Understanding Property

Transcription

1 Understanding Property

2 Understanding Property TABLE OF CONTENTS What is property? 3 Benefits of investing in property 4 Investing in property 4 > > Ways to invest 4 > > Risk-return characteristics 5 > > Drivers of performance 6 > > Risks specific to property investing 7 The importance of active management 7 ABOUT PROPERTY 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 property 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 property 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 property fund managers in the Asia Pacific region. Our integrated and strategic approach to investment management spans the property 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, property 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 specialists, as well as experts from our infrastructure, fixed income, equities and multi-asset investment teams. For further information Please visit ampcapital.co.nz 2

3 WHAT IS PROPERTY? Property is a physical bricks and mortar investment where income and value are driven by rents that are paid by tenants under contractually binding leases. Property 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 property ownership and highest in listed property investments. Direct property 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 property typically does not trade as quickly as equities, so its prices are more susceptible to investor speculation than listed property or equities generally. Being a physical asset, direct property is more illiquid (takes longer to sell) than equities and bonds. Investors seeking greater liquidity have the option of buying listed property securities. However, the trade-off for higher liquidity can be greater volatility in prices compared to direct property ownership. EXAMPLES OF PROPERTY 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 3

4 BENEFITS OF INVESTING IN PROPERTY Stable, reliable income streams Property can offer investors a stable source of income through regular distributions of underlying rental income. Over the long term, the majority of property returns come from rental income which is generally less volatile than capital returns, as rents are contracted under a lease agreement. In commercial property, this can be five to 10 years for major tenants. Inflation hedging Some property 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, property income should keep pace with inflation, helping to maintain real returns. Low correlation to other asset classes Direct property 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 property), with and without exposure to direct property. An efficient frontier represents the best risk-reward ratio for an investment under the present circumstances. The chart below shows that when direct property is included in a diversified portfolio, the efficient frontier shifts to the left, thereby signifying a reduction in volatility. The inclusion of direct property improves the risk adjusted return Return Including direct real estate assets Volatility Source: AMP Capital. For illustrative purposes only. Excluding direct real estate assets INVESTING IN PROPERTY IMPORTANT NOTE: In this section, we outline some of the benefits of investing in property, 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 Direct property When investing in direct property, investors purchase the asset(s) themselves and gain access to the pure risk of property. This means they can expect predictable secure long-term rental cash-flows, and exposure to the property market cycle, not the equity market. The downside of owning a physical asset is that money has to be spent on maintaining the asset over time. However, historically direct property has produced relatively strong returns for investors see table on page 5. Direct property 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 property pricing. Direct property investment by most private investors is in residential property, 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 property 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 property either via a syndicate or institutional fund, together with some holdings in property securities. Listed property When investing in listed property, 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 property assets. Popular listed property 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 property, bad news or good news is usually reflected immediately and prices can overshoot on the upside and the downside. 4

5 RISK-RETURN CHARACTERISTICS Property s typical performance bridges the gap between fixed income and equities. Property can offer investors a stable bond-like payment structure with the potential for equity-like upswings in yield and capital. Property ranks between fixed income and equities on the risk return scale Return Cash Fixed income Listed Real Estate Infrastructure Direct Real Estate FACTORS INFLUENCING PERFORMANCE OF DIRECT PROPERTY When assessing the performance of property, consideration has to be given to the type of property 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 property investment categories generate returns from both income and capital growth. However, the proportion of that return varies when looking at each asset type. Historically, the highest returns have been produced by shopping centres, and prime residential property. Performance of direct property Risk Source: AMP Capital. For illustrative purposes only. Equities Private equity and hedge funds Total return (%) 10 year annualised New Zealand office 11.3 New Zealand retail 14.3 New Zealand industrial 15.8 Source: Property Council/IPD New Zealand Quarterly Property Index. Historical performance is not an indicator of future performance. Real estate and infrastructure are often classed as real assets because they are tangible Residential Definition: Property that derives its revenue from dwelling units. Historically, residential property has been able to deliver high capital growth because of low vacancy rates and an undersupply of rental accommodation. In recent years, housing demand has outstripped housing supply, particularly in Auckland 1. Some of this is due to town planning systems restricting the volume of new supply below demand. Low vacancy rates allow landlords to raise rents, and property values tend to increase when the potential rental earnings increase. 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 property can be less volatile, reducing the risk of a sharp rise in vacancy rates when the economy slows. Commercial Definition: Property that is intended for use by commercial, retail or wholesale businesses. Income yields in commercial property are generally supported by longer lease terms than residential property. 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 property sectors 2. 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 investors 3. 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 property 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. Office property is also more susceptible to economic and business cycles than other property sectors. Industrial Definition: Property that is intended for industrial purposes. The industrial sector holds over 100 million square metres of industrial space 3. 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. 1 Reserve Bank of New Zealand Analytical Note Series, JLL Research and PCNZ Shopping Centre Database, June JLL Research, June

6 DRIVERS OF PERFORMANCE The performance of the property market is affected by changes in physical and financial cycles. Property 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 financial cycle represents the capital flows that go towards funding property developments; new construction affects the price of property. The real estate market is affected by changes in physical and financial cycles PHYSICAL CYCLE REAL ESTATE CYCLE FINANCIAL CYCLE Economic upturn Increased property demand Credit expansion Economic boom Supply shortage Rising rents / falling yields Credit boom Building boom Economic downturn 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), Past performance is not a reliable indicator of future performance. 2 National Housing Supply Council, Housing Supply and Affordability Report,

7 RISKS SPECIFIC TO PROPERTY INVESTING Property 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 property debt, or costs and losses associated with natural disasters or other events which prevent the normal operation of property investments also have an impact on the performance of property returns. The following risks are among those investors should consider when investing in property: Sector risk There are a number of factors which may affect the property sector, including the cyclical nature of property values, overdevelopment and increased competition, increases in property 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 property market and other property capital market influences can also affect the performance of the sector. THE IMPORTANCE OF ACTIVE MANAGEMENT Active management may add 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, property securities have a number of unique features which present opportunities for active managers. There are significant differences between property markets around the world which require local knowledge. At a basic level, distinctions exist between property 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 property 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. Vacancy risk 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. A good approach for those wishing to minimise risk is to invest in property 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 generally advisable to look for well-located properties, in locations such as central business districts or central shopping malls, with anticipated lengthy and secure income streams. CONTACT US If you would like to know more about how AMP Capital can help you, please visit ampcapital.co.nz Important note: This document has been prepared to provide general information and does not constitute financial advice for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement (available from AMP Capital Investors (New Zealand) Limited website or by contacting the Client Service Centre on ), and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, AMP ) make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors. The Manager and Issuer of the AMP Capital Investment Funds is AMP Investment Management (NZ) Limited, Ground Floor, The Terrace, Wellington.