Where can you invest when even defensive listed assets are diving?

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Livewire Markets

Even the defensive characteristics of listed property are being tested in the current environment, the Australian Real Estate Investment Trust sector declining around 25% in the year so far. This has occurred as rising inflation prompted drastic action from the Reserve Bank of Australia, which last week hiked rates by 0.5% – the biggest jump in 22 years. And it's not done yet.

Some of the risks of A-REIT investing can be minimised, but others are intrinsic to the listed nature of these vehicles. This is a key point RF CorVal’s Rob Rayner makes in the following interview, in pointing out the main distinctions between listed and unlisted property.

"The prices (of unlisted real estate) are less volatile because it isn't subject to the fluctuations of secondary markets – volatility that many believe is driven by a speculative or trading mentality rather than fundamentals,” he says.

Rayner also points out the volatility of the listed real estate market is around 8 times higher than that of unlisted real estate when measured over a 25-year period.

“And the worst 12-month period for unlisted real estate delivered a -7.0% return, while the listed real estate market (AREITs) dipped by -57.7% in its worst 12-month period," he says.

In the following interview, Rayner details other advantages of unlisted real estate in the current environment. He also discusses how his team selects assets, a property sector he prefers over the next year, and some of the biggest property deals he's been involved in.


Who is RF CorVal and what do you do?

We're a specialist Australian unlisted real estate manager that was founded in 2009, offering investment opportunities that provide strong risk-adjusted returns for investors. We employ an experienced team of real estate professionals with extensive investment know-how and with a proven track record of performance excellence. Through deep industry networks, we are well placed to source attractive real estate opportunities for our investors, using a variety of on and off-market channels.

In short, what we do is:

  • Bring a disciplined approach to the acquisition of real estate assets at the right price and on optimal terms;
  • Actively manage these assets on an ongoing basis to drive value creation, and
  • When appropriate, sell the assets at the optimal time so as to maximise returns for our investors.

Since launching your first fund in 2009, how has the firm evolved and what do you regard as your main competitive advantage in unlisted property?

A broadening of our investor base is the main shift that has occurred over the 13 years since we launched. During this time, our team has also grown to 22 people across our Sydney and Melbourne offices.

Our investors now include large Australian institutions, family and multi-family offices, and high net worth and retail investors. This support has been achieved on the back of the consistent and strong returns we have delivered.

Our investment universe has also evolved. From an initial focus on office and industrial property, we now also invest across:

  • hotels,
  • retail,
  • land-leased communities,
  • agricultural facilities, and
  • National Disability Insurance Scheme accommodation.

Our conservative approach underpins everything we do, focusing on risks and downside mitigation, adding resources to our team or partnering with specialists to ensure we have the required in-depth expertise to acquire and manage property in these sectors.

Our size is also a competitive advantage – we’re large enough to cover all corners of the Australian real estate market but small and nimble enough to act quickly and decisively on investment decisions.

Why is unlisted property particularly appealing in a rising inflation environment?

The Reserve Bank expects the current rising inflation trajectory to continue through 2022 and into 2023. With inflation rising, commercial real estate is generally well-positioned to capture income growth because of the existence of inflation protection mechanisms. These might include features like annual fixed or CPI-linked rental reviews and also expense pass-throughs.

As an example of the rental review in practice, we currently have a large number of long-term industrial real estate leases with an annual rental payment increase of CPI plus a fixed percentage (eg CPI + 0.5%). These types of review terms can be observed across a high proportion of our office and industrial leases.

Additionally, a large number of our leases will contain expense pass-through mechanisms, such as triple-net leases, which means that the tenant is responsible for the ongoing running costs of the building, such as insurance and maintenance, and therefore as owners and landlords we are protected from rising expenses of this nature.

Can you discuss some of your past successes and failures?

We’ve been fortunate in that none of our investors has ever lost a dollar on their investments in the 13 years since we founded the business*. 

