Real Estate Investing The Search for Yield Adrian Harrington Head of Funds Management

Transcription

1 Real Estate Investing The Search for Yield Adrian Harrington Head of Funds Management 30 October

2 FOLKESTONE OVERVIEW 2

3 BUSINESS STREAMS AN ASX LISTED REAL ESTATE FUND MANAGER AND DEVELOPER PROVIDING REAL ESTATE WEALTH SOLUTIONS FOR PRIVATE CLIENTS AND SELECT INSTITUTIONS Funds Management Direct Direct Balance Sheet Balance Sheet Income, Value-add & Development Funds Social Infrastructure Residential Office Retail Listed & Unlisted Funds A-REIT Securities Fund Debt Fund Value-add & Development Social Infrastructure Residential Office Retail Underwriting Funds Fees Acquisition Management Performance Returns & Fees Dev Profits Pref Equity Interest Income Development Mgt Fees Offers listed and unlisted real estate funds to private clients and select institutional investors $917 million in funds under management 1 On balance sheet activities focus on value-add and opportunistic (development) investments Market capitalisation of $155 million 1 1 As at 30 June

4 FUNDS MANAGEMENT Public Markets Equity (Listed) Listed A-REITs Folkestone Education Trust (ASX: FET) A-REIT Securities Funds Folkestone Maxim A-REIT Securities Fund & SMA $917 Million in FUM and 7,291 Investors 1 A menu of real estate funds across: public (listed) and private (unlisted) markets, debt and equity to meet the various risk/return requirements of our clients sectors - office, retail, residential and social infrastructure Private clients and select institutions Private Markets Equity (Private Funds) Income Funds Altona North CIB Oxley Sydney Olympic Park Wollongong Development Funds West Ryde Truganina 1 As at 30 June 2015 and includes Folkestone and all its funds. 4

5 FOLKESTONE REAL ESTATE IQ 5

6 THE REAL ESTATE INVESTMENT MENU 6

7 WHY NON-RESIDENTIAL REAL ESTATE IN THE PORTFOLIO? Real estate has provided a competitive return over the long term core real estate is expected to generate a lower return than equities but higher than bonds Real estate generates income from contracts and leases more stable income streams across the cycle approximately 70% of the total return from core real estate is derived from current income generated by contractual rent payments associated with tenant leases provides a hedge against inflation Brings diversification benefits to the mixed-asset portfolio real estate exhibit lower correlations with equities and bonds Active management in real estate can add significant value an owner can actively manage a portfolio through market, sector and or asset selection decisions an owner can make physical changes to an individual asset, increase its operational efficiency or alter its capital structure in efforts to increase returns 7

8 Less than 2% 2-3% 4-5% 6-7% 8-9% 10-11% 12-13% 14-15% 16-17% 18-19% 20-21% 22% or more Proportion of Respondents INVESTOR OBJECTIVES Main Reasons for Investing in Real Estate: June 2015 Targeted Annualised Absolute Returns for Real Estate: June % Diversification 65% 25% 25% 23% Inflation Hedge 61% 20% 20% Reliable Income Stream 54% Low Correlation to Other Asset Classes Reduce Portfolio Volatility 32% 45% 15% 10% 12% 7% 8% 5% 4% High Risk- Adjusted Returns 32% 0% 0% 0% 0% 0% 1% High Absolute Returns 16% 0% 50% 100% Proportion of Respondents Source: Preqin Investor Interviews - June 2015 There are a multitude of reasons why investors invest in real estate Preqin Survey of Major Institutional Investors - diversification the primary reason the asset classes relative low correlation to equities and the diversity of real estate sectors (office, retail etc.), locations (domestic and global) and investment strategies (core, valued-add, opportunistic, debt or equity) 60% have a return target of below 9% reflecting the significant compression in global yields and low interest rates 8

