Understanding Real Estate
2014
AMP Capital Investors Limited
ABN 59 001 777 591
AFSL 232497
Understanding Real Estate
About real estate at AMP Capital
Delivering outstanding investment outcomes is our central focus and driving motivation
At AMP Capital, we are committed to delivering outstanding investment outcomes for our clients based on a long-term, trusted
partnership. This means managing our clients’ real estate assets to ensure they remain relevant both now and in the future.
Experience has taught us what matters most
With more than 50 years’ experience managing real estate investment, we’ve learnt what matters most - that is, to deliver
outstanding investment outcomes and build long-term partnerships with our clients based on trust. With decades of experience
sourcing and developing new investment opportunities, we are now one of the leading real estate fund managers in the Asia Pacific
region. Our integrated and strategic approach to investment management spans the real estate risk and return spectrum, so we
provide clients with access to global and regional, listed and unlisted real estate opportunities.
The whole is greater than the sum
For us, success is about expert teams coming together to discover the best possible insights and investment opportunities for our
clients A key distinction for AMP Capital is our integrated approach to managing our clients’ assets. We aim to deliver outstanding
investment outcomes by applying specialist expertise across funds management and analysis; asset, real estate and development
management; and sustainable performance, operations, leasing and marketing. Our clients also benefit from the additional
perspectives of the wider AMP Capital team, including our Investment Strategy and Economics team, as well as experts from our
infrastructure, fixed income, equities and multi-asset investment teams.
For further information
Please visit ampcapital.com/contact or email [email protected]
Table of contents
What is real estate?
3
Benefits of investing in real estate 4
Investing in real estate 4
>> Ways to invest
4
>> Risk-return characteristics
5
>> Drivers of performance
6
>> Risks specific to real estate investing
7
The importance of active management7
1 A
MP Capital is a proud participant in the Global Real Estate Sustainability Benchmark, (GRESB), an industry-led initiative committed to the rigorous and independent
evaluation of the sustainability performance of real estate portfolios.
What is real estate?
Real estate is a physical ‘bricks and mortar’ investment where
income and value are driven by rents that are paid by tenants
under contractually binding leases.
Real estate can be appealing to pension funds, sovereign wealth
funds, insurance and institutional investors because it provides
a high income yield relative to other asset classes, and it is often
less volatile in pricing. This volatility is lowest in direct real
estate ownership and highest in listed real estate investments.
Direct real estate offers relatively stable returns due to the
rental payments that tenants are required to pay under leases.
Major tenants typically lease space for five to 10 years.
This provides investors with predictable cash-flows for
an extended period of time. In addition, direct real estate
typically does not trade as quickly as equities, so it prices are
susceptible to investor speculation than listed real estate or
equities generally.
Being a physical asset, direct real estate is more illiquid (takes
longer to sell) than equities and bonds. Investors seeking greater
liquidity have the option of buying listed real estate securities.
However, the trade-off for higher liquidity can be greater
volatility in prices compared to direct real estate ownership.
Examples of real estate
1
2
3
4
5
1 Office space at Collins Place, Melbourne, Victoria, Australia
2 Office space at Coronation Drive, Brisbane, Queensland, Australia
3 Mt Ommaney Shopping Centre, Brisbane, Queensland, Australia
4 Bay Fair Shopping Centre, Tauranga, New Zealand
5 Warehouse, Chullora, New South Wales, Australia
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Benefits of investing in
real estate
Stable, reliable income streams
Real estate can offer investors a stable source of income through
regular distributions of underlying rental income. Over the
long term, the majority of real estate returns come from rental
income which is generally less volatile than capital returns, as
rents are contracted under a lease agreement. In commercial
real estate, this can be five to 10 years for major tenants.
Investing in real estate
IMPORTANT NOTE: In this section, we outline some of the
benefits of investing in real estate, and on page 7, we describe
some of the risks investors should be aware of when considering
investing in this asset class. When assessing performance, we
will draw on historical information. Investors should be aware
that historical performance is not a reliable indicator of future
performance.
Ways to invest
Inflation hedging
Direct real estate
Some real estate leases contain provisions for rental increases
to be indexed to inflation, while in other cases there is an
opportunity to increase rental rates whenever a lease term
expires and the lease is renewed. Either way, real estate
income should keep pace with inflation, helping to
maintain real returns.
When investing in direct real estate, investors purchase the
asset(s) themselves and gain access to the ‘pure’ risk of real
estate. This means they can expect predictable secure long-term
rental cash-flows, and exposure to the real estate market cycle,
not the equity market.
Low correlation to other asset classes
Direct real estate has significantly lower correlation to other
growth assets and it is not typically impacted by changes in
market sentiment as quickly as equities. Its low correlation with
other asset classes provides effective diversification benefits
and can reduce the overall volatility of an investment portfolio.
