
Lend Lease's next vehicle, Lend Lease Real Estate Partners III, is expected to invest in a range of assets and situations, but it will focus on large mixed-use projects.
Hattersley highlights apartments in Sydney, Melbourne and Brisbane as a particular area of interest. Though the Aussie housing market is struggling under rising interest rates, vacancy rates in the apartment sector are low and rents are increasing.
“In select markets there is emerging strength in apartments while the underlying housing market remains challenging,” he says.
Opportunity funds are also investing in land zoned for industrial use. AMP, for example, has recently invested on behalf of its latest opportunistic vehicle in a greenfield site on a major road linking Melbourne with Sydney that has been zoned for industrial development.
Though homegrown managers are pursuing their core competencies in their domestic market, and the vast majority of super funds invest in Australia, it is impossible to ignore that more supers are looking offshore.
Hamish Roth, director of property institutional sales at nab-Capital, links the closed nature of Australia's market to the current trend. “The fund managers certainly haven't given up on the Australian market, but they need to go searching further afield, including the UK, Europe, US and Asia,” he says.
He cites multifamily assets and car parks as examples of opportunities that deeper markets outside Australia can provide.
A recent report by DTZ highlights that lack of new stock and investment opportunities coupled with a desire to broaden risk profile is encouraging investors to go overseas.
It says the US dominates the overseas focus, but the amount of capital invested in Asia Pacific has grown significantly, perhaps explained by cap compression taking place in European and North American markets. In 2006, Australians acquired nearly $1 billion in US apartments. Meanwhile, the report characterizes investment in Europe as “sporadic.” At the same time, it notes that investors are expanding into more value-add opportunities and to other property types including some “with which they have limited experience.”
The real twist
As Lend Lease's Hattersley points out, increasing allocations to Asia, Europe and emerging markets and the applications of high levels of leverage come at a time when the cost of debt and associated risk has been creeping up in most markets.
But perhaps the real twist is that while Australian fund managers and superannuation funds are looking overseas, foreign GPs and pension funds are moving in. In addition to Morgan Stanley's acquisition of office developer Investa, Japanese firm KK daVinci recently purchased a majority stake in Australian fund company Quantum. It is also noteworthy that Lend Lease plans to tap UK, European and Asian investors for half the targeted A$400 million in its next opportunity fund.
That foreign pension funds should be wooed to invest in Australia at a time when superannuation funds are looking abroad should lead to an interesting dynamic in the country. The funds are seeing another truth of today's global real estate market: One fund's home turf is another fund's foreign diversification.