9 PUBLIC FOUR QUADRANT INVESTING EQUITY PUBLIC EQUITY Real Estate Investment Trusts (A-REITs) Real Estate Developers and Managers PRIVATE EQUITY Direct Real Estate Syndicates Open-ended Funds PUBLIC DEBT Corporate Bonds PRIVATE DEBT Senior Debt PRIVATE Commercial Mortgage-Backed Securities (CMBS) Mezzanine Debt Mortgage Funds DEBT 9

10 RETURN REAL ESTATE FUNDS INVESTMENT STRATEGIES ACROSS THE REAL ESTATE SPECTRUM INCOME VALUE-ADDED DEVELOPMENT RISK: Low Medium High DEVELOPMENT (15% PLUS) TARGET RETURN (IRR PRE TAX NET OF FEES): 9-12% 10-15% 15%+ VALUE ADDED (10 TO 15%) SOURCES OF EARNINGS: Current income (70%) + capital appreciation (30%) Current income (50%) + realised capital appreciation (50%) Current income (<20%) + realised capital appreciation (>80%) HOLDING PERIOD: 5+ years 3-7 years 2-5 years INCOME (9 TO 12%) FINANCIAL LEVERAGE: 0-50% 30-70% 50-80% INCOME ORIENTED RISK TOTAL RETURN ORIENTED BUILDING TYPE: Quality assets with long leases and quality tenants, fully or almost fully occupied Assets with upside potential through refurbishment, releasing and repositioning Development assets, distressed assets 10

11 A$ billion Number of Funds REAL ESTATE FUNDS IN AUSTRALIA 400 Property Funds by Sector: A-REITs Unlisted Wholesale Unlisted Retail Property Securities Other 700 Number of Funds by Fund Type: A-REIT Unlisted Wholesale Unlisted Retail Property Securities Other Source: PIR A-REITs have traditionally dominated but have been losing market share to wholesale funds FUM split - A-REITs: 47%, wholesale unlisted funds: 41%, property securities: 9% and unlisted retail funds: 3% Unlisted retail funds have lost market share both number of funds and assets under management fell 3% in past year 11

12 REAL ESTATE PERFORMANCE 12

13 Cash Rate 10 Year Bonds ING Direct Term Deposit Sydney Residential Australian Equities A-REITs Perpetual Mortgage Fund Real Estate Syndicates Mezzanine Debt THE SEARCH FOR YIELD Investment Yields: October % 14% 12% 10% 8% 6% 4% 2% 0% Source: Yield Report, CoreLogic RP Data, Credit Suisse, Folkestone Non-residential real estate equity and debt provides attractive yield Wide range of options outside of residential to generate yield 13

14 Dec-85 Jun-87 Dec-88 Jun-90 Dec-91 Jun-93 Dec-94 Jun-96 Dec-97 Jun-99 Dec-00 Jun-02 Dec-03 Jun-05 Dec-06 Jun-08 Dec-09 Jun-11 Dec-12 Jun-14 Jun-15 Rolling annual % p.a. NON-RESIDENTIAL INVESTMENT PERFORMANCE Non-Residential Property Total Returns: Income Return Capital Return Total Return Source: MSCI, IPD June total return was 11.3% underpinned by strong income return of 7.0% Direct non-residential property has provided stable returns for past 5 years in a period of financial market volatility Capital values in upswing phase driven by further cap rate compression rather than real estate fundamentals Income returns have been stable fluctuating between 6.3% and 8.8% over the 31 years 14

15 All Property Australian Retail Australian Office Australian Industrial Australian Other % p.a. NON-RESIDENTIAL INVESTMENT PERFORMANCE Total Returns by Sector: to June Year 3 Years 5 Years 10 Years 15 Years Source: MSCI, IPD Non-residential property despite the GFC has generated solid total returns across 1,2,5,10 and 15 years Industrial and Other Property (hotels, medical, carparks etc.) have outperformed retail and office 15

