Paul O’Connor:

Welcome to the Netwealth Portfolio Construction Podcast. I'm Paul O'Connor, and my role at Netwealth is as head of strategy and development for the investment options offered on our investment menus. Joining us on today's podcast is Chris Bedingfield, who is the co-founder of Quay Global Investors and co-portfolio manager of the Quay Global Real Estate Fund. Quay Global Investors or Quay is an award-winning boutique asset manager focused on the preservation and creation of wealth through innovative strategies in real estate securities. It was founded in 2013 by principals Justin Blaess and Chris Bedingfield, who later formed a partnership with Bennelong Funds Management.

The team manages the Quay Global Real Estate Fund Unhedged and Quay Global Real Estate Fund AUD Hedged, which both invest in a portfolio of 20 to 40 real estate securities listed on security exchanges around the world. The funds provide access to a wide variety of listed real estate opportunities across multiple geographies and aim to consistently deliver attractive total returns over the long term. The founding partners had more than 50 years of collective experience in direct property, equities research, investment banking, and investment management across domestic and global markets, which provides them with a unique skill and perspective which they bring to the management of a portfolio of global real estate securities.

Chris has over 30 years experience working as a real estate specialist with a background in investment banking and equities research. Prior to founding Quay, he was in the real estate investment banking group at Credit Suisse in Sydney and previously head of real estate investment banking at Deutsche Bank. In prior roles, Chris has also led top rated real estate equities research teams at HSBC James Capel and ANZ McCaughan and has experienced in equity and equity-linked capital markets transactions, M&A and debt issuance, with direct involvement in numerous cross-border real estate transactions. Chris holds a bachelor of business degree from UTS with majors in accounting, finance and economics and was awarded the Securities Institute Diploma in 1994.

Quay is a focus business offering the two global real estate funds, hedged and unhedged versions, and both the funds are available on the Netwealth Super and IDPS investment menus. Listed properties been a volatile sector in recent years with issues such as the impact of changing work patterns post-COVID on office property and the sharp rise in inflation and bond yields impacting on borrowing costs. However, this is balanced by the strong ongoing demand for commercial, industrial and residential property. A note listed property rebounded strongly in Q4 2023 led by signs that inflation was peaking and the increasing view that some interest rate relief is coming from central banks.

Real estate investment trusts or REITs have been trading at discounts to fair value, so is now an opportune time to invest in this sector. Rents from listed property are typically linked to inflation, so an allocation to this sector may assist inflation proofing a portfolio, but we'll allow Chris to elaborate more in our discussion. So Chris, thanks for joining us on the podcast this morning. And perhaps for starters, can you explain to the listeners what attracted you to working in global real estate and how you came to establishing Quay?

Chris Bedingfield:

Thanks for having me, Paul. It's a pleasure to be here. So what really attracted me to working in... I really just fell into real estate to be honest. I left uni in a very early 1990s during the recession we had to have. There weren't too many jobs around, and I was fortunate enough to get a job as a stock-broking firm in the research area. I've always had a sort of a desire to work in research. And so the thing was when I started, we were just at the point of the great commercial property collapse of the early 1990s that the freezing of the unlisted property trusts and a bit of a banking crisis we had back then as well. ANZ and Westpac had emergency capital raisings for those people who are old enough to remember. And really at the time, no one wanted to cover real estate.

And so at a very early age, I started covering listed REITs and that became a very big part of the market over the following 10 years or so. And I find real estate fascinating because it's a sector that almost everyone's got an opinion on. Obviously, people go to auctions, they go that might own their own house or apartment or unit. And they've always strong opinions on real estate in Australia, but I find it incredibly an inefficient market because I think most people look at it the wrong way. And so that opens up great inefficiencies in the marketplace and that's what sort of led me after many years in banking and finance on the side of real estate looking at transactions and research. 2013, my partner and I just saw this huge opportunity in the global real estate space for a couple of reasons.

