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Ep: The 5 real estate investment drivers of 2022 - Andrew Ballantyne and Fergal Harris, JLL
Episode 292nd February 2022 • JLL Perspectives • JLL Australia
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JLL has identified five key themes that will drive real estate investment decisions in 2022. They are where opportunity beckons and where global investors are focusing their strategies as more capital is ploughed into real estate on the back of a record-breaking 2021.

Guests: Andrew Ballantyne, head of research - Australia, JLL, and Fergal Harris, head of capital markets - Australia, JLL.

Host: Rebecca Kent, content director - Australia, JLL

Transcripts

Rebecca Kent

emes are likely to prevail in:

I speak to two people no better qualified to discuss the shape of things to come, covering industrial real estate, hotels, universities, medical centres, mergers and acquisitions, social and environmental influences and much more: Andrew Ballantyne, JLL’s head of research in Australia, and Fergal Harris, JLL’s head of capital markets.

I’m Rebecca Kent, host of this JLL Perspectives podcast and we are very pleased to have you listening.

recorded right at the end of:

Rebecca Kent

Andrew, how have you come up with these themes?

Andrew Ballantyne

It’s a good question. We spend our whole time looking at the macro factors that impact real estate markets. And it's really through that continuing research that we do that allows us to formulate what we believe are the key themes for investors moving forward. So this year, we decided to mix the themes with a range of macro or longer term factors. And then a number of factors which we believe are opportunity-led.

Rebecca Kent

Fergal, how would you describe the year that’s been?

Fergal Harris

d we looked at the themes for:

Fergal Harris

The strength of retail, the strength of that essential and necessity retail didn't surprise, but the depth of confidence in Australia to buy in domestically, did surprise. I think that was an almost bulletproof asset class. And arguably it had been mispriced on the back of just global retail and retail as a general asset class, not understanding the nuances that exist in Australia. So they're the two that I would pick out. I wasn't at all surprised by volumes in office, but they would be the two that I would say stand out in my mind looking back.

Andrew Ballantyne

It's a good point you make around that larger end of retail, Fergal, because we did start to see liquidity return to that sector. And there was a lot of confidence around 'well do we actually believe the valuations given some of the headwinds that we see within the sector?’. Seeing the number of significant trades over the second half of the year at those adjusting book valuations gives us a level of confidence that for most of those large centres, we're pretty much at the trough of the of the asset valuation cycle. And it's been interesting even looking at the rally that we've seen in the listed market for those major shopping centre owners, given that they've been trading at a significant discount to NTA.

Rebecca Kent

surpassed the record-breaking:

Fergal Harris

I think it will continue to weigh on office, if it weighs on any asset class at all. Omicron has got to play out in the first couple of months of next year in any event because it's a new variant and we need to get some data on what impact it has on health services and people's mobility. So I think that continues to have that same tale of a question mark over occupancy. I think the return to work question has kind of being put to bed. People are back when they can get back and more and more people that we speak to want to be back in some shape or form. But in terms of growth and what your office space will look like, that could be a couple of months before we appreciate what the impact of the variant has.

Fergal Harris

Internally within Australia, certainly internal travel is going to have an impact on retail and tourism because retail expenditure, when it's not happening, then there's only saving so those savings are now over 200 billion. And that will be spent when people start coming back to some sort of normal life or traveling around the country more often. And I think tourism will start to benefit from that too, in terms of that spend. So I'm still pretty bullish on office volumes recovering. But without Omicron we would have been into our stride in February with an increase in number of assets coming to market.

Rebecca Kent

s that JLL has identified for:

Andrew Ballantyne

sentially trended lower since:

Andrew Ballantyne

So I think ultimately, what investors are doing is saying, 'well, we know how we construct a return hurdle for real estate, it's the risk free rate plus an implied risk premium. What does that mean in terms of an unlevered return?' And what we've seen is that investors have retained the degree of discipline. So this spread between where bond yields and return hurdles at the moment are wider than historical benchmarks. So investors were expecting to see a partial reversion in bond yields.

