Mark Mazzerella, Portfolio Manager at APN Property Group, provides the key attractions of global property REITs for income focused investors, and the unique opportunities presented by the recent pandemic.

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Transcript

Paul O’Connor:

Welcome to the netwealth Investment Podcast series. My name is Paul O'Connor and I'm the Head of Investment Management and Research. Today we welcome Mark Mazzarella from APN Property Group who is a portfolio manager, real estate securities. APN is a specialist real estate investment manager that actively manages real estate funds on behalf of both institutional and retail investors. APN active actively manages 12 funds, including domestic, and international property securities, and unlisted direct property trusts.

POC:

The business was established in 1996 and has a market capitalization of $180 million and manages over three billion in real estate and real estate securities. APN's approach to real estate investment is based on a property for income philosophy. This philosophy remains central to APN's three businesses being AREITS, property securities funds, and direct property funds. Mark joined APN in June 2014 and is responsible as a portfolio manager for the Australian and global REIT analysis and funds management. Prior to joining APN Mark worked for Ernst & Young for four and a half years. Working at Ernst & Young as a senior consultant, Mark's responsibilities included real estate market research, property valuation, project feasibility studies, options and scenario analysis, financial modelling for real estate investments, transaction due diligence, and bespoke advisory engagement. So, Mark certainly has a very good experience over all areas of the property market. Mark worked across all the major real estate sectors including residential, commercial, retail, industrial and social.

POC:

He holds a Bachelor of Commerce in Finance and a Bachelor of Property and Construction from the University of Melbourne. Mark is also an associate of the Australian Property Institute, a certified practicing valuer, and a Chartered Financial Analyst. So, also is well educated to join us today and provide some insights into the listed property market. APN's investment style is to actively manage portfolios with a strong bias to REITs that generate sustainable income streams. The managers funds favor rent collectors rather than companies, which derive income from property related funds, management, and property development activities. Hence, APN's strategies provide investors with exposure to a more pure property experience, which should generate consistent income and be less volatile in down markets. But I will let Mark elaborate. There are three APN funds on the netwealth superannuation and IDPS menus, which are the APN AREIT Fund, the APN Asian REIT fund, and APN Global REIT Fund.

POC:

The listed property market has been a volatile ride for investors over the last 12 months post the onset of COVID. But has bounced back strongly as highlighted by AREIT's generating returns in excess of 40% over the last 12 months. There's also growing debate as to what the future of certain sectors of the property market look like, such as office property, given the structural changes to the global economy as a result of COVID. And the fact that many office workers, for example, including myself, has successfully worked from home for over 12 months now. Some workers may never return to the office five days a week. So this I guess is just one question that we have over the property market and how it will look going forward over the long term. Perhaps to convince Mark, can you explain to the listeners what attracted you to a career in property and specifically listed property?

Mark Mazzarella:

Sure, Paul, and thanks again for the invitation. I'm delighted to be on your podcast and talking to your event investors about everything listed property and REITs. I guess, personally, it was something, I guess real estate and construction was always front of mind given a lot of my family members were in the building and construction industry. So, I was always around that sort of chatter. And I think my parents were building a house when I was quite early in my age, and I can always remember going to building sites and seeing that evolve. So it was pretty natural, then when I went through high school and university to go down the property path. And funnily enough, I actually started studies in construction and project management as part of the property and finance stream, but then switched across after about six months because I thought it was a bit more interesting to get into the financial and investment side of things. So, I guess valuation of real estate is what everything comes down to and the economics behind an investment case. And that really drew me in so I thought that was pretty interesting.

MM:

So, went through that path and was fortunate enough to be working with some great colleagues over the journey in valuations and transactions, and also worked over in Singapore for a period of time. And it really sort of evolved into wanting to directly invest in real estate, but I think I was drawn to the listed property side, and an equity side of things, given the depth and diversity of what the role involved. So, when it comes to direct property, you do a heap of work and a lot of analysis through a long process to buy a single office building, or a retail shopping centre. And that's a fairly lumpy process, and the barriers are high. And if you wanted to then sell that asset, you'd have to go through another pretty lengthy process of offering that to the market and executing a transaction, and that might take three to six months.