One, it's a massive market, so the size of our universe is bigger than the ASX. It's close to $3 trillion of investment opportunities. It covers an enormously wide range of different types of real estate. Quite often REITs categorised as being a way of playing commercial real estate. And when people think of commercial, they quite often think of things like office towers or shopping centres or even industrial properties. But the global real estate investment universe covers those sectors, plus many, many others like single family housing, apartments, that's apartments to rent and single family housing to rent, not development, life sciences, self storage, senior housing, medical office buildings, hospitals, triple net leasing, a whole wide range of different types of investment opportunities. And so combination of the fact that we felt that the market has extremely inefficiently priced and the huge opportunity set really attracted us to the sector.

Paul O’Connor:

Yes, I'm assuming your first role there was with ANZ McCaughan, which I guess for mine was a great breeding ground for many people that had worked there and went on to work and forge successful careers in funds management. So yeah, I find it interesting. You're another one of the alumni, I guess, from that organisation.

Chris Bedingfield:

It actually had a very strong research culture, which was pretty unusual back in the early 1990s. Back then, a lot of broking firms were very much recommendations came directly from advisors straight from the desk. ANZ McCaughan back then made, fortunately for me, a decision to invest in research, and I was there on the time and was able to be part of that.

Paul O’Connor:

Yes. I also vividly remember the early 1990s, that's also when I left university, and it wasn't easy getting a job back in those days. Yeah. And I smirked as you said, you fell into your first role as I myself also I think followed that same path.

Chris Bedingfield:

I was not the first one chosen. I was like fifth on the list at ANZ, so fortunately, the four ahead of me got offers elsewhere, so I was really lucky.

Paul O’Connor:

Global property fund strategies vary significantly with some strategies having I guess a broad view and definition of property, and they might include not only REITs but property development and investment management while others take a more purist approach, providing exposure, I guess, to established properties to capture the income from rent with some capital growth. Can you elaborate on Quay's property strategy and how you believe you differ from your competitors?

Chris Bedingfield:

I suppose it comes down to the way we define our universe in real estate. So you're quite right, the global listed real estate universe includes developers and fund managers, includes emerging markets. I suppose where we differ from our peers is that we define real estate as being already built real estate that is already leased and in developed markets only. So we're not in developing markets. So we're in all the locations you'd imagine the US, Canada, Germany, France, UK, Australia, etc. And we exclude in our universe real estate funds for business, and we exclude the real estate developers or REITs that have a very large component of their business being in the development business, and we do that for two reasons.

Firstly, we feel it's a lower risk way of playing the real estate cycle. You don't have the same issues when you're going through the development. Lots of things can go wrong, particularly if you get caught halfway through a development and the cycle turns, you can get caught out from a balance sheet perspective pretty quickly. But fundamentally, the main reason they exclude developers is that our overall philosophy in real estate is it's always best to buy the underlying real estate below the cost to build. Real estate is a funny industry in that the barriers to entry in real estate are infinitely high or infinitely low or zero I should say. If you buy an asset below the cost to build, people just won't compete with you. Developers won't compete with you with new supply because it doesn't make economic sense to build new supply at a loss.

And if you own real estate above replacement costs, the opposite occurs. You are subject to potential competition as developers supply the market for profit. If you view real estate through that prism, it becomes very difficult to justify owning developers whose sole business model is based on the sustainable prices staying above replacement costs. That's the way they make their money. And I've been doing this for over 30, getting close to 35 years now, it always turns, right? Eventually, if prices stay above replacement costs for long enough, developers continue to build, overwhelm the market in supply that weakens the leasing market that weakens the secondary trading market and prices adjust and start to fall below replacement costs, so they're the two reasons we define the universe that way. So yeah, that does set us apart from our peers.

Paul O’Connor:

Sounds very rational there, Chris, being able to I guess get exposure to property at below the replacement costs there. And I guess also it strikes me as your strategy may be a lower volatile strategy compared to a number of competitors because as we know, property development brings a whole new basket of risks as well and duration lags and what have you there. So simply buying established properties certainly gives you a more purest exposure, I guess, to the market.

