Beauty is in the eye of the beholder, so too will be value

Where will there be demand? Where is the risk going to be? Where are we going to get a safe warehouse for our capital and the opportunity for outperformance, driven by strong market fundamentals?

I spend my days looking at opportunity, reading data and on the phone speaking with other fund managers, investors, property owners, financiers, banks and valuers getting a handle on what seems to be shaping up to be more positive domestic conditions. Yet there is the distinct underlying feeling of unease as we slide into deep recessionary conditions, for the time being at least. The normal frames of reference seemed to have shifted.

The long and the short of all of the information is that consumer spending is highly impacted and confidence is currently volatile as most remain conservative in their approach in the face of record unemployment and softer business conditions.

The IMF has released data suggesting that China will escape with the least amount of damage, with growth predictions forecast at 1% for June 2020 and 8.2% for June 2021.

Australia ranks 9th with negative growth of -4.5% this year and positive growth of 4% in 2021. The USA ranks closer to the bottom of the list at 22nd with negative growth at -10.2 for June 20 and back into positive growth at 6.3% by next year.

India, who would on face value appear to be an emerging alternative trade partner with their population of 1.35 billion (vs China’s 1.39 billion ) sits close behind Australia in forecast recovery with -4% this year and 6% growth in 2021.

My key take aways from this are:

1. Australia is heavily reliant on China for economic buoyancy, so China’s recovery and our trade relationship with them - specifically in regard to our iron ore reserves - will be positive for Australia’s post-COVID economic recovery, pending our ability to tread diplomatically with this somewhat erratic global superpower.
2. The USA has been economically crippled, if only for the short-term. Despite the IMF’s rebound forecasts for next year, Texas has today recorded its highest incidence of new daily COVID cases at 5,489. There are 15 states in the USA with 40,000 or more confirmed cases of COVID, with the USA reporting a total of more than 2.3 million cases since the start of the pandemic, and a staggering 34,000 new cases since yesterday alone. Government officials suggest the real numbers are 10 x those reported with closer to 20 million actually infected in the USA. If, as some conspiracy theorists would surmise, China did plant the COVID-19 virus as an economic advantage, wouldn’t they have played their cards exceptionally well.
   
3. Globally a new world order is emerging and the implications of this will only become clear as time goes on. Australia’s trade relationships with China are of economic benefit, but its geographic proximity to China and relative isolation from the rest of the world is something to be aware of as this reshuffling of global power emerges.
4. Pending the longer-term stability of the diplomatic and political relationship between China and Australia, Australia will become an increasingly sought-after immigration and investment destination.

Post COVID, private investment will be skewed towards those wealthier individuals and families looking for a safe haven or a bolt hole in the event of world disaster or pandemic.

Liquidity and the price of risk

In one of the most recent larger post-COVID private commercial transactions, Sydney-based Stanley Xue last week acquired 16-18 Wentworth Street, Parramatta for $40m, reflecting a sales rate just below 2019 rates of $8,000-10,000 per sqm. The 6,400sqm asset offers no real yield on the purchase price as a result of its 50% vacancy. The property offers future upside and is located close to Westfield and the railway.

Given business conditions and the post-COVID economic risk on office vacancy, at face value this investor has paid the same or a similar price as pre-COVID, but with a higher degree of risk. The certainty surrounding the timing to release the property as we slide into softer business conditions and a recessionary environment, demonstrate that the price of risk has gone up.

In February, the same buyer paid $52.5 million to buy a four-storey office building in Liverpool, south-west of Parramatta. The 211 Northumberland Street building is leased to Centrelink until 2022.

It would appear in the short to medium term (and pending the FIRB review process for those inflows from offshore) that ‘parking’ capital in Australia will become more and more attractive for investors seeking political economic stability.

One particular family office of several that I speak with on a regular basis has vast property holdings that include many core trophy assets. Upon checking in recently they suggested that offers to buy these trophy assets are still being fielded by genuine buyers, for rates not too dissimilar to pre-COVID prices.

The rationale behind this is that there is a high degree of liquidity in the market at the moment, and with interest rates so low it costs money to keep money in the bank. There are significant sums of capital looking for a safe home with the possibility of outperformance.

With some $US12 trillion ($17 trillion) forecast to be wiped off the global economy and the equivalent of 300 million full-time jobs lost in the June quarter leading to an inevitable global recession worse than the 1930s depression, it’s important to look at the current state of liquidity with the same philosophy touted by Sam Zell last week: ‘The market is liquid, until it’s not’.

On this basis, the expectation around short-term commercial property prices will be inconsistent. In the same way beauty is in the eye of the beholder, so too will be value.

Cash flow is expensive

As a result of the low global interest rate environment and the lean towards industrial assets, institutional capital is looking to buy cash flow, which is keeping asset prices high.

A–grade long WALE (Weighted Average Lease Expiry) institutional assets are trading at sharp cap rates, with most recently the Aldi Portfolio selling to Charter Hall for $648m and a cap rate of 4.75%, the WALE was seven years. Post COVID Charter Hall has also recently acquired the Winc logistics facility at a similar cap rate.

Dexus this week announced the sale of 45 Clarence street for $530 million to a Singaporean fund, which is consistent with the property’s pre-COVID book value at 31 December 2019.

Advantage, urgency vs patience & blind spots

While the equities market provides volatility and real-time reactive reflections of sentiment, unlisted property is a bit different in that it's less liquid, and the shifts in fundamentals and pricing take longer to manifest.

It's not yet clear, given the amount of government stimulus and our globalised nation how the supply-demand fundamentals across the various property sectors will play out. Industrial property is the chosen asset at the moment, yet it’s probably the most accessible sector to create supply out of all of the property sectors, given the simplicity of putting up four walls and a roof - which takes about six months to construct.

According to Australian Banking Association data, 779,458 loans worth $237bn have been deferred, including $176bn in mortgages and $60bn in business loans. This, together with the ongoing government stimulus packages, make visibility difficult for the time being, creating a blind spot.

Australia has an economic advantage given our abundant iron ore resources which bolster our trade relationship with China, and our relative isolation from the rest of the world during the pandemic. Our reliance on immigration to keep the domestic economy buoyant is undeniable.

There is an urgency concerning understanding the evolving dynamic of the market, and the interplay concerning our local fundamentals and the emerging geopolitical drivers which will place a new weighting on risk and reward. It's an excellent time to be patient because there are still a lot of blind spots and value is fully priced.