MM:

Whereas, in the listed property space, it's all available in real time. And if your research and analysis led you to the conclusion that you wanted an exposure to a certain asset type or market, you could basically institute that in real-time. And conversely, if you wanted to get out the liquidity is there, and you could then reinvest that elsewhere. So it was just a lot more dynamic and actionable in the listed properties space. And it also allowed you to have a look across a heap of different geographies and markets. Whereas, I found in the direct side of consulting and transactions, you were very much focused on one asset class or one segment of the market at any point in time, which I didn't find as interesting or stimulating.

POC:

Yeah. Well, I guess the opportunities in global REITs have certainly developed a lot over the last probably 10 to 15 years. But I guess your earlier comments there were, I was thinking in my mind there that a childhood experience, and a passion developed as a child has certainly set you up for a long career, a lifelong career in property there. So, I guess we're all influenced by our childhood experiences there strongly.

MM:

Yeah, exactly.

POC:

All right. Well, maybe moving into the questions there, I thought, potentially, well, just starting at a macroeconomic level, the response by central bankers and governments to the economic downturn post the onset of COVID has been extraordinary as highlighted again recently by US President Biden's two and a half trillion dollar stimulus package. So the fiscal and monetary responses supportive of the property market in general and I assume the low interest rate environment we're in are acting as a tailwind for listed property?

MM:

Yes, sure. Certainly look, low interest rates are good for listed property. And commercial property generally. Obviously, it reduces the cost of debt that a lot of portfolios and REITs will employ as part of their capital structure. And it also improves the relative attractiveness of listed property, in particular, when you were to compare the distribution yields on offer against cash in other investment opportunities, in particular. But I think is we'll probably discuss at some point as well given what's happening with bond yields and everything like that. REITs are far from just a bond proxy and interest rates are one part of the equation. But to your question on government stimulus and monetary intervention in light of the pandemic that's definitely positive for real estate and absolutely appropriate.

MM:

Look, over the last year, we've gone through an unprecedented upheaval in society generally, and governments simply have had to act, of course, in concert with the central banks. And they've had to step up. And in the words of the US Fed chair, almost 12 months ago now, it was basically whatever it takes, and a bridge had to be built over the economic fallout from the effects of a pandemic led lockdown, and the restrictions that come with it. And I guess the fiscal stimulus that you just highlighted two and a half trillion, from President Biden now was obviously signed off with a couple of weeks ago. And all of the Republicans were against it. But the politics, of course, comes into it, but it's absolutely necessary, and a positive for REITs.

MM:

Look, as a real estate investor, a functioning and sustainably growing economy provides excellent backdrop and conditions for real estate returns. GDP obviously went off a bit of a cliff, but the IMF are anticipating the swiftest bounce back from this coming recovery on record. Obviously, a lot of stimulus will flow through to the direct consumer, but also businesses. And if you're in the US, and you're getting $1,400 directly into your bank account, and some more economic support in the form of unemployment benefits that has to flow through to the economy, and the dynamics for real estate returns. And if you want to do the crude type of analysis where you have a look at GDP percentages that stimulus makes up across the globe, it's basically the developed markets are leading the charge.

MM:

So, Australia and Singapore in particular have got anything upwards of 20% across all of the government fiscal stimulus as a percentage of GDP in indirect support for economies. The US isn't far behind, and the likes of Canada and in some parts of Asia, and of course, Europe are also employing the same type of measures to really help economies get through this lockdown restriction period. And that's a beneficiary for real estate. Of course, from here on end as it's an asset class that depends on direct utilisation and the health and vitality of the underlying user, which is the commercial tenant.

POC:

Now, the listed REIT market is a broad universe of securities that invest in I guess, a wide range of pure property, property management, and development, and even property funds management. So, it's interesting to note that APN are focused on the pure property market, not the broader universe. Can you provide a few comments on the investment universe you look at it as an analyst and why APN's focus is on pure property?

MM:

Sure. Look, I love your characterization of the universe as pure property and our focus being on pure property. And I guess that just comes down to our philosophy as an investor, as an investment house that's basically been built up since the company was founded and the funds management component of the business launched in 1998. And that's essentially property for income. So commercial property should at its core be an investment in income returns directly linked to rent receipts paid by corporate tenants. At the crux of it, that's exactly what it is. And that's how we've always managed our funds and will continue to do so.