Chris Bedingfield:

It's not as exciting. You don't get those big earnings upgrades as developments come through, but you avoid the big earnings downgrades when the cycle turns.

Paul O’Connor:

In Q1 of 2023, markets were concerned about a potential US recession brought on by the sharp rise in interest rates and bond yields, but I guess the resilience of the US economy has surprised many and continues to go from strength to strength. What are your views on the US and is the GDP growth sustainable?

Chris Bedingfield:

Yeah. I mean, if you go back to late '22, early '23, that was exactly the consensus. And there was a lot of talk about the inverted yield curve in the United States. There's a bit of a belief that when the yield curve inverts, that is when the long-term rate is lower than the short-term rate that the markets are expecting a recession, and it's historically that inverted yield curve has had a pretty decent track record. We actually wrote a paper around this time last year saying the US is not going to go into recession. The US is going to continue to grow and employment's going to be okay, and the markets are going to hold together. And the primary reason for that is that the thing that most people miss on monetary policy and particularly in the United States is the fact that there is a big interest income channel that's working to support working to the economy.

What do I mean by that? I mean, that when interest rates go up, all other things being equal, people with mortgages obviously theoretically pay more and people have cash deposits receive more. It's like a bit of a wash, but in the US, it's a bit different because 90% of mortgages in the United States are fixed for a long period of time, 15, 30 years. A lot of Americans locked in 3% type mortgages during the pandemic, and they're not going up. On the other side of the equation any cash that's sitting in accounts is accruing higher and higher net interest income. And then on top of that you have the United States government with about $33 trillion of debt. They're paying more on their debt as well. And that is a huge fiscal pulse right now in the US, interest payments on the US government debt are exceeding a trillion dollars on an annual basis.

That is pretty much what the COVID recovery or COVID relief bill that was enacted by Congress in early 2021, that's now coming through and just net interest income to the private sector from the government, and that's just not a one-off payment. This is a flow. This is an ongoing flow of income coming out of the US government and into the private sector. And that is supporting wages, it's supporting jobs, it's supporting growth. So the fact of the matter is that so long as there's a positive fiscal support in the US, we see the economy continuing to do well.

Ironically, if the Fed wants to slow the economy, they actually have to cut interest rates. Although that's not a consensus view, but when you look at what's happening at the flow of cash flows from the government to the non-government sector, higher interest rates are actually boosting the economy in the US. That's not the same everywhere. Now, obviously, in Australia we don't have the same level of fixed rate mortgages. Our government has almost got to a balanced budget, whereas the US government is running bigger deficits. So it's kind of a bit different everywhere. But in the US, the economy's holding up well, and I expect if interest rates stay where they are, it'll continue to hold up well.

Paul O’Connor:

So last year both in Australia and other developed markets, there were fears of a significant decline in house prices, and I guess the so-called impact of the fixed rate mortgage cliff, however, prices rose steadily last year and again this year. So what's happened and do you believe price rises can continue?

Chris Bedingfield:

Yeah. I mean, it's quite strange and that was that expectation that higher interest rates was going to somehow lead to lower house prices. We always found that a weird way to view it because if you look at the history of Australian house prices, if you look at the history of house prices generally, they tend not to necessarily fall when interest rates are rising. If you go back again to the late 1980s, early 1990s, the RBA was in a very similar situation as today. They were raising rates, raising rates, raising rates, house prices in Sydney, but I think it was between 88, 90 went up 50% despite the fact interest rates were going up. If you go back to 2000 and through to 2008, the RBA was raising rates during that whole time. And generally, the market, the Australian residential market, was going up, particularly Perth at that time was going... It was very, very strong.