We’re quietly very proud of our results but also acknowledge there have been some isolated occasions where our investment thesis hasn’t played out exactly as planned. 

For example, a residential land subdivision opportunity in suburban NSW initially presented an attractive forecasted risk-adjusted return based on our modelling.

But there were several unforeseen delays to the project over the course of the investment period, for which we had undervalued the risk. While we are ultimately forecast to deliver a positive return as the investment matures in the coming months, it’s unlikely to meet our own high expectations for performance.

One example of a success story would be the purchase of a tired and empty office building in Canberra. We subsequently worked determinedly to repair, refurbish and regenerate the space and have now attracted several high-quality tenants on attractive leases, the building now 100% occupied. Being prepared to do the hard work can go a long way in real estate investing.

* Note that past results should not be relied upon as an indicator of future performance.

What opportunities do you see in the current market environment?

The current volatility in public markets presents some attractively valued unlisted real estate opportunities. These range across office, industrial, hotels and even the beaten-up retail sector – for example, shopping centres.

The quality of each opportunity will ultimately depend on the value and terms on which the asset can be acquired. This highlights the importance of buying well and being disciplined on valuation. These are reasons why we focus a huge amount of time and effort on due diligence at the acquisition stage.

Current opportunities we favour include:

  • Select office assets that best meet the needs of tenants in a “post-COVID” environment;
  • Assets in the agricultural sector that have long-term leases in place with strong tenant covenants;
  • Assets in the National Disability Insurance Scheme sector, which we access by partnering with trusted delivery partners for assets in this space, as well as looking to acquire existing NDIS properties;
  • Development opportunities through working with external developers that require a capital partner to fund developments that we feel provide the appropriate return versus risk outcome for investors; and
  • Select opportunities in the hotel sector to reposition existing assets to cater for the pick-up in tourism, both domestic and international, as we move out of the Covid environment that we have been in.

Where does unlisted property fit within a retail portfolio? What type of investor is this strategy best-suited to?

Our open-ended flagship fund, RF CorVal Property Fund, offers exposure to Australian real estate assets, diversified across geography, asset class and tenant. The portfolio will be constructed with various assets in the following sectors:

  • office,
  • industrial and logistics,
  • healthcare,
  • agriculture and
  • retail.

The overarching objective is to provide investors with attractive and consistent quarterly income and the potential for long-term capital growth. We believe that a sector-agnostic approach to investing in commercial real estate provides appropriate flexibility for the investment manager to allocate to the best opportunities at the right time.

With this in mind, our fund may be most appropriate for investors with a longer-term investment horizon and also those who are seeking high relative income levels, and less so for those who like to trade dynamically and/or speculate.

For investors and advisers constructing a diversified portfolio, the fund can be included as either a core allocation or also commonly as a supporting satellite allocation of between 5% and 25% of the overall portfolio.

Managed Fund
RF CorVal Property Fund
Australian Property

What are the primary drivers of returns for the assets in your funds and what changes have you seen as inflation has ticked up?

In basic terms, the primary drivers of returns in commercial real estate are:

  1. The income derived from rental payments and
  2. Changes in capital valuation derived from changes in land and asset prices.

Income return is generally sheltered from the negative impacts of inflation, assuming the owners of the assets have done the work when negotiating leases, to help ensure tenants are of high quality.

As for capital valuations, a belief that unlisted real estate is inefficient is a core tenet of our philosophy. This asset class offers astute investors the opportunity to benefit from pricing arbitrages by taking advantage of superior local information and knowledge. This principle continues to lead our investment returns, regardless of any specific macro or inflationary environment.

One of our key observations as inflation has risen in 2022 is an increasing volume of commercial real estate transactions, the highest seen since 2015.

We have also observed that capitalisation rates – the rate of return based on the income the asset is expected to generate – have stabilised. And in some cases, these have softened in line with the narrowing spread between the yields from real estate and government bonds.

What are the major differences and relative advantages of unlisted commercial property?

