“[An illiquid asset] is a decent asset to have and protect against short-term volatility,” said an Australian superannuation fund. This is one of the key reasons why Australian superannuation funds invest in alternatives. Preqin data shows that a near-majority (80%) of such institutions seek to allocate more than 5% of their total assets to the unlisted real estate sector. This proportion of Australian superannuation funds is higher than that of other asset classes, which stands at 69% for infrastructure, 57% for hedge funds and 31% for private equity.
Domestic bias is undeniably strong among Australian superannuation funds, with a stark 95% preferring real estate investments at home. However, currently, “while yield basis still looks relatively attractive versus bonds, everything looks overpriced,” as one superannuation fund said. Fund managers and investors alike will have to take the fight-or-flight approach when it comes to investing in Australia.
Rather than competing for assets at home, one particular fund manager prefers investments overseas and pools investor capital from its home ground. Sourcing investments in a stable market overseas allows the firm to provide not only portfolio diversification for its largely Australia-focused investors, but also higher returns.
“It is of course more challenging to convince investors to put their money outside of Australia since [many] of them are focusing on the Australian market, but [many] of these investors are also looking to diversify their investment portfolio elsewhere,” said a fund manager. Even for fund managers that are largely focused on the Australian and New Zealand markets, they are “open to opportunities in similar markets where the investment case is strong.”
The chart above illustrates a gargantuan decline in aggregate capital raised by Australia-based fund managers for core real estate funds from AUD 2.09bn in 2012 to AUD 230mn in 2017. Funds employing value added, opportunistic and debt strategies were clearly prominent in 2017, when 89% of total capital raised was accounted for by such strategies. While the shift to higher-risk strategies is consistent with global trends, going forwards debt strategies look likely to gain momentum in Australia.
“The main reason for this ‘switch’, in our opinion, is the fact that total returns on core real estate are at historic lows. The search for yield has expanded to alternative strategies, with debt being the main ‘benefactor’.”
– Wayne Lasky, Managing Director of MaxCap
The banking royal commission is looking to enforce responsible lending laws among other issues raised in its September 2018 interim report, and the banks will likely respond by tightening credit lending. As large trading banks reduce their commercial real estate appetite and limit lending to such developments, some fund managers see it as an opportunity for the private fund market to fill in the gap. Andrew Schwartz, Group Managing Director of Qualitas, shares this sentiment, saying that “for every 1% of the market share that the banks give up, there are significant opportunities for groups like Qualitas to fill the gap.”
While some are concerned about how fund managers can convince investors to invest in the debt market since it is mainly controlled by the four major banks, others are not so worried. One fund manager is looking to launch a real estate debt fund next year, and mentioned that “fund managers are looking to raise more debt funds, which is something new in the market [in Australia].” Schwartz is also seeing more interest from Australian superannuation funds as they seek to diversify their real estate exposure, particularly as the commercial real estate debt market matures in Australia.
Preqin data reveals that debt funds accounted for almost one-third of Australia-focused real estate funds closed in 2017. Furthermore, these funds only took an average of nine months to complete fundraising, compared with core funds which took an average of 16.5 months, suggesting that investors are enthusiastic for debt vehicles. Lasky is optimistic about the Australian commercial real estate debt market: “While regulatory intervention happened in [the] US years ago (active in debt since 1981), we expect debt to become the mainstream investment in Australia too. It is [an] opportunity that is going to last a very long time.”
For more information on alternative assets in Australia and the investment activity of superannuation funds, download our free report, Australian Superannuation Funds in Alternatives.