MM:

The property management, development, and funds management aspects of the listed property market, and the universe more broadly are generally an add-on. So, a number of REITs, particularly in Australia will do funds management and development at the margin, but it won't make up the lion's share of their returns, which are essentially income base. However, there are a number in Australia and globally solely focused on the derivation of funds management and development earnings as well as transaction and performance fees. And we'd argue that they're relatively not as pure as the income from rents, albeit, that risk profile is changing and has changed. But I guess the rent receipts and pass through of that income to investors in a tax efficient manner through the REIT structure is basically what we've set up these funds to do.

MM:

There's a targeted exposure on offer to certain commercial tenant themes and industries that's very compelling from a risk adjusted basis. Because essentially, a corporate tenant needs to pay their rent before they pay their security holders their own dividends. And that's basically part of the appeal of the investment case for REITs and commercial property, and in its listed form, provides the tax advantages that come with the REIT structure. And, of course, the liquidity benefits that come with being listed on developed market exchanges.

POC:

Well, I guess, too, with thinking through as you're making a few comments there, Mark, that the pure property play. You're buying an established building and getting most of your return being the rent paid by the tenants there would be a lower risk form of investment in the asset class as opposed to property development, which can be fairly risky in terms of getting regulatory approval and council approval and what have you there? So would it be fair to say that the buying AREITs that are more focused on just pure property are lower risk than the other types of AREITs or GREITs?

MM:

Certainly, that would be the case, and that's been the case through time. There are some aspects of funds management, which are relatively the risk has been somewhat defrayed by the fact that the fees are generated based on an established asset value, or an accounting book valuation. But for the most pure exposure to commercial real estate, it would definitely be suggested that the rent receivables are definitely a compelling risk adjusted return. And exposure to a whole host of underlying themes and tenants in particular. I mean, one example would be globally over the last 12 months, definitely the likes of the largest online retail companies like Amazon and platforms like that have been phenomenal investments and where a number of trends from COVID have been accelerated in their favor.

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MM:

And of course, if you were to invest in Amazon as an income investor, you wouldn't get a dividend. But if you were to own a number of REITs globally, and particularly there's one that we have a position in, in the UK that has almost 20% of its underlying income derived directly from Amazon's rent. We'd argue that that's definitely a risk adjusted exposure to that kind of trend and tenant that an income investor in real estate would be attracted to.

POC:

So, we've seen global REITs slowly becoming more accepted as a mainstream allocation in a diversified portfolios. So, in your opinion, what are the key attractions of global REITs for income focused investors? And how does this differ from AREITs?

MM:

Sure, look, that's an excellent question. It just comes back to essentially diversification. Across the global REIT market, we've got access to geographies and property types that simply aren't available here in the AREIT market, and exposure to certain tenants that simply aren't present in Australia and that are doing extremely well given the underlying characteristics and cases of their own businesses in other markets. So, global REITs just provide a much greater scale of opportunity compared to the AREITs, which is relatively concentrated both in terms of the number of individual stocks and also the underlying sectors that you'd provide exposure to.

MM:

So, for example, in Australia, there might be around 30 to 35 REITs. Globally, there's upwards of 500. When it comes to the market cap of AREITs, it's at around that 130 odd billion. But global REITs will provide access to over two trillion in market cap for investors. There's thousands more properties on a look through basis able to be accessed through global REITs. And when it comes to concentration, I think upwards of about 75% of REITs are outside of the top 10 stocks, whereas in Australia, it's probably closer to 20%. But perhaps more importantly, and much more attractive for investors is the sectors of property that are accessible to global REIT investors. And we're talking land and buildings here. But we're also talking access to themes and tenants that are really in tremendous shape.

MM:

Not withstanding the pandemic, but also, obviously, because of it. And global REITs basically provide access to data centers, mobile cell towers, life sciences assets, and a host of healthcare assets like medical centers, acute care, and hospitals. And a number of those, in fact, all of them aren't available in the AREIT market for a pure play exposure. So, look, access to a whole world of property for income is essentially what the global REITs offer. And the ability to allocate across various regions and sectors where developing structural trends and local fundamentals are driving the best prospects for sustained rental growth. And that's basically what we aim to offer our investors over the long term.