And so what really governs property prices ultimately is the difference between demand and supply both in the buyer market and rental market. And we came out of COVID with, I would say, a balanced market but started raising interest rates, and then you also had a big spike in construction costs. What happened was prices in the secondary market for housing ended up trading below replacement costs. So you're going to keep hearing this concept throughout this podcast. It's the best way to view real estate prices started to trade below replacement costs. So what became really clear to us was that you were going to get very little new supply coming down the pike over the next couple of years because again, developers don't want to put $100 into a project to get $90 back. It's irrational. So we knew supply was going to start falling courtesy of the combination of the RBA and also the fact that building costs kept going up.

And so we just saw the same parallels as we saw back in the late 1980s or in the early 2000s, where supply and demand was going to be... There was going to be a bit of a mismatch, and you could see it in the rental market, they would see rents were starting to accelerate. So to contemplate like a 30%, some people calling like 20, 30% decline house prices, it was just nonsensical, just didn't make any sense at all because there was just this big sort of demand supply mismatch. And what we were predicting was not out of the unusual, anyone with any sort of history of Australian house prices, knowledge of the history of Australian house prices, knew that interest rates alone were not the determinant factor of where real estate was going to go. And so again, we published a paper about 18 months ago basically saying all of this, and we coined the phrase that FOMO, fear of missing out, has been replaced by FORA, which is fear of renting again.

And our thesis was, and I think it's proven to be correct, is that, yes, households were going to get squeezed, but if you are thinking about... You think about someone who's bought a house in 2021, they've saved a good part of their life to come up with a deposit, they've bought their home and markets are a bit soft. I mean, what does it take for someone to sell their home at a loss, lose their deposit, possibly never ever get back into the housing market again because it'll take years to save that deposit again and then tip themselves into a white-hot rental market. So our view was that other forms of spending were going to be sacrificed before we saw any sort of deterioration in house prices, and that's kind of the way it's played out.

Paul O’Connor:

Yeah. I think you make a very salient point there around it gets back to demand and supply and not only... Well, I guess we had such significant migration as well, skilled migration coming into the country. And I guess I also hadn't, which is driving demand, but then I hadn't considered the impact of inflation on building costs and again, the replacement value even for a residential property that the prices had to go up at the end of the day, I guess.

Chris Bedingfield:

Yeah. I think the argument of population growth is overstated. We have plenty of capacity in this country to build enough housing, plenty of capacity. There's 1.3 million people working in the construction industry today. That's up from about 1.1, 1.2 million just prior to COVID. And prior to COVID, we were building enough homes so that rents were growing at only one or 2%. We've got plenty of capacity to supply the market. Yes, demand has been high because of population growth, but... I mean, you can see the headlines almost every day.

Construction companies are going to the wall, and they're going to the wall because they're getting caught between price squeezes and end prices are not matching up. There's no profit in development. And so this is a... If you're going to lay the blame at the feet of anyone, you're probably laying the blame more on the RBA than population growth per se. Both are playing a role, but I think people are understating what the RBA has done in terms of access to funding, cost of funding, along with creating uncertainty about end pricing and what it's done to the construction industry and our capacity to deliver to the market.

Paul O’Connor:

Into the questions for today's podcast, Chris, global property fund strategies vary significantly with some strategies having exposure to property development and investment management, whilst others take a more purist approach, providing exposure to established properties to capture income from rent and some capital growth. Can you elaborate on Quay's property strategy and how you believe you differ from competitors?

Chris Bedingfield:

Yeah. Sure, Paul. I mean, the way we define the investment universe is that we only want to invest in real estate companies where the land and the building is already in place, the tenants preferably are in place, the rents are already being paid. And so we tend to avoid the developers and the fund managers. And so when you look at the key strategy, it really is just owning, in listed form, physical real estate that's already in place, and we do that mainly. Obviously, there's a different risk profile to that, but it also we do it because from a philosophical point of view, our approach to finding the best investment opportunities, our approach to value when it comes to real estate is to own the underlying real estate where possible below replacement costs. We see that as one of the ways of thinking about valuation.

