"Feeding the Tiger: Asian Investment in Australian Real Estate"

Australia DLA Piper Panel

Christian McKelvey (Group Head of Pepper Property) was invited to take part in an industry panel organised by Les Koltai (Head of Real Estate, Australi DLA Piper). Below is a summary of Christian's presentation.
To hear his answers in full or to view the other panellists watch the full DLA Piper interactive presentation.

What do you perceive as being the most important factor that will shape the participation of Asian Investors in the Australian real estate market over the next 12 months?

It is vital that Asian investors are properly informed and have access to high quality real estate investments across the market.

A perception still exists that our market lacks scale and depth, as opposed to other markets such as the U.K. and the U.S.A, and that local players gain control of high quality opportunities.

We need to better inform, educate and guide offshore investors so that they can move efficiently when new opportunities meet their investment criteria. There is no benefit to any market participant, whether they are tenants, funders or non-institutional vendors, if asset ownership is limited to a few institutions. Nor should participation be limited to equity asset ownership alone. The Australian Real Estate Market provides an environment for developers to participate in opportunistic projects either in their own right or in conjunction with local experienced players on either an equity or a debt funding basis.

Other factors, such as the differential between yields and interest rates, the volatility of the Australian dollar and a stable regulatory environment will continue to factor but unless we can genuinely provide transparent access to high quality investment products we will remain subordinate to the U.K. and U.S.A. in the competition for offshore investors.

Where will Asian investors look to invest – in relation to cities, asset classes etc. over the next 12 months?

Geographically, investors should gravitate towards markets that provide depth, stability and scale. This prioritises Sydney and Melbourne, although, for diversification, certain sub-sectors in Brisbane, Perth and Adelaide will out-perform over the next 3-5 years.

Sydney and Melbourne are characterised by strong population growth, sound infrastructure networks and, specifically in the case of Sydney, an improving planning regime. As for sectors it depends on the objectives of each investor but residential (Sydney), industrial (Melbourne), neighbourhood retail centres and the hotel accommodation sector (all cities) demonstrate strong dynamics and will out-perform over the next 5 years. The commercial office sector has performed well over the last 2-3 years and there exists further opportunities in this space, specifically, with respect to A and B grade assets but only where a sound repositioning strategy is adopted.

Being just open to opportunities will not necessarily deliver optimal outcomes and we often witness uninformed investors making mistakes. There are some unique characteristics to the Australian Real Estate landscape that can trap new investors, so proper independent advice is recommended.

Australia’s real estate market has traditionally been dominated by A-Reits and superannuation funds. Off shore investors have, until recently, remained out of the action. How do you see the landscape changing given the increased flow of capital from Asia?

Greater capital flows (both domestically and from offshore) will obviously place further downward pressure on asset yields. What we need to remind ourselves is that recent capital flows have concentrated on gaining control of prime grade assets in core CBD locations, compressing yields in these assets and locations.

The differential in yields between prime and secondary grade assets has widened and continued capital inflow will begin to make its way to higher attractive yields in these secondary grade locations. Capital cities such as Brisbane, Perth and Adelaide will benefit from this increased flow of capital. So will some major regional centres and alternate asset classes that have been largely unfavourable over the past 3-5 years (such as, bulky goods retail, student accommodation and serviced apartment models).

We also believe specific capital inflows should consider allocation towards the debt piece of the capital structure. The returns generated on this type of capital structure may become more comparatively equitable on a risk return basis. Participation in this space is appealing to some of the super funds but significant scale still exists for new market entrants.

Are there enough high-quality assets, and is the Australian market deep enough, to feed the appetite of real estate investors – both domestic and Asian?

Simplistically, yes but there exists some headwinds.

Naturally, there will always be exceptions in a market and continual forces that affect this balance, such as, exchange rates, interest rates, economic policy, regulatory frameworks and planning regimes. These factors will all influence whether investors are active within a particular market.

At present, Australia is a favourable equation for investors. Our market is relatively transparent, we operate within a stable economic and political environment and enjoy a sophisticated legal system which is highly attractive to offshore investors. Notwithstanding, our market has some limitations such as that many prime grade assets are jointly owned by institutional partners. The joint ownership model doesn’t necessarily align with a core requirement of Asian investors, where full control is preferred and often mandatory.

When a point of equilibrium occurs, both domestic and Asian investors will begin to look offshore for other more attractive investment opportunities.

How can domestic real estate players capitalise on the increased interest from Asia?

Partnering is essential.  Structures incorporating joint platform models, both in development and investment, need to be established to provide pipeline opportunities to Asian investors and increase the competition across all real estate plays.

Proper independent advice is a must to identify and mitigate the perceived risks of partnering whilst maintaining an equitable return profile. This is particularly so on many prime commercial office assets where Asian investors’ propensity is not to invest in a partnership structure given a perceived lack of control. We need to establish a more acceptable regime for these structures in order to be more appealing to Asian investors, which will further increase opportunity and competition.

Participation via debt plays may be an optimal means to employ offshore capital, providing mortgage security and priority payments as an alternative to joint ownership at the equity level.

To view the other panellists' responses watch the full DLA Piper interactive presentation.