POC:

So, I guess ultimately, it sounds like it's the same basis for why investors and diversified portfolios allocate to both Australian equities and international equities for their diversification, for the access to sectors and industries and regions that the Australian share market can't give you. So I think you sort of nailed it up front there with your comment there. It's really about diversification, and getting access to sectors that currently aren't available through the Australian market there.

MM:

That's right. If you had to comp the diversification benefits you'd just be staggered by the opportunity that's available in global REITs given those varied property types. It's really like something that we just don't have access to here in our local listed market in particular.

POC:

How would you actually assess the effects of the COVID pandemic on global REITs? And what sectors have been the hardest hit? And are there any sectors that have been beneficiaries?

MM:

Yeah, there definitely has. Look, just at a high level, obviously COVID's just thrown up an unprecedented array of circumstances for societies, and of course, real estate globally. I think I mentioned at its core, it's an asset class whose returns and prospects just basically tethered to its utilisation. So essentially, COVID has place restrictions on the utilisation of some types of properties and actually served as a tailwind for the utilisation of others. So unpacking this and what it's meant for some of the key sectors. Landlords with exposure to hospitality type assets like hotels, for example, or leisure assets have fought fared relatively poorly. Not just because of the inability to travel and holiday, but because people simply weren't allowed to gather in certain assets.

MM:

And, of course, that also feeds through to the traditional retail shopping centre where discretionary based retail was basically an activity that you weren't allowed to do because the shopping centres were closed. And obviously, the retail landlords in the REIT space they had exposure to those types of asset uses fared the worst through the pandemic. On the flip side, though, online retail growth was obviously a win for anything to do with logistics and the ferrying of those goods and the transmission of those orders. So, we're talking about industrial sheds and distribution centres, mobile cell towers and data centres because everyone's got a computer in their palm of their hand and can buy just about anything on their smartphone. And that has to route through some signal towers and then through a data centre to the end retailer who processes the order. And that good then needs to flow through a logistics facility and supply chain on to your front doorstep.

MM:

So those types of commercial property assets that were in that chain of events definitely were assisted through the pandemic. And of course, when it comes to pure survival, those retail assets that served for groceries and daily needs shops where we were still allowed to go through albeit wearing a mask traded extremely well. And obviously, everyone's ofay with the Coles and Woolworths example here in Australia, but that's basically been a trend that was transported across other developed markets where grocery retail was a big beneficiary and Walmart, Kroger's in the US, as well as Sainsbury's, Tesco, Carrefour in the continent of Europe were very good performers and those assets, obviously, performed quite well and have been beneficiaries of the pandemic.

POC:

So I assume these GREITs that are purely focused on buying supermarkets and renting them on long term leases to the likes of Walmart and Tesco and those types of businesses?

MM:

That's absolutely right. And one of those is in the UK. And it's a REIT called Supermarket Income REIT, and it's 100% leased to Tesco, Sainsbury's, Morrisons, and Waitrose. And that's, again, one of the appeals of global REITs. Unfortunately, here in Australia we don't have a REIT that's 100% leased to a grocery anchored retailer. And that's obviously performed relatively well and been quite resilient in spite of the pandemic. And of course, there has been, obviously an increase in online grocery shopping. But given the breadth and efficiencies that come with the existing store networks, it's probably won't be a surprise to anyone that the majority of the fulfilment and delivery is out of existing grocery properties. So, they're serving as an omnichannel hub for those retail grocers to service their consumers, which, again, is obviously a beneficiary of the pandemic, but there's no doubt that'll become a legacy effective of the pandemic as well.

POC:

So, the pandemic has had a significant impact on the economy. And I guess it really has accelerated changing human behaviors such as the move to working online, the rise of eCommerce, examples of what you've already mentioned. So, are you anticipating any legacy effects from the pandemic on global REITs?

MM:

Yeah. Look, there's no doubt there will be. I guess, when it comes to retail, more of a focus on online shopping. Consumers, I guess, through the pandemic have had to change their behaviours simply to eat, and to buy any matter of good. And of course, I speak to anyone I can and family members, of course, on the impacts of the pandemic on their real estate based consumption. And people like my mom and grandma have been ordering groceries online, and things online, whereas they hadn't before.