We invest entirely in unlisted real estate. The major difference between listed and unlisted real estate lies in the way investors transact, which leads to differences in volatility, liquidity and correlations to other major asset classes.

The main relative advantage of unlisted real estate is that investors gain exposure to the fund’s underlying assets by purchasing units priced on the value of the underlying assets. These units don’t trade at either a discount or premium to valuation based on market sentiment on any given day, as is often the case with listed real estate.

The unlisted nature of these assets means long-term investors, in most cases, give up daily liquidity. But the prices are less volatile because unlisted real estate is not subject to the fluctuations of secondary markets – volatility that many believe is driven by a speculative or trading mentality rather than real estate fundamentals.

For example, in 2022 so far, the A-REIT market has fallen by 25.23%. But the value of our unlisted commercial assets, as independently valued or transacted on, has either held stable or increased.

Viewed another way, over the past 25 years, the annual after-fee return for unlisted real estate has been 9.3% at a volatility level of 2.6%. The listed real estate market delivered an annualised after-fee return of 8.1%, but at a volatility of 16.7%.

And the worst 12-month period for unlisted real estate delivered a -7.0% return, while the listed real estate market (A-REITs) dipped by -57.7% in its worst 12-month period.

Which is your preferred property sector for the next 12 months and why?

The outlook for rental growth in some of the major sectors remains strong. We believe industrial and logistics real estate should see elevated tenant demand over the next 12 months. Why? We’ve seen that the current demand in this sector double the 10-year average and vacancies hit record lows.

The industrial sector has been one of the winners during the global pandemic, which has accelerated pre-existing trends, such as e-commerce and ‘Just-in-Case’ inventory management. More specifically, we favour industrial assets located in and around the suburban areas of Australia’s major cities where industrial land is scarce and is surrounded by residential populations that our tenants are trying to service or access within shorter timeframes.

Importantly, for us as an owner and purchaser of industrial real estate, tenants in this sector can generally easily absorb rent rises in a higher inflationary environment. That’s because only about 10% of their overall expense is rent versus around 50% on transport and delivery costs.

And the final kicker? We like urban industrial assets because in many cases, the underlying land value represents a significant proportion of the acquisition price. This further reduces downside risk and increases the prospect of future re-development for existing or higher value use, such as residential.

How many assets do you currently hold and how do you decide which to hold in your portfolio? And how long do you typically hold onto these?

In our flagship open-ended fund, the RF CorVal Property Fund, we currently provide investors exposure to 15 assets. Our acquisition team continues to screen the breadth of the Australian real estate market for both off-market and on-market opportunities, and only those investments that meet our rigorous valuation discipline are progressed to focused due diligence.

Depending on the specifics of each opportunity we may look to acquire real estate on a fixed term of between five and seven years, or sometimes longer. And we increasingly look to acquire real estate on an indefinite basis, assuming that we can continue to deliver attractive risk-adjusted returns on the assets.

What are some of the biggest asset deals you’ve been involved in since inception and what did you learn from them?

One of our largest deals was in partnership with a large Australian institutional investor with whom we acquired the Waterfront Place office tower in Brisbane in 2011. The building needed some investment capital to modernise and enhance the profile, as well as to implement some energy efficiency improvements.

After doing that, we worked with our partners to secure new leases, improve occupancy and also increase the average length of leases.

Several years later, once our investment thesis had played out, we consulted with our institutional investment partner and agreed to sell the asset in what was the largest single office transaction in Brisbane at that time.

Bespoke real estate investments delivering strong, risk-adjusted returns

The recently launched RF CorVal Property Fund provides investors access to institutional quality real estate investments in a fund that offers investors improved liquidity over traditional unlisted real estate funds. Please visit the RF CorVal website or reach out to the team for more information.

Alternatives in Focus will highlight some of the unique ways in which investors and advisers can access alternative investment opportunities across the market. Read more from the series
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