16 CORE RETAIL PROPERTY FUND 16

17 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 June-15 Sydney Shanghai Singapore London Paris New York Hong Kong Tokyo AUSTRALIAN MARKET CONDITIONS CAP RATES Cap Rates vs. 10 Year Bond Yields: Global Office Yields: June 2015 CBD Office Major Regional Retail 10 Year Bonds Yield Gap 10.0% 9.0% 8.0% 7.0% Neighbourhood Retail 10 Year Bonds Industrial Warehouse Still not back to pre-gfc levels 7.0% 6.0% 5.0% 4.0% 6.0% 3.0% 5.0% 4.0% 3.0% 2.0% 1.0% 2.0% 0.0% Source: MSCI, IPD, JLL Cap rates have fallen most for industrial lowest spread from historical average Wide spread over 10 year bonds Expect further cap rate compression in FY16 driven by weight of money from offshore investors who see Australia attractive on both absolute yield and relative to AUS 10 year bonds basis 17

18 REAL ESTATE SOCIAL INFRASTRUCTURE GOES CORE Types of real estate social infrastructure education early learning, schools, tertiary/vocational, student accommodation health medical, hospitals, specialist centres seniors living manufactured housing, retirement villages, aged care social housing transport bus & train stations, park & rides, car parks government accommodation police stations, court houses, prisons, etc. Benefits of real estate social infrastructure include longer leases than traditional real estate assets net or triple net leases (operator/tenant pays outgoings) secure (often government backed) cashflows low correlation to other real estate and non-real estate assets Drivers of demand for real estate social infrastructure demographic and social changes governments looking to private sector to fund yields tend to be higher (although gap is narrowing) some sectors have undersupply and/or existing stock is obsolete opportunities to manufacture new product 18

19 Jan-10 Oct-10 Aug-11 Jun-12 Apr-13 Feb-14 Dec-14 Yield REAL ESTATE SOCIAL INFRASTRUCTURE PERFORMANCE Performance of the Top Five A-REITs: Year to June 2015 National Storage REIT GrowthPoint Properties 15.0% 13.0% 11.0% Early Learning Centre Sale Yields: Metro Yields Linear (Metro Yields) Regional Yields Linear (Regional Yields) Arena REIT 9.0% Folkestone Education Trust Hotel Property Investments 0.0% 20.0% 40.0% 7.0% 5.0% 3.0% Source: ABS More capital being allocated in both the listed and unlisted real estate markets to alternative assets such as early learning, medical/health and seniors living 4 of the top 5 performing A-REITs in the year to June 2015 were social infrastructure related Alternate sectors typically higher yields than office, retail and industrial, although yield gap closing due to growing investor interest in alternate assets Benefits of investing in social infrastructure typically include longer leases (often 10 years or more), net or triple net leases (whereby the operator/ tenant pays outgoings and is responsible for repairs and maintenance), often government backed cash flows & lower volatility compared to other assets 19

20 NON-RESIDENTIAL PROPERTY VS OTHER ASSETS Asset Classes Total Returns: To June Non-Residential A-REITs Equities Bonds Year 3 Years 5 Years 10 Years 15 Years Source: IPD A-REITs were the best performing asset class over 1, 3 and 5 years, while non-residential property was the best performing asset class over 10 and 15 years 20

21 CORRELATION MATRIX Total Returns to June 2015 Market Sector / Asset Class Retail Property Office Property Industrial Property Other Property Non- Residential Property A-REITs Equities Bonds CPI Retail Property 1 Office Property Industrial Property Other Property Non-Residential Property A-REITs Equities Bonds CPI Source: MSCI AU Real Estate Equities Gross in Local Currency, MSCI Australia Equities Index Gross in Local Currency, J.P. Morgan, GBI Global, Australia, Unhedged index in AUD, 7-10 Years, AUD, CPI: Eight Capital Cities 21