If you can buy a building through the list or a listed structure at, say, $100 and you feel confident that it costs maybe $200 to rebuild that building, that gives you great downside protection, potentially some very good upside capture when the cycle turns. And when you think about real estate in that context, it doesn't really make sense to own the developers whose business model is based on the very opposite of that philosophy. The business model there is to participate or be active in a sector where prices of real estate are above replacement costs, that's where you get the margins. So for a number of reasons, we have a very simple philosophy around owning real estate. We want to own real estate that's, as I said, already in place and ideally below replacement costs, and that eliminates those developers fund management type businesses from our universe.

Paul O’Connor:

Well, I guess to a degree that'd make your strategy also a lower risk strategy and less volatile compared to some of your competitors that will take on development risk in a portfolio. And as we do know, developments can be delayed and have cost flow outs, etc. So I guess that makes sense.

Chris Bedingfield:

Yeah. I would just say that volatility can come from macro as well as fundamental, and so we can't avoid macro volatility. You wake up in the morning and the Fed does this or RBA does that. But underlying business volatility, we believe we would've lower volatility. That's right.

Paul O’Connor:

In Q1 of 2023, markets were obviously concerned about a potential US recession bought on by the sharp rises in interest rates and bond yields, but the resilience of the US economy has surprised many and continues to go from strength to strengths. What are your views on the US and is the GDP growth sustainable?

Chris Bedingfield:

Thinking back at that time, I think one of the things that markets tend to get wrong in our view from a macro point of view is they tend to underestimate the power of fiscal policy, and they overestimate the power of monetary policy. And you see it even today, most of the financial press is dedicated to what central banks are or are not doing. But if anything we've learned over really since the global financial crisis is that fiscal policy has been a major driver of overall economic performance. You had a weak recovery coming out of the global financial crisis when fiscal policy out of the US was pretty weak. The Obama presidency spent most of its time cutting back on benefits and raising taxes and trying to get the budget back into balance as it will. And then during COVID, the opposite happened. They'd really just opened up. Every country around the world opened up the floodgates.

From a fiscal point of view, we had a very, very strong recovery. And I think that framework, thinking more about fiscal than about monetary policy, is really what we were thinking about last year when we said the US economy be fine. The US deficit was expanding. And ironically enough, it's expanding because of monetary policy. The fact that central banks are putting up interest rates means that interest payments on government debt are increasing very rapidly. And so perversely, we think what's happening is that interest rates, while they can be restrictive in some sense, they're actually being quite stimulatory in particular with the US. And the second part of your question, is it sustainable? Well, we feel so long as the budget deficits keep expanding, more dollars will be sort of printed into the US economy and the US economy should be fine. Interestingly, Australia's going the other way. They're trying to balance budgets and contract spending, and I think you will see a difference in Australian economic performance and US economic performance going forward because of that.

Paul O’Connor:

Yeah, interesting comment you make there. And I don't think a lot of people reflect on the overall impact of both fiscal and monetary policy. And I guess we've seen it where central banks in a number of countries have been running, I guess contractionary monetary policy, but at the same time, expansionary fiscal policy. So yeah, I think very wise comments there, Chris, about trying to get a total picture on the impact of both of those levers that governments and central banks have to stimulate or slow an economy down.

Paul O’Connor:

Last year, both in Australia and developed markets, there were fears of a significant decline in house prices and the so-called impact of the fixed rate mortgage cliff. However, prices rose steadily last year and have continued to do so again this year. What do you think's happened and do you believe price rises can continue?

Chris Bedingfield:

Well, this comes back to our overall philosophy about how real estate gets priced over time. What happened last year and coming out of COVID, you had pretty strong house prices and very low interest rates, but what you also had was a very steep rise in construction costs. And when you view real estate through the prism as we do of price relative to replacement costs, you tend to see real estate in a very different light. And the way we saw it in early 2023, late 2022 was that prices in the secondary market for housing, both in Australia and elsewhere around the world were basically trading below replacement costs, not so much because prices fell but because replacement costs, building costs went up. And when you have a situation where the secondary market, the end value of your product, if you think of a house like a widget and the development cycle just being like a manufacturer, you're not going to push the button on manufacturing widgets at $100 if you're only going to get $80 for it at the end of the manufacturing process.