Andrew Ballantyne

Our view is that if we're moving back to an environment of somewhere between 2.5%-3%, an implied market risk premium of 300 basis points for core real estate gets you into unlevered, return expectations of around 5.5%-6%. And we're really comfortable at that type of level. I think the risk for the asset class is that bond yields move beyond the 3% territory. Because that's ultimately when risk premiums start to get crunched, you can start to make a case that real estate looks expensive in that type of environment. And real estate can look expensive if you believe in the income growth story. And at the moment, the income growth story is very strong for industrial and logistics, but probably less so for the other sectors.

Fergal Harris

What would be interesting - and I'm going to use this for the purposes of our podcasts, and maybe the next one, is to look at what the broad money supply is doing when bond yields were at 5%. Because we've clearly seen true quantative easing, an enormous amount of printed money, which, by definition, any schoolboy economists will tell, you should drive down the price of that money. And so those bond yields may have a natural cap, simply because there are so many dollars and hard Western currency - U.S. dollar, Pound Sterling, Euro and Aussie dollar in the market. So it would be interesting to see what that looks like in terms of where we think a bond yield ceiling might be, when our bond rates are not rising because of an inherent risk in Australia.

Rebecca Kent

And Fergal, what are Australia’s unique factors when it comes to real estate investment in the context of interest rates creeping up again across the globe?

Fergal Harris

ot continue to be the case in:

Rebecca Kent

Okay, thanks, Fergal. Let’s move onto theme number two, being ESG, which stands for environmental, social and corporate governance, factoring more heavily in investment decisions. How’s that, Andrew?

Andrew Ballantyne

Part of the challenge with the social aspect is that it's actually very wide and broad. So we think about Sydney office sectors specifically, there's a lot more discussion around the fundamental health of buildings. And one of the aspects that we're hearing a lot of discussion around is the fresh air provision within buildings, because ultimately, there's been research that shows it reduces absenteeism, and improves mental wellbeing of the occupants of the building. And a lot of that is covered by the WELL Institute and WELL ratings.

Andrew Ballantyne

What I think's even more interesting is how we start to think about the requirements of a diverse workforce. So we're now starting to hear greater discussion around 'does the building have the inclusion of a prayer room? Are there gender neutral end-of-trip facilities to account for a diverse workforce.?' So it's going to be really interesting to see how those aspects evolve as we move forward.

Andrew Ballantyne

The other area, which is one that I'm quite passionate about, is I've always taken the view that real estate turns its back on its neighborhood. A large part of the social aspect is how does real estate actually integrate with its neighbourhood? And how does it actually provide additional third space, not just to occupants of the building, but also to the broader community as well? So while some of that is governed by planning, we're starting to see new developments actually think about integration with the neighborhood. We're seeing examples of amphitheaters or additional steps put in, where people can actually sit and have an informal meeting, they can have lunch, they can have a cup of coffee. So I think that's going to be interesting from a new development perspective.

Andrew Ballantyne

When we start to think about investors, it's very much around who are the occupants of the building. So do the occupants have very strong political views? Are they actually operating in an industry which is a high pollutant? So previously, the focus was very much on the quality of the covenant, that is, what's the credit rating? What's the term? There's now a lot more discussion around, 'what activities does that particular user undertake, what views do they actually hold?' And that fits in with the broader social bucket and terms of how investors are actually thinking about their real estate investment moving forward.

Rebecca Kent

And from a futureproofing perspective, developers have got to be a step ahead of ESG demands unless they want to be refurbishing every few years. Thank you, Andrew.

Moving on to theme number three: healthcare. It is to feature more prominently in portfolios. Why is that?

Andrew Ballantyne

So the reason we're looking really closely at healthcare is quite simple. If you look at the growth sectors of the Australian economy and the growth sectors for mature economies, healthcare is one of those key sectors. Its share of economic output is going to increase over the next 10 years.

Andrew Ballantyne

If you look at it from an employment perspective, the number of people in mature economies that work in that broader healthcare sector is going to increase. So ultimately, investors like to invest into integral sectors. So the healthcare sector immediately gets attention due to the fact that it has significant growth drivers. And we know what they're related to: in particular, around demographics - aging of population, the emergence of health tech, etc.

