Finding outliers in the property market
I love this quote from renowned American investor Sam Zell that says:
I've always believed in buying into in-place demand rather than trying to create it
Sometimes the in-place demand will be obvious. Other times, there will be anomalies that will outperform the market on a risk-adjusted basis.
The question is how to pick these outliers and look at the various attributes of a specific property to identify what will yield outperformance – even when the textbook and face-value would seem otherwise.
In about 2011, I met Jaginder Singh Pasricha, the first Sikh I had ever dealt with. Ex-Babcock and Brown, Jaginder founded Thakral Capital Australia with the Singaporean Thakral Family.
Small in stature and softly spoken, I was a good head taller than him. I was drawn to his intelligence and intense work ethic. In return I think he was slightly annoyed but fascinated that an unmarried woman younger than his daughter thought she could do what he did.
Over the course of the next several years, I went to Singapore to meet the Thrakral Family and we ended up doing five or so deals together, which each delivered an investment return of around the 20% (IRR) per annum mark.
A blanket view
Prior to 2011 we had been looking at financing residential developments in Brisbane and I had compiled mountains of research on supply and stock absorption rates. Given the supply and demand dynamic – it was blatantly obvious that supply significantly outstripped demand. And yet developers kept building more apartments.
The driving factors in this apartment boom were the stronger yields in Brisbane from an off-the-plan investment perspective vs Sydney or Melbourne, and the fairly relaxed planning environment which meant achieving development approval was more of a “box ticking” administrative exercise than the complex and often frustrating bureaucratic planning systems in place in Sydney and Melbourne.
Developers were building low-quality renter-focused stock by the thousands, to cater to investor demand. As a result the broad-brush market numbers were indicating a low overall absorption vs a huge (over) supply.
Playing the deal
Jaginder presented me with a deal in West End. The project was on the riverfront with an end value of about $90m. The apartment product itself was unique in that it a higher quality finish with larger-than-average floor plans, catering to local owner occupiers rather than to the Sydney and Melbourne investor market.
The product was pre-sold to local owner occupiers, the senior bank debt in place with Bank west and our principal and capitalised interest position was covered by unconditional pre-sale contracts ex GST. A fixed price design and construct contract was in place with publicly-listed builder Devine, and so the sales and delivery risk were largely mitigated.
There were of course some risks associated with the location of the site on the riverfront and the potential excavation issues that could create delays and cost overruns, but the numbers in the development margin were more than sufficient to allow for sensitivities and therefore significant profit and downside protection, and so we did the deal.
We entered the deal as secured mezzanine debt with a second ranking mortgage, and we made a 22% annual return.
Playing the man
Another deal we did together was financing a 650-apartment building close to Brisbane’s CBD. Jaginder had initially found the site together with the developer. The deal was presented to me as an architectural plan with a dramatic artists impression of the completed building along with a list of assumptions as numbers. The site was raw with no development approval, no pre-sales, no builder in place, no visibility to bank funding and a huge amount of risk.
I said no: there were too many variables.
“You have to meet the developer and you will see what I mean” was Jaginder’s response.
The deal relied on pre-selling the initial 650 apartments plus another second planned stage of the project, totalling about 1200 apartments or close to $350 million in value over a launch period of just three to six months. When I looked at the market reports, the net absorption for the previous quarter had been about 350 apartments, so there was not a chance in my mind that this developer could sell over triple that amount over the same period.
Nonetheless I went to the sales launch, curious.
The display suite had been knocked together over just a few weeks and it presented immaculately. It was like nothing I had ever seen put on in Brisbane before. The developer had tapped into all the major investment selling intermediaries as well as the Asian buyer market and the room was buzzing with excited agents. The sense of anticipation in the room was visceral.
As the developer got up to do his presentation to the room it became clear to me what Jaginder had seen in him.
Everything about the way the developer approached the development: the execution, the process, the vision, the attention to detail, even the way he presented, was infectious and meticulous. Over the course of that presentation it became blaringly obvious to me that to this young developer, reputation was everything, and he would not let this project fail.
Translating that into downside risk protection; I was 100% confident we would get our money back.
The words of a former CEO of Westpac came to me while watching him in action: ‘hitch your cart to the right horse’.
The developer had managed to, with an impressive marketing, sales and PR strategy, capture the attention of the channel sales agents and syphon the attention of the entire market onto this project. Not only did the project reach the required pre-sales target easily within 12 weeks, it sold out completely in six months, a feat I had initially thought was impossible.
We did the deal as preferred equity, with the $120 million senior debt and $50 million second mortgage debt ranking in front of us in the capital stack. Our position ranked third and we were repaid with a 21% (IRR) annual investment return.
Find your outliers
The point that I want to make is that as we transition through a more uncertain market, fuelled by the aftermath of COVID and global market volatility, whilst blanket judgements can be made about various asset classes, there will always be the outliers where certain factors mean that outperformance and enhanced value can be achieved on a risk-adjusted basis.
Whilst at the moment retail property is copping a hammering in the media, not all retail property is bad, and while logistics and industrial is favoured, not all industrial property is good.
CBD office may end up being oversupplied with a potential increase in vacancy rates as a theme, but here too, there will be opportunity.
Looking for the outliers with a deep understanding of the supply-demand dynamics of the market, the property fundamentals and the certain nuances at play, is what enables outperformance and strong downside protection.
So often this business is so much more than just a simple a numbers game.
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