MM:

And there's no doubt that they'll continue to do so. So there will be an element of carryover of legacy from online retail. But they'll obviously still be going to the major shopping centres to buy certain goods immediately, and where they've got the agglomeration benefits of that in a small sort of space. And basically that feeds into the likelihood that the best fortress malls will continue to survive. The tenants want and need to be in some of those locations. So at the expense of further expansion into greenfield opportunities or keeping retail space in the less productive malls. They'll basically fall by the wayside and concentrate their exposure to the best assets globally where they can get the most foot traffic. And of course, grocery anchored retail.

POC:

The malls also seem to be changing the retail shopping centres in becoming, I guess, a lot broader than just retail shopping with dining and entertainment facilities, etc. there. So, do you think that'll be a continuing trend, also?

MM:

Look, it has been a big part of how retail malls have changed their mix of offer from apparel and goods that had basically migrated to online, to a large extent, to more of the experiential type services that require you to be there in-person. I think that continues. As soon as lockdown restrictions ease and the ability for people to go out and socialise re-emerges, they'll definitely continue to be a large component of how retail services the consumer, which essentially is a social being. And we all like to be out and about and probably couldn't wait to get out from our restrictions whenever we had the chance to and that's definitely flown through to a peak in traffic to certain assets and will likely continue.

POC:

So in terms of the comments you've made around the legacy effects from the pandemic on global REITs, how does this feed into the opportunities you've been identifying for the funds and have taken advantage of over the last 12 months?

MM:

Yes, sure. Look, I guess across each of the sectors and markets coming through the initial stages of the pandemic, it was very much looking to identify those sectors, geographies, where REITs were able to withstand the impacts of restrictions, so lockdown restrictions and pandemic, but also where value was on offer and mispricing occurred. And there are a lot of opportunities across industrial obviously, with the prospects of greater eCommerce growth. And of course, the requirement for users to keep more inventory on hand because they were going through a period where goods weren't able to be shipped with the same level of certainty, but they still had consumers to satisfy. That'll be a legacy effect going forward, but also provided some tremendous opportunities over the last 12 months in particular in the logistics space in the US and Europe in particular, as well as in Asia.

MM:

Another component of our global REIT mandate that provided exceptional opportunities through the pandemic and continues to do so is the ability to invest into the REIT of preferred securities. Particularly in the US, these are essentially securities which offer exposure to the preferred coupon of REITs. So, a REIT will typically have a capital structure with debt, preferred securities, and then common equity and the common equity holder or the REIT investor at the equity level gets paid their distributions last, and there's a piece in between called preferred securities that REITs in the US have issued to diversify their funding mix.

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MM:

But also to access a different type of investor, and these preferred securities have typically been able to be accessed below their par value providing the opportunity for both capital growth upon the rebounding and then a relatively high income, and those preferred coupons or distributions are cumulative. So, if they're not paid, they have to be paid at some point in time. And there's been instances over the last 12 months we were able to access some preferred securities that upwards of 50% discount to their par value and they've since rebounded all the while allowing us to access the constant distributions that were unchanged. So they've been some great opportunities we've taken advantage of.

MM:

The others of course have been in retail. The defensive retail that's based on nondiscretionary, and shopping locally for daily needs that has allowed us to access that strengthening consumer backdrop, of course, in the nondiscretionary space. As well as a number of the specialised asset classes that I just alluded to before/ obviously, in healthcare and mobile towers and data storage. And I guess a key aspect of how the funds positioned over the last 12 months has been the view on office obviously, has been one with a lot of question marks with working from home and what the structural legacy effect of that might be on office demand and supply. And how that interacts to create returns for investors.

MM:

We at the initial stages took the view that generic offices in CBDs with supply that was relatively high against demand were probably not where we wanted to position the fund. Having said that, there's a number of office markets and segments, which are described as non-generic and having exceptional attributes and conditions for relatively high income base returns. And that's in the government sector of the office market in particular, as well as life sciences. So, that's probably a bit of an overview of how we've taken advantage of some opportunities despite the pandemic.

POC:

So in terms of, I guess, the sub sectors of property mobile towers, you've mentioned, data storage, some of the office properties, sub sectors, is this where you're seeing the most compelling opportunities?