The following chart maps out the efficient frontiers of a
diversified portfolio (comprising shares, bonds and listed real
estate), with and without exposure to direct real estate. An
efficient frontier represents the best risk-reward ratio for an
investment under the present circumstances.
The chart below shows that when direct real estate is included
in a diversified portfolio, the efficient frontier shifts to the left,
thereby signifying a reduction in volatility.
The inclusion of direct real estate improves the
risk adjusted return
Return
The inclusion of direct real estate improves the risk adjusted return
Volatility
Including direct real estate assets
Excluding direct real estate assets
Source: AMP Capital. For illustrative purposes only.
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The downside of owning a physical asset is that money has
to be spent on maintaining the asset over time. However,
historically direct real estate has produced relatively strong
returns for investors – see table on page 5.
Direct real estate is usually valued once a year with the valuer
aiming to capture a year’s worth of events at one point in time.
Actual underlying market fundamentals and asset-specific risks
are the principal drivers of direct real estate pricing.
Direct real estate investment by most private investors is
in residential real estate, as it is beyond the reach of most
individual investors to buy an office block or shopping centre,
mainly because of the higher dollar amounts required.
These days, however, direct real estate is becoming more
accessible to retail investors via fund products that offer access
to these types of assets.
Pooled Funds
>> Syndicates – Retail investors can buy partial shares of physical
assets with other investors. This style of fund typically invests
in one or two assets.
>> Hybrid funds – These are funds that give investors exposure
to partial ownership of direct real estate either via a
syndicate or institutional fund, together with some
holdings in real estate securities.
Listed real estate
When investing in listed real estate, the investor does not hold
the title to the property, but instead owns units in a fund or
trust that pools money with the money of other investors to
invest in a range of real estate assets. Popular listed real estate
investments are Real Estate Investment Trusts (REITs), which
make up a significant part of equity markets.
One of the advantages of REITs is that they allow investment in
commercial and industrial assets, something that is harder to
do directly. The pricing of listed securities is driven by market
sentiment and prices are considered a reflection of future
expectations. Unlike direct real estate, bad news or good news
is usually reflected immediately and prices can ‘overshoot’ on
the upside and the downside.
Risk-return characteristics
Real estate’s typical performance bridges the gap between fixed
income and equities. Real estate can offer investors a stable
bond-like payment structure with the potential for equity-like
upswings in yield and capital.
Performance of direct real estate
Total return (%)
10 year annualised
Australian retail
- Prime retail
- Secondary retail
10.8
11.2
10.5
Australian office
- Prime office
- Secondary office
9.9
9.8
9.6
Australian industrial
- Prime industrial
- Secondary industrial
9.5
9.4
9.8
Source: IPD Australia, quarter ending June 2013. Historical performance is not an
indicator of future performance.
Residential
Definition: Real estate that derives its revenue from
dwelling units.
Historically, residential real estate has been able to deliver
high capital growth because of low vacancy rates and an
undersupply of rental accommodation. For the past 10 years,
housing demand has outstripped housing supply2. Some of
this
Real estate ranks between fixed income and equities on the risk return scale is due to town planning systems restricting the volume of
new supply below demand. Low vacancy rates allow landlords
to raise rents, and real estate values tend to increase when the
Private equity and
potential rental earnings increase.
Real estate ranks between fixed income and equities
on the risk return scale
hedge funds
Return
Equities
Listed Real Estate
Infrastructure
Direct Real Estate
Fixed income
Real estate and
infrastructure are
often classed as
‘real assets’
because they
are tangible
Cash
Demand for accommodation is also influenced by population
growth and demographics, and less so by the economic or
business cycle. Therefore, over the long term investing in
residential real estate can be less volatile, reducing the risk
of a sharp rise in vacancy rates when the economy slows.
Commercial
Risk
Source: AMP Capital. For illustrative purposes only.
Factors influencing performance of
direct real estate
When assessing the performance of real estate, consideration
has to be given to the type of real estate asset (residential,
commercial or industrial), where it is located, the quality of the
tenants and how much of an investor’s money is in one asset.
It is important to understand that all of the major real estate
investment categories generate returns from both income and
capital growth.
However, the proportion of that return varies when looking at
each asset type. Over the long term, the highest returns have
been produced by shopping centres, and prime residential
real estate.
2 National Housing Supply Council, Housing Supply and Affordability Report, 2012
3 JLL Research, Real Estate Investment Service, June 2013
4 IPD Australian Quarterly Digest, June 2013
Definition: Real estate that is intended for use by commercial,
retail or wholesale businesses.
Income yields in commercial real estate are generally supported
by longer lease terms than residential real estate. Lease terms
of up to 10 years or higher are common for major tenants
in shopping centres and prime central business district
office towers.
Shopping centres: Historically, shopping centres have had the
lowest vacancy rates of all the commercial real estate sectors3.