22 A-REIT SECTOR 22

23 SCG CQR FDC SCP BWP IOF GOZ NSR AJA ANI ARF FET GHC GMF HPI IDR TIX GPT DXS WFD GDI ABP SGP MGR INA GMG CMW CHC A-REITs BACK TO TRADITIONAL MODEL A-REIT Sector Gearing: A-REIT Income Split Rental vs Corporate Earnings: October 2015 A-REIT Sector Beta: % 100% Rental Income Non-rental 45% 90% 40% 80% 35% 70% 30% 60% 25% 50% 20% 40% 15% 30% 10% 20% 5% 10% 0% 0% Source: Petra Captial Source: Petra Capital Source: JP Morgan A-REIT sector has moved back to less riskier sector than pre-gfc: gearing lower less non-rental (funds management, development etc.) income and offshore earnings lower beta 23

24 Market Cap $bn No. of A-REITs A-REIT INDEX HIGHLY CONCENTRATED A-REIT Index Composition: October 2015 A-REIT Sector Composition Underlying Assets: October 2015 Top 8 A-REITs Rest of A-REIT 300 Non-Index A-REITs Industrial 14.0% Other 1.0% Office 20.0% Retail 65.0% 0 Market Cap of A-REITs No. of A-REITs 0 A-REIT Index highly concentrated by stocks and sector Index funds higher risk than most people understand: top 8 A-REIT stocks represent over 80% of Index retail assets 65% of the underlying assets Many of the A-REITs outside the index are not covered by brokers Benchmark unaware investing in A-REITs can provide real opportunities for outperformance 24 Source: IRESS/UBS

25 (% p.a.) A-REIT SECTOR PERFORMANCE Slope of the Yield Curve vs. REIT Relative Performance: Source: IRESS, Credit Suisse estimate Strong correlation between interest rates and A-REITs A-REITs have performed well since mid 2013 when bond yields fell A potential lift in global yields is likely to be a major catalyst for A-REIT under performance 25

26 A-REIT SECTOR PERFORMANCE A-REIT Price to NAV vs. 10yr Bonds: A-REIT Price to NTA: Source: IRESS, RBA, Credit Suisse estimate Source: IRESS, Credit Suisse estimate Recent sell-off has created better value in the A-REIT sector but still above historical average A-REITs trading on a: 2% premium to NAV (Stockland, Micvac and Dexus all at significant discounts) 29% premium to NTA 26

27 A-REIT SECTOR PERFORMANCE A-REIT Sector P/E Ratio: A-REIT Sector DPS Yield: Source: Company data, IRESS, Credit Suisse estimate Source: RBA, IRESS, Credit Suisse estimate A-REITs are trading on 6.35% prospective earnings yield and 5.41% dividend yield Payout ratios are not stretched and the dividend yield for most A-REITs remain cash covered FY16 outlook largely as expected in recent A-REIT outlook statements 27

28 Mar-96 Sep-97 Mar-99 Sep-00 Mar-02 Sep-03 Mar-05 Sep-06 Mar-08 Sep-09 Mar-11 Sep-12 Mar-14 Rolling annual % p.a. A-REITs VS DIRECT REAL ESTATE A-REITs vs Direct Real Estate: Direct Property Listed A-REITs A-REITs vs Direct Ongoing Debate? Both are legitimate forms of real estate investment A-REITs will return to more historical long-term performance A-REITs will continue to be used as liquid form of real estate Short-term pricing arbitrage between A-REITs and direct real estate will continue driven by lag in direct real estate valuations For many investors both will have a place in their portfolio Source: IPD / MSCI 28