MM:

Look, that's a great question. Obviously, markets are changing rapidly. And if there's been one thing that's been a function of the last year, it's been volatility. And we've gone through a period where restrictions were significantly crimping the ability to utilise property to the prospect of stimulus coming through, and inflationary and activity concerns off the back of a vaccine and reopening. So the beauty is, I think I alluded to at the start was the ability to be nimble in listed property and to redirect investments where you see opportunities. And there's no doubt that off the back of the tremendously helpful stimulus from governments and monetary authorities globally as well as the vaccine rollout leading to more people being inoculated every day and restrictions looking like easing. That's created opportunities from here on in.

MM:

Look, while I spoke about the global industrial and logistics names and prospects we see them as being great places for our investment at the moment because those trends of online retail requiring greater fulfilment and higher inventory levels are likely to persist. But off the back of vaccine and reopening, we've come to see some more opportunities in certain segments of the US net lease sector of REITs, for example, where they might own some real estate that's leased to a couple of different segments of the retail or services sector where reopening and transactions are able to occur and that's able to drive some growth from those names, which hadn't been priced into their share prices. So, some really compelling opportunities there.

MM:

We're also continuing to see some great prospects for real estate returns in the Canadian market, in particular, where there's grocery based retail with higher incidences of underlying land value that's able to offer a backstop to valuation with some tremendous tenant covenants on offer, as well as global healthcare. And of course, here in Australia, we're seeing some defensive income opportunities that are looking relatively compelling from a value perspective given what we've just seen with bond yields. And a little bit of a sell off through the February period, in particular.

MM:

Another aspect of opportunity has been up in Asia, of course, and obviously everyone will be ofay with China and how they've come through this pandemic. And we've seen some opportunities to invest into some retail portfolios that are listed through Singapore and Hong Kong in particular, but I own some retail assets in China, which are performing relatively strongly in a very compelling valuation. So they're some of the opportunities we're seeing as the world reopens. And, of course, at a differentiated pace, of course, across markets and different regions.

POC:

Yeah. Well, I guess the rise of the Asian consumer and i.e. the Asian middle class, I think, will continue to provide investors with great opportunities across the various sub sectors of the listed property market. So in terms of your fund's positioning now, and given the comments that you've made, can you maybe just give me a short summary of your largest overweights and underweights in terms of sectors and maybe one or two stocks?

MM:

Yeah, sure. Look, we've got a relatively large overweight to global industrial. And that's basically off the back of the prospects for sustained and growing rents across the portfolios. And that leads through to growing distributions, and growing values. So we've got some large exposures in the markets of North America, in particular, in the US and Canada, as well as the UK, and of course, Asia. So one REIT in particular that we have a large relative position to is Tritax Big Box REIT. And that's a UK based REIT that owns assets across the United Kingdom. And that's a logistics portfolio leased to all manner of blue chip tenants in that market, of which Amazon is the largest. And that's been a tremendously successful investment over the last year as that REIT's grown, and also been able to get some wins on the development front. They're building one of the largest warehouses across the European continent and the UK, which is leased to Amazon for 20 years, for example. And that has an income profile that's growing each year. So, that's one example.

MM:

The other would probably be across aspects of the US REIT market. And I think I spoke to the net lease component where these are assets that are leased to tenants across a range of different retail and office and industrial segments in a variety of markets, typically off the back of corporate sale and lease backs over time. So there's an ability there to provide tenants with a capital solution and unlocking the capital that goes with selling real estate with a high relative covenant strength and a relatively secure income profile. And that's where we're seeing a heap of the opportunity at the moment in particular.

POC:

And what areas are you avoiding now or where do you have your largest underweights in terms of the different properties sectors?

MM:

Yeah, sure. Look, obviously, the hospitality and leisure sector is one that's undergoing significant pain. Not particularly over the last 12 months, but the outlook is relatively uncertain. We might have a vaccine and lifting of lockdown restrictions, but of course, when it comes to the confidence of consumers to travel overseas, and of course, business travel. That will be one that remains to be seen how that plays through. Of course, there are some pockets of resilience where travel might be relatively domestically focused. But on the whole, the hospitality and leisure segment is one where we have an underweight position.

