Australian investors’ home country bias approach to real estate investing has worked out quite well given the robust performance of the domestic real estate market.
This is evidenced by annualised returns over the past three and five years in the range of 11.5 per cent to 12 per cent (The Property Council/IPD® Australia Property Index). However, based on the composition of this index, a domestically centric portfolio is generally characterised by a high relative portfolio exposure to the retail property sector; a low relative exposure to logistics assets; a very limited exposure to the multifamily residential sector; and little global geographic diversification. Could these portend underperformance ahead?
As an example, in the face of the inexorable advance of e-commerce globally and its disruptive impact on traditional retail tenants, one might ask how portfolios with higher retail and lower logistics exposure will perform going forward, especially over the near to intermediate term. An indexed portfolio of US institutional real estate investments will provide, de facto, a significantly enhanced allocation to logistics and multifamily assets and a lower exposure to retail properties relative to the Australian Property Index.
With the US economy on the verge of becoming the longest expansion on record, economists are increasingly in agreement that the late phase of the current business cycle portends a slowing economy (although not necessarily a recession) in the near future. Is now the right time to be looking at rebalancing portfolios by adding US real estate investments? Or would investors be better off waiting in order to time their new investments into the US real estate markets?
As regards the latter question, the short answer is “no” because in our view the benefits of portfolio rebalancing likely outweigh the risks of waiting. Real estate has proven itself resilient to market ups and downs over the long term. In fact, an academic study looking at real estate performance over a period of nearly 400 years in the Netherlands proves this to be the case despite spanning two world wars, the Black Plague and the Great Depression. Empirical data shows US institutional real estate providing good risk-adjusted returns with a Sharpe Ratio (risk-adjusted returns) higher than stocks or bonds over the past 40 years of track record. The defensive nature of real estate with a high proportion of the return coming from income and lower volatility compared to public equities coupled with the global diversification and a reduced retail property exposure stemming from a US indexed portfolio makes a sound case for rebalancing sooner rather than later. In addition, it is not certain that US real estate prices will experience a significant downward correction even in the event of an economic slowdown or mild recession (particularly in light of very low treasury rates) and as such a dollar cost averaging, portfolio rebalance-oriented strategy could be more effective than waiting.
What can Australian investors do to make portfolio adjustments from an investment solution perspective if they want to increase US exposure?
Investors can carefully and selectively expand their investment activity into the US real estate markets via strategies such as:
a) Invest in open-end core or enhanced core funds that provide overweight exposure to industrial/multifamily at the expense of the retail sector
b) Invest in value-add or opportunity/development funds (typically closed-end funds, which admittedly may be of less interest to Australia investors than are open-end funds) that are planning to overweight industrial/multifamily and to significantly underweight retail
c) For larger cap Australian investors, invest in separate accounts or club relationships (i.e. teaming with a small number of other large cap global investors) to invest in industrial, multifamily, office or mixed-use investments, including a build to core program
d) For those investors concerned about the risk of an economic downturn and thus seeking more defensive investments, higher yielding debt opportunities including mezzanine or construction loans may be attractive. In a debt structure the investor is giving up the potential upside from increases in property value – but receiving the trade-off of having a higher certainty and protection of one’s income stream in return – it’s an effective way to de-risk investments.
Real estate has a proven track record of stable performance over the long haul. The global real estate market is large and diverse with an estimated size of US$33 trillion. The US share is a sizeable at about US$13 trillion. The US real estate market is an efficient and transparent market offering a multitude of investment options for Australian investors to consider. Rebalancing an Australian-centric real estate portfolio by increasing US exposure offers many positives to a multi-asset investment portfolio even in the late stages of an economic cycle. In addition to increasing geographic diversification, a US portfolio can help reduce an investor’s high relative retail exposure while increasing logistics and multifamily residential exposure.
Guy Tcheau is managing director of private real estate at Principal Global Investors.
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