Harbour builds a new real estate fund

Harbour Asset Management is adding a real estate fund to its offerings as a defensive tool for investors.

Thursday, October 4th 2018, 8:16AM

The Harbour Real Estate Investment Fund (REIF) provides investors with exposure to the long-term defensive growth listed real estate asset class.

Portfolio manager Shane Solly says the fund will predominately invest in listed Australian and New Zealand property funds, but it will also have the ability to invest in other markets and unlisted funds.

To be included securities which are neither in a listed property security nor in a REIT benchmark indices, underlying profit certainty needs to be high.

Like other Harbour products the fund will be actively managed and will look to capture inefficiencies in the market.

“Harbour’s research shows that listed real estate may not be the passive investment class that many investors think it is,” Solly says.

He says there is a wide variance in returns from listed property securities which can be exploited through active management.

“This suggests that investor returns may be enhanced, and risks reduced, by actively and selectively managing investments in listed real estate assets, where supported by a strong research process.”

The divergence in returns can be observed by the difference in returns from individual securities across benchmark indices.

The S&P/NZX All real estate index delivered a 15.9% total return over the 12 months to September 27, 2018 – but within the overall market returns Goodman Property delivered a 25.7% total return, Vital Healthcare delivered -0.8% and market heavy weight Kiwi Property delivered a 9%.

The Australian S&P/ASX 200 property index is up 13.9% over the same one-year period but the spread of total return to investors over the period ranged between 41% for Charter Hall and 30% for Goodman Group, and – 5% for Abacus and just 3% for market heavy weight Stockland and 5% for Vicinity.

Solly says to enhance returns and diversify risk, the Harbour REIF will invest in real estate sectors not included in the New Zealand listed market, such as multifamily residential, student accommodation and data centres, predominantly by investing in real estate securities listed on the Australian market, but from time to time may include internationally listed property securities or local unlisted property securities.

An example of international listed investment would be investing in the European listed Unibail Rodamco Westfield, which recently took over Australian listed Westfield.

EXTENSIVE RESEARCH

Harbour has done extensive research on the real estate sector to better understand where returns come from and what assets are closely correlated.

The research shows New Zealand’s M1 narrow money supply had the highest correlation with the returns for New Zealand listed real estate securities.

“M1’s relatively high positive correlation with real estate returns suggests that as private sector credit increases, businesses are more inclined to expand activity, supporting demand for commercial real estate including the take up of space and willingness to pay higher rentals,” he says.

New Zealand 10-year government bonds had the second highest correlation with listed real estate securities.

“NZ 10-year government bonds relatively high negative correlation with real estate returns may be explained by income investors seeking the higher yield of low volatility listed real estate securities as long-term bond interest rates fall, and reducing exposure to listed real estate as long term government bond interest rates increase.”

RETURN EXPECTATIONS

The Harbour REIF’s objective is to deliver an income plus growth return based on the economics of real estate investments for New Zealand based investors.

The REIF is benchmarked against the S&P/NZX All Real estate industry Group Index, which is predominantly composed of securities with high quality real estate assets, which provides a solid base for long term investment for many New Zealand investors.

The PIE tax status of the majority of securities included in the S&P/NZX All Real estate industry Group Index also provides some tax advantages for some New Zealand investors

While the S&P/NZX All real estate index provides a solid base for investor returns, with its sustainable current average spot 4.8% cash, tax paid dividend yield (before PIE tax benefits) providing a good core for investment, its narrow focus of the S&P/NZX All real estate index limits growth potential.

Average earnings for the S&P/NZX All real estate index are expected to grow by less than 5% annually over the next few years.

Solly says potential New Zealand tax changes provide a potential upside to growth.

The fund will use Harbour’s ESG Corporate Behaviour scores which highlight long term risks within potential investments and favours those investments with better corporate behaviour practices.

While the Harbour REIF has significant flexibility, it has strict exposure limits which limit risk and ensure that the fund’s key return objectives of income plus growth are delivered through time. Examples of the limits include:

A minimum of 50% of fund assets must be invested in New Zealand listed property securities
A maximum of 25% of fund assets may be invested in Australian listed property securities
A maximum of 10% of fund assets may be invested in International listed property securities
A maximum of 10% of fund assets may be invested in unlisted property securities

Solly says the real estate cycle may not be different to the pre-GFC environment, but the companies are.

“Commercial property valuation metrics are full versus history – but remain attractive versus bond yields – and rental growth prospects remain positive.”

There will be variations in what parts of the real estate sector do well – for example, there are structural challenges for retail property (clicks vs bricks), structural tail winds for industrial property owners (limited supply at economic prices, strong demand reflecting changing business models that focus on supply chain flexibility).

He says companies are better positioned than pre GFC.
They have lower debt levels compared to 10 years ago, and greater diversity of debt sources including from bond issues.

Dividend pay-out policies are increasingly based on more conservative measures that take account of stay in business maintenance capex and short-term tenant incentives.

Also income risk has been reduced as there is more investment grade property with high occupancy rates and and the weighted average lease terms now sit around five-years plus.

And finally, governance is generally better then before the GFC with more independent boards.

Tags: Harbour Asset Management