MM:

Similarly, will be in the shopping centre or mall based REITs, particularly across Europe and the UK where the assets are basically under pressure from tenants not renewing leases and going into some form of administration or financial stress. But there are some assets that are quite good in some portfolios, but unfortunately a number of those have not only got some tenant weakness, and potential downside of the income line, but their capital position is relatively weak. So we have maintained a relatively underweight position to those types of assets.

MM:

And the other, of course, is that generic CBD office asset, or portfolio that where we're probably a bit more discerning now and into the future into what that exposure looks like. It's important to be focused on those markets and segments where the supply and demand dynamics are favourable for an investor. And of course, if you have a look at New York, or some parts of the European continent, and of course including London the [inaudible 00:45:47] supply and demand are just not favourable for the real estate investor at the moment. And tenants are requiring a heap of inducements to make a leasing decision.

MM:

Not just because of... Yeah, that's right.

POC:

Economics 101, supply and demand.

MM:

Yeah, exactly. And then, of course, in office, the working from home backdrop and what that means from a structural perspective and flow through to tenant demand. I guess the office isn't dead. We're all going to be going into the office at some level, and that will vary by business. But of course, it's a large question mark over the sector at the moment, but one where investors must be discerning in where their exposure is to where those ingredients for sustained rental and valuation growth are the strongest, and they're out there. They're just not in a number of markets that they had been pre-pandemic when it comes to office.

POC:

So, finally, does the prospective rising inflation and bond yields concern you and how this could impact on the outlook for global REITs? And I know both the Australian and the US 10 year bond rate yield has spiked dramatically over the last six weeks. So, what sort of impact could that have on the valuations for global REITs?

MM:

Yeah. Look, it's a great question, Paul. I mean, the convenient position is to take that view that REITs are a bond proxy, and that's just simply not the case. REITs are a real asset class. Real estate is an asset class that, of course, is subject to commercial leases and lease obligations, which most importantly are structured to provide the investor with some level of constant growth in income. And that's tethered to often CPI each year or a fixed percentage. So, as inflation or economic growth increases that would obviously be in response to some level of growth in the economy. And there might be some more tension in rent levels as a result of demand from tenants expanding and needing more space driving rental growth.

MM:

So, an investor in real estate is basically enjoying some level of natural hedge to inflation by investing in real estate. And of course, we should also remember that capital is relatively defensively hedged against inflation purely by the construct that land and buildings, materials and labour are input costs. So the replacement cost of an asset is obviously another aspect that that anchors valuation. So, as a real estate investor, we're basically extremely positive on the prospects for sustained economic growth if they are indeed able to translate to actual growth.

MM:

Governments and central banks have been trying to achieve that over the last decade and haven't been able to. We touched on stimulus. Look, markets are suggesting that inflation will translate through to actual inflation. And that's come through in the bond yields. And overnight, I think Janet Yellen said that she strongly doubts that the 1.9 US trillion stimulus will be inflationary. So, look, bond yields and inflation risks aside, yes, we'd hate to see an inflation sustained spike, and we end up in a developed market type scenario. But if there was sustained inflation within the target band of central banks, and a sustainable level of growth in economic conditions that would be great for investors in real estate over the longer term.

POC:

Yeah. Well, I guess that's a key point you make there, and particularly I was thinking as you were talking about inflation that so many rental agreements actually have inflation in built as an adjustment for the actual rent being paid by the tenant there. So you do get a natural form of inflation protection to some degree in the AREIT and GREIT market there. But Mark, thank you very much for joining us today. The netwealth Investment Podcast Series. I don't think we've had a global REIT portfolio manager on. Certainly not for a couple of years now. So, it's been really insightful, your comments into I guess the property market as a whole, the impact of COVID and changing human behaviours of head on the various sectors, sub sectors of the property market. I think as always you've managed to highlight there that there is still a lot of investment opportunity that is continuing to pop up given the breadth of particularly the GREIT market there. So thank you very much for joining us, Mark, there. It has been very much appreciated.

MM:

Thanks so much, Paul. It's been a pleasure.

POC:

And to the listener, thank you again for joining us on the Investment Podcast Series. I certainly hope you enjoyed the beautiful weather that we enjoyed down here in Victoria over the Easter long weekend. And all the best to you and your clients and the direct investor also for a safe and healthy 2021 in the year ahead. So all the best to all, and look forward to joining you on the next instalment of the netwealth Investment Podcast Series.