With cash rates at historical lows, investors continue the hunt for yield investments.
A lot of capital is flowing into prime office, retail and industrial assets in the major markets. Investors are being attracted by the secure income of these assets, underpinned by long-term leases to quality tenants. This is driving significant competition for prime assets and putting downward pressure on yields.
Investors (directly or via financial advisers) are increasingly looking at unlisted real estate funds (syndicates) as a way to capture yield in their portfolios. Confidence in using unlisted funds is increasing, as the new breed of funds have addressed many of the issues that arose during the GFC.
However, in the rush for yield, we are beginning to see some investors (and their advisers) focusing on the first year yield and wanting higher yields. This comes at a time when, due to the weight of money flowing into real estate, yields are coming down.
The risks of chasing yield
Investors shouldn’t forget that the higher the yield, typically the higher the risk. A prime neighbourhood retail centre, anchored by Woolworths on a 20 year lease at an 8 per cent yield, has a very different risk profile to an office building in a non-core market with multiple tenants on shorter term leases being acquired on a yield of 8.5 per cent. Investors may not fully appreciate the additional risk they are taking on to capture the 50 basis point yield premium.
Real estate is a long term investment and we believe it fits comfortably in a closed-end fund with an investment term of 5 to 7 years. However, under ASIC guidelines for unlisted funds, managers are only required to disclose the first year’s metrics in the PDS – yield, gearing and NTA.
Total return forecasts over the life of the fund are not published – ASIC won’t allow it. Therefore, it is easy for investors to get sucked in based on the first year metrics, especially the starting yield.
What to look for
What investors need to consider is how the asset is likely to perform beyond the first year. Here’s just some of the things investors need to consider when assessing an unlisted fund offering:
- When are the leases due to expire?
- Is the asset under or over-rented compared to the market?
- Will the asset require capital expenditure and if so, how will the fund pay for it?
- What is the prognosis for supply and demand in the surrounding market?
- What’s the manager’s likely exit strategy?
There are a number of quality managers offering unlisted real estate funds. The good managers are asset enhancers; they create value by their ability to manage the asset through the cycle. They don’t rely on capital management and financial engineering to deliver returns to investors.
Unlisted real estate has a valuable role to play in a multi-asset portfolio, particularly for those investors not concerned about liquidity (ie SMSFs) and who don’t want the volatility of listed A-REITs.
However, like any investment, investors need to do their homework, understand the risks and appropriately price those risks.
Adrian Harrington is head of funds management at Folkestone
