Unlisted property investors warned of entrapment as demand plunges

July 26, 2023
Posted in News
July 26, 2023 veps

Double-digit falls in capital values and lower income are being forecast for the unlisted commercial property sector if rising interest rates, a slowing economy and less demand for office space continue to drag down performance, say industry specialists.

This is adding to problems with liquidity (the ability to retrieve money when expected) for investors and managers and might lead to forced sales that could further aggravate price falls, they warn.

Dugald Higgins, head of responsible investment at Zenith Investment Partners, expects to see more liquidity events if interest rates and structural problems continue to weaken investor sentiment.

“When one fund does it, the others get nervous. It can have a snowball effect,” Higgins warns.

Damian Diamantopoulos, fund manager and head of property research for Australian Unity, adds: “No one wants to leave when times are good and funds are returning double-digit returns. But it can get constrained when the market turns and everyone wants to leave at the same time. But these funds are not ATMs, they contain assets that take time to sell.”

Some unlisted funds, such as Charter Hall Direct, are already restricting investors to redemptions of 25 per cent and informing them they will have to wait until mid-next year for the remainder.

Centuria Capital has told investors its 25 Grenfell Street Fund’s distributions will be suspended for the 2024 financial year because a major building needs a refurbishment and negotiations to increase debt are “protracted” due to rising rates.

An unlisted property trust is not listed on a public market, such as the Australian Securities Exchange, which means it is not subject to the same level of market scrutiny as listed funds, which are constantly being analysed and repriced by investors.

The accompanying MSCI/Mercer table shows that overall capital growth for the year to the end of June is down by around 5 per cent, with office funds falling nearly 8 per cent, while industrial, which includes logistics, posting gains of 2.4 per cent.

It also shows that all sectors generated income ranging from between 3.5 per cent to 4.8 per cent over the same period.

The table covers the performance of around 100 office, industrial and retail property funds with around $13.7 billion under management and gearing of 10-25 per cent.

Diamantopoulos says there are hundreds of other unlisted retail funds not included in the tables that can be geared up to 55 per cent.

AMP chief economist Shane Oliver says unlisted property is being hit by a triple whammy: rising interest rates and bond yields are reducing their valuations and making them less attractive to new investors; structural changes, such as employees working from home; and a weakening economy reducing demand.

Oliver says less demand for office space will slash building values by more than 20 per cent while capital losses across office, industrial and retail could be more than 15 per cent.

Oliver adds: “The divergence in performance between sectors, such as office space and industrial, reflects the differing exposure of each property class to the second hit of reduced structural space demand.”

For example, industrial fund demand is underpinned by e-commerce and the growth in online retail sales, which means more demand for warehouses and record low vacancy rates pushing up rents.

“But office and retail are very vulnerable to a reduction in demand for space,” says Oliver.

Retail is adjusting to the shift to online shopping, but office property is struggling with a change in work practices as more employees split their working week between home and the office, he says.

“This means something like a 40 per cent or so reduction in demand for space from companies for their office workers, which will show up in vacancy rates as leases are progressively renewed,” Oliver adds.

David Clark, partner with boutique investment adviser Cameron Harrison, says big discounts in the value (net tangible assets) of listed funds implies a large amount of the impact of higher interest rates are priced in. “This is not the case in unlisted markets,” Clark warns.

He adds: “This sector is taking longer to recover, with weak rental growth and high incentives magnified by an intense resistance to return-to-office policies from employees.”

Another rise in cash rates, which could happen next Tuesday when the Reserve Bank of Australia meets, could further weaken valuations, lower tenant demand and increase the risk of recession. “All bets are off if there is a deep recession,” adds Higgins.

Australian Unity’s Diamantopoulos says this is not like the global financial crisis where many managers were caught struggling with high levels of debt and were forced to sell illiquid assets at bargain prices.

“There are no distressed sales and this time lenders are willing to work through financing problems with funds,” says Diamantopoulos.

According to Alex Jamieson, a financial adviser with AJ Financial Planning, long-term retail investors who do not need the cash immediately should consider “riding out the short-term loss in the value of their investments”, particularly when income payments are competitive with banks.

Oliver adds: “Unlisted property, as with equities, always has risks, and it’s common to see periodic setbacks. The best way to invest in it is as a long-term investor.”

Diamantopoulos says investor sentiment can turn around quickly, particularly if there are signs interest rates are peaking.

Higgins recommends investors rethinking their exposure should be asking about gearing ratios (the higher the gearing, the greater the risk), how comfortably a fund’s earnings before interest and tax cover interest payments on loans, length of leases and quality of the assets.

source: afr