Andrew Ballantyne

So the challenge with healthcare is, there's a whole diverse range of sub sectors that sit under healthcare. We're starting to see more healthcare organisations actually occupying office space. That's been a significant growth driver. So you can actually get exposure to health care by investing in the traditional office sector, but having the tenant that's in that building being related to healthcare.

Andrew Ballantyne

What I think you're starting to see more of is the capital trying to understand the stories around private hospitals, around medical centres, and then, as an extension of healthcare, the emergence of the life sciences sector. Each of these sectors have their own unique characteristics. But what we're finding is that investors are trying to work out how they can get exposure to those sectors, either through development, or through investment in established assets.

Andrew Ballantyne

If you take the life sciences sector, specifically, some of the key points around the investment rationale are you're getting exposure to very strong covenants. You tend to find that life sciences organisations take very long lease terms. And the other one that's quite interesting from a real estate perspective is that those organisations make significant investment into their real estate. You tend to find there's very high barriers to exit for life sciences organisations. So they tend to stay in the real estate for a significant period of time. That's been our experience of what we've looked at in the U.S.. And from an investment perspective, that makes it very attractive, because what might be an initial seven to 10-year lease in reality is probably going to be a 15 to 20-year tenure within that asset.

Fergal Harris

The only thing I'd add to that on healthcare and life sciences in the Australian context for the time being is scale. A lot of our investors when you consider this relative size of the office market or retail or logistics markets, is the scalability of that growth. A lot of the investors are getting in now because in the next couple of years, that's going to scale up. But currently, it's quite difficult to build scale. So you have to have a long-term view as an investor of getting into healthcare in all of its broad forms. I fully agree with Andrew, I think it's going to be about medical centres and co-operatives on the private side, and of course, the life sciences for sure.

Rebecca Kent

Even as a consumer of medical services, I can see how quickly facilities and buildings are already changing.

So, moving on to our fourth theme: COVID-impacted sectors, including student accommodation, hotels, large shopping centres. They all got pretty heavily whacked at the peak of the pandemic. But they're making a comeback. Andrew?

Andrew Ballantyne

It's been interesting to look at those COVID-impacted sectors. The one that really jumps out to me as having a strong rebound potential is around the student accommodation market. There's clearly strong growth and appetite for education. We've clearly got strong growth in student numbers from emerging economies, such as India and China. And we certainly do believe that Australia is very well placed to capture a growing part of that market. I mean, there are a number of reasons why we're attractive. One of the key ones to me is just the quality of our institutions.

Andrew Ballantyne

So, the Times newspaper out of the UK does a global ranking on universities, and Australia scores very highly in that ranking. And New Zealand also has a number of institutions in the top 300. So ultimately, for me, education is very much about the brand or the provider that you go to, which ultimately sets you up for your career. And Australia and New Zealand are very well placed in that context.

Andrew Ballantyne

It's also been interesting to note that while we have pivoted towards an online delivery model, looking at the student enrolment and commencements data for Australia, we're seeing growth out of countries like India. And I do think that's going to be a significant growth market for us moving forward. And we're going to see greater diversity of students by country of origin coming into Australia.

Andrew Ballantyne

Earlier Fergal briefly touched on the hotel sector. The hotel sector through COVID has been bifurcated. We've actually seen regional areas perform quite strongly. Because while there's a view that Australia has been impacted by border closures, and tourists not being able to come to Australia, Australians have actually been vacationing within their own country in numbers that we've never seen before. Australia normally has a significant export of people into the international tourism market. So ultimately, people have been vacationing in those regional areas and they've performed quite strongly. Clearly for the CBD, the inner city hotel market, we're looking for the return in business travel and the return of international tourism which actually really stimulates that sector.

Andrew Ballantyne

The last area that we highlighted was around that larger end of retail. As we touched on earlier in the podcast, we've certainly now started to see a reduction in the bid ask spread, we've started to see greater liquidity for those centres. Some of the centres that we've seen trade ultimately have a pathway towards a mixed use future. So they could potentially see new developments, which could be built to rent, it could be office, it could be hotel, it could even be healthcare or medical related use. And for part of that larger end of retail, that's clearly going to be a thematic moving forward.