29 REAL ESTATE DEBT 29

30 LEVERAGE Why Use Leverage? allows for greater diversification can put more equity to use across multiple investments often enhances returns higher leverage equals less equity and therefore potential greater return on equity tax advantages negative gearing Asset level considerations the point in the cycle - what is the likelihood of the asset s price increasing or decreasing in the coming years location how deep is the market if you want to exit, what are the supply and demand fundamentals? quality of the tenant covenants what is the likelihood of tenant default? lease expiry profile are there any vacancies or upcoming lease expiries? quality of an asset s income streams can the cashflow from the asset adequately cover the debt costs, what are the lease structures and rent review mechanisms in the leases? investment hold period is the asset being held for short-term trading or long-term investment? impact on operational flexibility - cash flow escrows, deposit requirements, prepayment lockouts and penalties In structuring and managing the debt, factors to consider include: cost of debt - the higher the leverage, typically the higher the cost of the debt that the lender requires to compensate for the increased leverage risk debt covenants the maximum loan to value ratio and minimum interest cover ratios that the lender will require type of debt interest only or principal and interest? source of debt traditional bank lending or capital markets medium term notes, CMBS etc? capital stack is the debt just senior first ranking or has the capital stack been layered to allow a combination of senior and mezzanine debt duration of the debt - short or long-term debt? hedging profile - how much of the debt is at fixed or variable interest rates? 30

31 LEVERAGE The impact of leverage using 30%, 50% and 65% gearing on a real estate asset that has been acquired for $1 million Two key points: 1. leverage magnifies the creation or loss of value; and 2. the volatility of an investor s equity rises as leverage increases. 31

32 REAL ESTATE CAPITAL STACK Priority In Priority Out Equity Junior Mezzanine Mezzanine Debt Unsecured Subordinated debt Secured second ranking Subordinated debt Secured third ranking Senior Debt Bank debt Secured First ranking Conservative leverage Real estate debt exposure ranges from senior to junior mezzanine Higher up the capital stack, the greater the risk and higher the expected return 32

33 MORTGAGE SECURITISATION ISSUANCE Yearly Securitised Issuance: Yearly Securitised Issuance Non RMBS: Source: Macquarie Debt Markets Analysis Residential Mortgage Backed Securities (RMBS) is the dominant form of mortgage securities Commercial Mortgage Backed Securities (CMBS) has not had the same level of acceptance very few issues since the GFC unlike the US where CMBS is a prevalent form of securitisation 33

34 REAL ESTATE CORPORATE BONDS Issuer Maturity Coupon Rating May 2015 (%) October 2015 (%) Movement (bps) CFS Retail 19-Dec A Lendlease 13-Nov BBB Lendlease 13-May BBB Mirvac 18-Sep BBB Mirvac 16-Sep BBB Stockland 1-Jul A Stockland 6-Sep A Stockland 25-Nov A Westfield Retail 23-Oct A Source: Yield Report Real estate corporate bonds not available to retail investors 34

35 MORTGAGE FUNDS Have been a popular source of income yields for investors Provide a source of non-bank capital for borrowers At peak mortgage trust sector managed $18bn since GFC this has reduced substantially to less than $2bn Open-ended mortgage funds have created issues inherent mismatch between assets (longer term lending) and liabilities (daily liquidity) Pooled mortgage funds where funds from multiple investors are pooled and invested across a range of loans with varying risk and returns are now less common structures Contributory mortgage funds which consist of multiple sub-trusts each holding a loan and the investor invests in an individual sub-trust that they like rather than the fund as a whole the structure therefore matches an investors investment and return to a particular mortgage are now more common 35

36 CONCLUSION 36

37 UNLISTED REAL ESTATE FUNDS LESSONS LEARNED ISSUES PRE-GFC POST-GFC Asset Quality Leverage Distribution Fees Liquidity Manager Capability Focus on higher yielding, lower quality assets rather than lower yielding, higher quality assets Gearing above 50% with little or no head room in LVR and ICR covenant Higher yields sometimes due to propping up from higher payout ratios (sometimes greater than 100%) and/or financial engineering No alignment of interest, focus on up front fees and disposal rather than performance fees Often had daily/monthly/quarterly redemptions and roll over provisions at end of initial term with low hurdles Lack of transparency and sometimes poor governance Higher quality assets with longer term leases Gearing between 30% - 50% with head room on LVR and ICR covenant Focus on income generation of the asset, sustainable payout ratio less than 100% of income and not using debt to drive higher distribution yield Greater alignment with investors on fees with a focus on lower upfront and ongoing management fees (often based on net not gross assets) and a performance fee based on actual outperformance Limited or no liquidity during investment term, clearer mechanisms for rolling over funds at review date and a performance fee structure that incentivises the manager to wind up the fund early if in the best interest of investors Managers focus on alignment of interest with investors, stronger corporate governance, higher quality reporting and often backed by an institutional manager or listed A-REIT 37

