Australian investors in real estate are very parochial and should diversify offshore says Tom Lee, managing director and chief investment officer and head of EMEA for Blackrock real estate.
“Most of you have highly domestic real estate portfolios. There is continued competition in the domestic market with investors coming in. If you have a solely domestic allocation, you need to think about investing a portion offshore, to get diversification, but also because you will see a diminishing market.”
Lee says there is a lot of foreign capital moving into the Sydney and Melbourne markets with 57 per cent and 32 per cent, respectively, of total investment made up of foreign capital. This has the effect of reducing the domestic opportunity set, he said.
But he noted that prime yields are at a historic low point for many markets.
“So the obvious question is are you entering at the top of the market?”
“You need to understand the context. Spreads above government bond yields are above average. We think about real estate in nominal terms, but I would encourage you to think about it based on what the spread is over bonds, as it shows a very different picture, and [explains] why we will continue to see capital flows come into real estate through the risk spectrum.”
Lee says that there is a very low correlation between the Australian real estate market and many developed markets.
For example the US, Italy, Germany, China and Japan have very low correlations with the Australian market, he said.
Diversifying a 60:40 equities:bond portfolio by adding a 7.5 per cent exposure to domestic real estate outperforms that 60:40 portfolio, but adding a further 7.5 per cent of global real estate adds further to the risk–return profile of a portfolio, he said.
“Investors need to take a long-term view and think about investing through the risk spectrum. Core and value-add real estate needs to be part of that strategy,” he said.
Lee said investors could look at investments in real estate on an unhedged basis but take a long-term view and think about currency hedging on a total portfolio basis.
“You can always think of a reason not to do it – whether it be currency or different cycles in the real estate market. But there are imperatives that are important to consider.”
One of these imperative is the inbound capital into the Australian market is causing the already big pool of capital to grow, which is forcing domestic capital offshore.
“[This is happening anyway, and it’s] better to pace yourself and allocate slowly across the risk spectrum,” Lee said.