Rebecca Kent

Speaking about larger-sized property, let’s discuss the mergers and acquisitions happening across real estate at the moment. And that’s being driven by investors aspiring towards more scale, but also the need to bring specific types of expertise into their fold. Fergal tell us more.

Fergal Harris

You're absolutely right. We spoke earlier about the wall of capital that is around. The world's looking to deploy into real estate, generally as a percentage of overall portfolios of major German pension funds, or major U.S. and Canadian pension funds. It’s rising and that gives rise to greater appetite for scale.

Fergal Harris

With regard to M&A, if you have a REIT trading at a significant discount to NTA (net tangible assets) - and I'll come back to 'significant' in a moment - then you're buying that real estate implied at a discount. Through p2p (public to private), you're getting access to underlying real estate at a discount because your share price doesn't reflect the equity value or the asset value of your underlying assets. And because you are a REIT, it's highly transparent, and it's very easy to make an assessment as to what is in your balance sheet. A significant discount is significant because there are costs associated and premiums to be paid in order to close out various shareholders. But I have no doubt that there will be undoubtedly M&A activity because of that need to build scale, exactly as you've said.

Fergal Harris

Funnily enough, I don't think we're going see a lot of M&A in the fund and manager space. You'll see a lot of recapitalisations, and we'll see LPs (limited partners) swapped out and swapped back in. But it's unlikely that you'll see the consolidation on the private side. It's more likely going to be that if you're trading at a significant discount - and that's 15%-plus, even 10% would be on the cusp - I think you are an M&A target.

Rebecca Kent

Industrial and logistics real estate, to make a fluid segue into the final theme, is to shift to infill warehouses. These warehouses are a fair bit smaller than large distribution centres, which can be around 15,000 to 20,000 square metres. They are also located much closer to large population hubs. And this shift is a response to the demand for goods to be delivered quickly, I presume, Andrew?

Andrew Ballantyne

I think it's a good point. I think we're experiencing in Australia what they've seen in the UK and in the U.S., which is essentially the instantaneous delivery model. If you're actually going to execute on that model, you have to be very close to where your customers are located.

Andrew Ballantyne

One of the benefits of being an analyst in Australia is we often see these trends actually emerge in other mature economies first. And then we try and look at them through an Australian and New Zealand lens. We look at the urban or the infill story in the U.S. and that has been very strong. We've seen a number of investors actually build scale within that sector, that’s private equity investors as first movers. Then they've actually sold those portfolios to more passive pension capital. I think we will see a similar observation here in Australia. I think the challenges are trying to understand what locations work best for this thematic.

Andrew Ballantyne

We've been starting to do a little bit of work that we're yet to publish, saying that if we look at areas with a very high number of people aged between 20 and 40 with a high degree of educational attainment and above average income levels, they are the areas where the instantaneous delivery model is most relevant. So ultimately, we need to work out where those demand drivers are based on that analysis, and then where the existing product is to meet that 30-minute delivery window.

Rebecca Kent

for real estate investment in:

A last word on the future real estate investment for Australia and New Zealand?

Fergal Harris

It will be more diverse and there'll be significant rebound in volumes, and capital will be more discernible and foreign. More foreign capital.

Rebecca Kent

Andrew?

Andrew Ballantyne

Similar to Fergal. You're going see a diverse range of capital sources competing for product right across the risk spectrum. Australia and New Zealand are beneficiaries of two major themes. Firstly, higher allocations to real assets. And if you look at recent surveys, most institutional investors are still underweight in real estate. And the bigger story is the portfolio tilt towards Asia Pacific. Recent surveys of Western European and North American investors show that they're becoming more comfortable with investment into Asia Pacific, but they tend to stop their investment in Australia and New Zealand, Japan or Korea. So we're very much a beneficiary of additional inbound investment into the region.

Rebecca Kent

Superb. All right, thank you, Andrew Ballantyne and Fergal Harris.

You can download the full JLL report covering the five investment themes, at Jll.com.au, in the Trends & Insights section.

I’m Rebecca Kent, this is the Perspectives podcast. Thanks for listening.

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