Retail spending is also more influenced by population growth
and demographic shifts than office and industrial, which
are more sensitive to the business cycle. Therefore, the retail
sector has historically produced the most consistent growth
in rents and the most attractive capital growth opportunities
for investors4. The space for shopping centres in Australia is
more regulated than for office buildings and factories because
of town planning and this has helped to drive strong, stable
returns for investors over the long term.
Offices: Office markets have historically been a more volatile
direct real estate investment for investors, mainly because
multi-storey office buildings take three to four years to build
and the market has historically mis-matched the timing of
construction with the shifts in demand because of the length
of time it takes to build a skyscraper. Office real estate is also
more susceptible to economic and business cycles than other
real estate sectors.
Drivers of performance
Industrial
>> The financial cycle represents the capital flows that go
towards funding real estate developments; new construction
affects the price of real estate.
Definition: Real estate that is intended for industrial purposes.
The performance of the real estate market is affected by
changes in physical and financial cycles. Real estate cycles
typically last over a decade, and reflect a process of events
such as fluctuating prices, vacancies, and rental demand.
>> The physical cycle represents vacancy rates which, in turn,
influence changes in rental levels.
The industrial sector holds over 100 million square metres
of industrial space3. As a consequence, the industrial market
has historically had higher vacancy rates than other property
sectors. Because of higher vacancy rates, the industrial market
has struggled to increase rents faster than inflation due to an
abundance of land to build new warehouses. Consequently, the
majority of the return from industrial assets tends to be derived
from income yield rather than capital growth.
The real estate market is affected by changes in physical and financial cycles
Physical cycle
Real estate cycle
Economic upturn
Financial cycle
Credit expansion
Increased property demand
Supply shortage
Rising rents / falling yields
Economic boom
Economic downturn
Building boom
Credit boom
Increased supply &
Slackening demand
Rising interest rates
Falling rents / rising yields
Recession
Property slump
Credit squeeze
Source: AMP Capital, adapted from Barras, R. (1994) Property and the economic cycle: Building cycles revisited. Journal of Property Research, 11(3), 183-197.
Past performance is not a reliable indicator of future performance.
2 National Housing Supply Council, Housing Supply and Affordability Report, 2012
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Risks specific to real estate investing
Real estate returns may be affected by factors such as investor
demand for assets, demand by tenants for commercial space,
rental income levels and the supply of new commercial space.
The cost of real estate debt, or costs and losses associated with
natural disasters or other events which prevent the normal
operation of real estate investments also have an impact on
the performance of real estate returns. The following risks
are among those investors should consider when investing
in real estate:
Sector risk
There are a number of factors which may affect the real estate
sector, including the cyclical nature of real estate values, overdevelopment and increased competition, increases in real
estate taxes and operating expenses, demographic trends and
variations in rental income. Changes in the appeal of properties
to tenants, increases in interest rates, the level of gearing in
the real estate market and other real estate capital market
influences can also affect the performance of the sector.
Vacancy risk
The importance of active
management
Active management adds value for an investor if it earns back
its costs – investment management and transaction fees –
and achieves a return greater than that available through
passive management.
In our view, real estate securities have a number of unique
features which present opportunities for active managers. There
are significant differences between real estate markets around
the world which require local knowledge. At a basic level,
distinctions exist between real estate investors, fund managers
and developers. There are also material differences in corporate
structures and regulatory frameworks – for instance, there is
an obvious difference between REIT and non-REIT structures.
Within the real estate sector, there are many important
regulatory considerations which allow active managers to add
value through research, local knowledge and prudent asset
allocation. However, not all active managers are the same and it
is important to select an active manager that has the ability to
generate consistent strong performance.
The risk of a tenant vacating a property, failing to meet their
rental obligations or failing to renew a lease can have a
detrimental impact on rental returns.
Value risk
Asset values are influenced by location, supply and demand,
rental agreements, occupancy levels, obsolescence, tenant
covenants, environmental issues and government or planning
regulations. Changes to these drivers may affect the end value
of the asset.
Contact us
If you would like to know more about how AMP Capital can help you, please visit ampcapital.com
Important notice to all investors:
While every care has been taken in the preparation of this document, AMP Capital
Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation
or warranty as to the accuracy or completeness of any statement in it including,
without limitation, any forecasts. Past performance is not a reliable indicator of
future performance. This document has been prepared for the purpose of providing
general information, without taking account of any particular investor’s objectives,
financial situation or needs. An investor should, before making any investment
decisions, consider the appropriateness of the information in this document, and
seek professional advice, having regard to the investor’s objectives, financial situation
and needs. This document is solely for the use of the party to whom it is provided.
AMPC_UnderstandingRealEstate_060114_Retail
A good approach for those wishing to minimise risk is to invest
in real estate which is leased to good quality corporate type
tenants. In selecting assets, we believe the higher the quality of
the asset, the higher the quality of the tenant. Therefore, it is
advisable to look for well-located properties, in locations such as
central business districts or central shopping malls, with lengthy
and secure income streams.
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