There is good money to be made in commercial property for investors able to find the right opportunities, according to Blackrock real estate investment veteran Hamish MacDonald.
Contrary to the current narrative – that rising interest rates have smashed valuations and decimated the sector – MacDonald, who oversees the world’s largest asset manager’s APAC real estate portfolios, recalled his experience when visiting some of the US pension fund clients based in capitals of smaller states.
MacDonald told the Investment Magazine Fiduciary Investors Symposium that he saw some office complexes with minimal amenities, and in isolated locations.
“It’s like a bad scene from The Office,” he said.
“Should it be any surprise that these buildings in the middle of nowhere are now vacant, and that you can’t do anything with them? It shouldn’t be.”
“What’s real estate all about? It’s supply and demand. And successful real estate investing is all about pricing power as an owner.”
MacDonald said he could probably count on the fingers of two hands in any major city the number of buildings that have genuine pricing power and which are not just commoditised assets.
“So are there opportunities in the office sector? Absolutely,” he said.
“In fact, is there going to be accelerating opportunities for the very few that have pricing power? Are rents going to accelerate for the very few? Probably.”
Australian Retirement Trust’s senior portfolio manager Mark Lee agreed with MacDonald’s assessment of market dynamics. The $260 billion fund, now the second biggest in Australia, has just over eight per cent of its assets invested in unlisted real estate, with a 50/50 mix of onshore and offshore.
Earlier this year, ART wrote down some of its office towers by as much as 15 per cent. This came after the fund has been cutting exposure to the segment in recent years – to diversify away from GDP risks and focus on alternative sectors like self-storage and residential, according to Lee.
Lee suggested the industry also start linking characteristics of office occupants to the fundamentals of the actual building. For example, he said, office opportunities were “bigger and better” in Asia, because workers were keen to come in after Covid lockdowns lifted and “no one wanted to work in their 20-square-metre home”.
In comparison, “the mobility of the labour market in the US is now actually somewhat hamstrung”, Lee said.
People who used to live in New York, Seattle and San Francisco will not move back, because they may have bought a house in Nashville at two per cent interest rate for 30 years during the COVID low, Lee said.
“We’re going through a really interesting change of how real estate is used – not just in retail and industrial, but also in offices,” he said.
“Are we using these assets in a mixed-use precinct style? Or community-style?
“Ultimately, we’re going to need a place to be in, and the winners will be the ones who can figure out how to purpose real estate for the coming 10 or 20 years.”
‘Nascent’ sectors in spotlight
Looking ahead, MacDonald believes one real estate sector that holds great potential for institutional investors is childcare centres. MacDonald said the beauty of the segment is the term of the lease (often 15 to 20 years), with an uncapped annual CPI indexation and mostly a three per cent floor.
“Critical to that [strategy] is the question of whether the tenant can afford it,” he said.
“And of course, they can afford it – they can pass on the additional rent to mum and dads, and that is at the moment on average 70 per cent subsidised by the government.”
Lee said he is confident that childcare subsidy will continue to receive bipartisan support because of its benefits for female participation in the workforce, and hence productivity.
“I think that it [childcare centres] will be hotly in demand by investors and really our job as private equity real estate investors is to build these portfolios that capital wants to buy,” he said.
JANA principal consultant and head of property Mary Power, meanwhile, said she is confident about the health of the whole sector.
“I think the good thing for the property sector – and you might debate office – is that none of the sectors are broken. The cash flow is in a reasonably strong position,” Power said.
“If you overlay population growth in Australia, the increased cost of construction, which has led to less supply, and you then overlay sustainability, when it [property] reaches its floor with the adjustment from interest rates, it’ll take off and it’ll be okay.”