Making hay ‘in the eye’ of a property market storm

Nearly four years since Australia began its reckoning with a once-in-a-century pandemic, local investors have borne levels of uncertainty and volatility not seen since the global financial crisis.

For those – typically more cautious – REITs investors, the rapid exodus from corporate offices, malls and local retailers was likely never on the bingo card of life. Yet, as post-Covid life returns to some level of pre-pandemic normality, property investors are still facing a difficult trot, with stubbornly high inflation, a record jump in policy rates, the domino-like collapse of property developers (here and abroad), and a still uneven return to offices.

Grant Berry, a founding principal at the well-credentialed SG Hiscock & Company (SGH), has shown, however, that taking a consistent, disciplined and “low-turnover” investment approach – even through the eye of successive market storms – can still deliver reliable gains for REITs investors.

The proof, as they say, is in the pudding. SGH’s Property Opportunities Fund, winner of Financial Newswire’s Fund Manager of the Year award in the Australian REITs category, returned 9.16% to investors over the three years to June 2023, notably outperforming its peer group, which hit 7.59%, and the benchmark index, at 8.52%, over the same period*.

The fund is “benchmark-aware”, Berry said, with its universe centred on the S&P/ASX 300 AREIT Accumulation Index. Like SGH’s benchmark-agnostic Property Income Fund – which was also nominated in the same award category – a core focus of the Opportunities fund, he said, is income generation and valuation, rather than just capital gains.

“We are focused on income… because at the end of the day and over a long period of time, income is a core contributor in real estate to returns, and we aim to capture that,” Berry said.

Both funds maintain a “low-turnover approach”, he added, and typically a five-year investment horizon.

“[This] makes sense in our view when you’re looking at investing in property. Being too aggressive with your turnover – that is, ‘short trading’ – may not be helpful in terms of after-tax returns either,” Berry said.

Through the downturn, SGH stayed true to its low turnover, slow-burn investment philosophy. Yet, being an active fund, consistency does not mean ignorance of and unresponsiveness to prevailing trends.

As interest rates dropped to a record low during the height of the Covid lockdowns, Berry said SGH “never calibrated ourselves down to the aggressive pricing of low rates”.

“As a result,” he said, the fund was “already positioned ahead of the curve when the sector sold off”.

“When the cycle turned down last year with rates rising, we really held up relatively well. We recognised that we were moving into a higher inflation regime but we’d already been using higher capitalisation rates, or ‘lower multiples’, with our valuation methodology,” Berry said.

As lockdowns eased, the fund was already in good stead to benefit from the Australians’ eager return to retailers, restaurants and offices.

“During the depths of Covid, people mostly thought that we’d be working on Zoom and shopping online, but that didn’t eventuate to the same extent that many anticipated.

“Now, when you look at ‘shopping centre’ sales, they’ve well surpassed where they were pre-Covid.

“The consumer has been in great shape, [and while] the foot traffic is yet to recover fully, the typical spend is 30% larger in some of the shopping centres compared to pre-Covid.”

Being able to effectively track human behaviours and wider societal changes is critical in property investing.

“When analysing trends, you’ve got to look where we’re going to find ourselves next and consider how people are going to behave in that context – and I think we were pretty good on that.

“I come from a direct property background… We are constantly assessing where the value is in the market segment and looking for the disconnects, where assets can be priced relative to the real market, recognising that the real market can also be wrong or maybe in a process of adjustment.”

The SGH team, he said, was quick to recognise both the exodus from and now steady flow back to offices.

“We recognised that there will be a shift to more work from home, and we were less represented in the office sector.

“Having said that, now we’ve started to allocate more into office because it has been heavily discounted in the AREITs sector, and we’re seeing some really good value opportunities.”

“The return to the office has some momentum, even though we’re not going back to what it was before. Clearly, we still need the office space and we’re clustered in our offices typically the same three days of the week. As a result, and somewhat ironically, we need the same space. In fact, we took on more space.”

Coming out of an unprecedented period of volatility – with Berry citing Covid lockdowns, vaccination mandates, the gradual opening of the economic tap, the war in Ukraine (and now Middle East), the surge of inflation, and the interest rate cycle, said the fund has kept its eye firm on securities with attractive valuations.

“We use what we refer to as ‘through the cycle capitalisation rates’ – in other words, the property income yields throughout the cycle.

“We’ve found that this has held us in a really good stead.”

Reasons to be property positive

For Berry, there are good reasons to be sanguine about the local REITs market.

Whilst qualifying, naturally, that any 12-month forecast is fraught – the last three years of volatility being “testimony to this” – Berry believes Australia’s property market is well placed for growth over the longer term. This, he believes, owes in large part to consistent population growth.

“The forecast population growth rate for Australia over the next few years is well in excess of what we are expected to observe across all of the other major developed countries that we are aware of.”

“We are experiencing very high population growth and I think it’s still underappreciated.”

While strong population growth will “not necessarily translate to higher returns”, Australia’s strong governance structures and transparent market, he said, “sets up well for property over the longer term”.

Additionally, he said, the public AREITs market (that is, publicly listed REITs stocks) is currently trending at a discount to private markets.

“That in itself, I think, positions Australian REITs well for the longer term, while also providing a good source of income.”

“And, at the moment, good quality core real estate is trading significantly below net tangible assets.”

While commercial property remains the Opportunities Fund’s ‘bread and butter’, Berry also sees significant opportunity in the residential market over the medium-to-longer term, particularly with interest rates now likely peaking.

“We have an undersupplied housing market and, in fact, a chronic shortage of housing, as evident in the vacancy levels in rental markets.”

Looking at the evolution of work-from-home flexibility, particularly as commute times decrease, there is an increased expectation of Australians seeking out “more space and lifestyle in the family home”.

“In our view, this means that land will do a bit better in the longer term. Two of our holdings represent some of the biggest land banks in Australia, because we think there will be more of a land focus going forward streaming from people seeking more space.”

*Correction: Performance figures updated to the latest data.