38 GOVERNANCE & TRANSPARENCY UNLISTED FUNDS Investors are more demanding of their managers when it comes to reporting, risk management processes, governance and succession planning 38

39 GOVERNANCE & TRANSPARENCY MORTGAGE FUNDS Investors are more demanding of their managers when it comes to reporting, risk management processes, governance and succession planning 39

40 WHAT TO LOOK FOR IN A MANAGER? SIMPLICITY SOLID AFTER TAX RETURNS TRANSPARENCY GOOD COMMUNICATION ADHERENCE TO MANDATE ALIGNMENT OF FEES STRONG CORPORATE GOVERNANCE 40

41 RISK MANAGEMENT Don t take the conventional wisdom approach to evaluating risk when you evaluate risk, expect the unexpected think broadly and expansively about events that can impact your probable outcome at times there is a rush to herd mentality in pricing assets. The seemingly safest position today may actually be far riskier than might be perceived by the herd mentality. An example is core real estate in some of the gateway global cities is currently being priced to perfection 41

42 LESSON S FROM PAST - A GUIDE TO THE FUTURE Real Estate & Capital Markets need to understand both real estate and capital markets capital structure is important balance between debt and equity and investing across the capital stack capital flows at certain times in the cycle will overwhelm real estate fundamentals (its happening now) markets come unstuck when risk is not understood and therefore not priced appropriately Investors need to fully understand their risk and return profile want basic, transparent and true to label products need to understand that comparing funds and/or A-REITs based on 1 st year yield does not guarantee it is a good product property is a total return proposition and has a cycle! Managers must remember investors come first be transparent with investors especially in relation to NTA and yield calculations need to always be looking ahead what are the key drivers? what are the keys risks? - be prepared to adapt and change 42

43 DIRECTORY Folkestone Limited ASX Code: FLK Website: ABN: Level 12, 15 William Street Melbourne Vic 3000 T: Level 10, 60 Carrington Street Sydney, NSW 2000 T: Board of Directors: Garry Sladden Non-Executive Chairman Mark Baillie Non-Executive Deputy Chairman Greg Paramor AO Managing Director Ross Strang Non-Executive Director Company Secretary: Scott Martin Investor Relations: Lula Liossi T: lliossi@folkestone.com.au DISCLAIMER: This paper has been published for information purposes only. The information contained in this paper is of a general nature only and does not constitute financial product advice. This presentation has been prepared without taking account of any person's objectives, financial situation or needs. Because of that, each person should, before acting on this presentation, consider its appropriateness, having regard to their own objectives, financial situation and needs. You should consult a professional investment adviser before making any decision regarding a financial product. In preparing this presentation the author has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which has otherwise been reviewed in preparation of the paper. The information contained in this paper is current as at the date of this paper and is subject to change without notice. Past performance is not an indicator of future performance. Neither Folkestone Limited, nor any of their associates, related entities or directors, give any warranty as to the accuracy, reliability or completeness of the information contained in this paper. Except insofar as liability under any statute cannot be excluded, Folkestone Limited and its associates, related entities, directors, employees and consultants do not accept any liability for any loss or damage (whether direct, indirect, consequential or otherwise) arising from the use of this paper. If a product managed by Folkestone Limited or its associates is acquired, Folkestone Limited or its associates and related entities may receive fees and other benefits. The author 43 of this paper does not receive commissions or remuneration from transactions involving the financial products mentioned in this paper. Registry: Boardroom Pty Limited PO Box R67, Royal Exchange NSW 1223 Telephone: or enquiries@boardroomlimited.com.au Website: