Australian pension funds are staying bullish on real estate investments despite a daunting commercial property market, as less-traditional opportunities that favour their long-term investment horizons open up.

Most profit-for-member funds plan to either maintain or lift the size of their property portfolio even as they forecast negative returns from the sector for a second year in a row, as valuations in the office and retail segments shrink.

Funds have been grappling with a slew of challenges in commercial property including poor income growth and a liquidity squeeze, resulting in lower returns amid rising interest rates and faltering demand.

But that is also encouraging investment heads at cashed-up funds to shift attention to less conventional segments such as logistics, storage, data centres and affordable housing.

“It is challenging but this market environment really opens up opportunities that you normally will not be able to get access to,” says Alek Misev, head of property at Aware Super.

“Liquidity has dried up and people are very cautious. We have the money to invest, so we are looking at the market both locally and globally.”

The $150 billion super fund, one of Australia largest, has been on the lookout for more investments in segments that include build-to-rent, self storage, cold storage, and data centres, which are linked to its mainstay residential and industrial real estate.

It holds nearly 40 per cent of its $10 billion property portfolio in various forms of residential assets, and another 30 per cent in industrial after having diversified away from office and retail over several years.

Attractive asset class

Globally, pension funds have invested in real estate for decades because of its relatively stable valuations and steady rental yields over multiple years. Funds typically hold between 6-12 per cent of their assets in the form of real estate.

However, commercial property has proven to be a drag on returns since the pandemic, and the downward trend intensified after central banks started lifting rates last year. Valuations slid as much as 40 per cent in some markets in the US, but have fallen to a much lesser degree in Australia.

Still, top landlords including Australian Super, Australian Retirement Trust (ART) and Cbus have been forced to write down some assets by up to 20 per cent amid a slowdown in retail and CBD office vacancy rates rising to near three-decade-highs, as companies cut costs and rising remote work weakens demand.

Fund investment heads believe the headwinds in the two big traditional segments could continue for at least another 12-18 months. Most are predicting single-digit negative returns from property over the next year before the sector steadies over the medium term.

The disruption will mean owners will have to reckon with issues such as likely divergence in returns from assets within sectors, Unisuper’s head of property, Kent Robbins, believes.

The $115 billion Unisuper has made some unconventional bets in recent years, including raising its allocation to retail in the midst of the pandemic via purchase of stakes in Sydney’s Macquarie Centre, Gold Coast’s Pacific Fair and a refurbishment of the Karrinyup shopping centre in Perth.

“We’ve seen it in retail as online disrupted the retail footprint for the last five years. The strong retail centres became really strong, but there was also a lot of collateral damage in the form of shopping centres that simply don’t work anymore and should be repurposed,” Robbins said.

“Office is going through exactly the same thing at the moment. Iconic office buildings with high environmental ratings will probably prosper through the next phase, but it will become uncomfortable like it did in retail. Bifurcation will happen to industrial as well.”

The threat of near-term turmoil apart, real estate remains an attractive long-term investment opportunity for Australian super funds.

A key factor in favour is their tendency to hold property in the form of unlisted assets, which many see as an effective way to blunt volatility in their overall portfolios.

“Listed assets incorporate a meaningful exposure to market risk. And we already have significant market risk in the rest of our portfolio through the dominant holdings in equities,” says ART’s chief investment officer Ian Patrick. He argues the stability of private assets allows super funds to diversify their equity risk.

“The other aspect of favouring unlisted (real estate) is we then have the capacity to construct a more diverse portfolio more directly.”

Patrick points to the difficulty in getting direct exposure to large, quality assets – such as ART’s majority investment in G’day Group (the largest operator of lifestyle holiday parks in Australia) – in any other market as an example of why unlisted property remains attractive for institutional investors looking to play an active role.

Industrial windfall

One segment of the property market that’s got investors lining up for more has been industrial real estate. Demand for assets such as warehouses and data centres has surged despite the downturn in commercial property, and vacancy rates in Australia are among the lowest in Asia Pacific, dropping below 1 per cent early this year.

“Structurally, the demand for industrial and particularly strong logistics centres has been phenomenal,” said ART’s Patrick.

“It’s easy to point to it as e-commerce driven. I think there are other factors as well such as the resetting of supply chains – whether you call it near-shoring, onshoring or moving away from ‘just-in-time’ to ‘just-in-case’.”

The shrinking vacancy rates have been fuelled by rising demand from online retail as well as insufficient supply in major cities because of factors such as construction delays and lack of appropriately-zoned land.

This has also raised prospects for double-digit increases in rentals, encouraging local and global pension funds to lift exposure to the sector.

Andrew Bambrook, head of property at super fund REST, attributes this to a shift away from bricks-and-mortar retailing towards e-commerce, and says penetration rates are increasing demand for both well-located logistics hubs as well as last mile distribution facilities. It’s an opportunity he is trying to tap into.

“One of the major focuses for us is trying to increase exposure to this sector and to keep finding those assets and investment types that will benefit from the transition from physical to digital commerce,” he said.

“We’re absolutely out there actively looking for opportunities to buy those sort of assets.”

A shift in focus from office to industrial property has also turned the commercial real estate debt market into an emerging opportunity for super funds, as rising interest rates make the risk-return profile more attractive for institutional investors.

Housing opportunity

Meanwhile, a growing debate around affordable housing in Australia has formed the backdrop for burgeoning interest in the housing sector from super funds.

Australian funds have been investors in overseas residential developments for years, but the absence of a long-term housing policy, skinny returns and unfavourable planning and tax laws have traditionally been obstacles for domestic investment.

However, the Albanese government’s push to build more social and affordable housing as well as improving prospects for longer term returns in the sector have helped attract a larger share of Australia’s $3.5 trillion retirement savings pool.

Bambrook says REST is seeing opportunities emerge in such non-traditional segments as student accomodation and affordable housing.

“We think the demographic tailwinds there are really strong and feel like they’re really sustainable investments where we can grow cash flow over time,” he said.

REST holds the bulk of its property portfolio in the big three sectors of office, retail and industrial but has increasingly lifted exposure to other segments in the residential space. The $70 billion fund, which has committed to having 1 per cent of its funds in impact investments by 2026, says affordable housing also fits neatly with this goal, given its broader social impact.

Other funds, including Australian Super, Cbus, HESTA and Aware Super are also seeing potential in areas like build-to-rent, with focus on increasing supply of affordable housing, and have committed investment in the sector.

HESTA last year announced it would seed $240 million into a new affordable housing fund run by Super Housing Partnership.

Aware Super has also committed $1.5 billion to further build its residential property portfolio by 2025. It stepped up exposure to the global build-to-rent (BTR) sector following a $900 million investment in UK-based BTR company Get Living.

Aware’s Misev says rising capitalisation rates, and the resulting decline in valuations, are providing opportunities to access good quality assets that are better priced.

“We’re quite excited about what’s potentially coming our way because if you’ve got the equity to spend, we think this is a pretty good environment to get those outsized returns on track for the longer term,” he said.



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