It was no surprise to us to see that you saw a decline in housing approvals, not just here, but around the world, housing starts and populations and household formation ticking along. You were going to get a big sort of squeeze in the rental market, which we have seen here and around the world and where rents go values soon follow. This shouldn't be a particularly controversial point for people that have studied real estate for a long period of time. We had very high interest rates in the late 1980s in Australia. Between 1988 and 1990, interest rates were well into their teens. House prices in Sydney went up almost 50%. We had rising interest rates between 2000 and 2008, and we had very strong house prices, particularly in and around Western Australia and Perth. So it really is governed through replacement costs and what will eventually happen is prices will go above replacement costs at some stage. We'll get a supply response and then prices will come back down again, and that's kind of the way the cycle works.

Paul O’Connor:

So I guess my take on that, it's effectively prices adjusting for inflation, which is something we haven't had to deal with for many years.

Chris Bedingfield:

Yeah, that's exactly what it is. And that's why very wealthy families going back centuries will hold a lot of their assets in real assets because they think about generational inflationary effects. And yes, inflation over one to two years caused short-term market disruptions. But if you think about generational wealth, if it costs a million dollars to build a house today, well, in 2030 years time, it's going to be 2, 3, $4 million. And so you get that natural hedge against long-term inflation because prices do oscillate around inflation. Real estate prices oscillate around inflation over the long term.

Paul O’Connor:

So Australians love investing in residential property, but ASX listed rates have not historically invested in housing. So there are many opportunities to access the residential housing market on the ASX, and what about globally?

Chris Bedingfield:

So it's a bit tricky on the ASX. We do have several rates that specialise in developing residential property. The two big ones are Mirvac and Stockland, Mirvac more on the apartment side and then Stockland more on planned estates. However, you don't really get a clean shot at what we would be looking for, which is existing standalone apartments and units 98, 99% lease generating free cash flow. There isn't a movement in the Australian market for a build to rent industry. So copying what we've seen overseas, but that is really in its infancy and very hard to access for most investors unless you're a major institution looking to direct invest in specific projects. But globally, yeah, I mean, residential is almost one-sixth of the global index. It's a meaningful part. There's many ways you can play it in the United States. You can play it through single family or standalone housing.

Houses on their own block with backyard front yard, little driveway picket fence if you will. Or you can play it through the apartments space, which can be multi-story apartments in built up urban areas in and around the cities. You can do it through manufactured housing or what we would call land lease here in Australia where our rates own the land and the tenant owns the house, and we get a ground rent. There's student accommodation, you can do that particularly in Europe. There's areas like Canada which can also do apartments and also in Europe as well. So there is an enormous range of opportunities not only geographically but also by type to invest in residential, and it's a sector we actually like right now.

Paul O’Connor:

Yeah. Well, given all the talk recently about Australia having to build so much more residential properties, that sort of would make sense, wouldn't it for the federal government to try and encourage the development of a residential rate or a number of residential rates to help meet the housing supply shortage?

Chris Bedingfield:

It does, but the maths has got to work. And so the government can say all at once, but we've outsourced the housing construction industry to the private sector, and the private sector will only do something for profit. That's kind of how markets work. And if there's no profit, if there's no return, it's hard to wheel an industry into existence. And it all comes back to the really simple idea that prices have to be above replacement cost for there to be the desire to put capital and real resources into a project. You will get people trying to will it into existence for political or maybe for asset allocation reasons, but if the government really wants to create a supply response, they could look at the cost side of the equation for housing as much as anything else and maybe try to do something there.

Paul O’Connor:

Global rates are a vast investment universe covering different countries and regions, but also different sectors being commercial, industrial specialist, residential, et cetera. So what are some of the major investment themes in global real estate right now and where are you seeing the opportunities?

Chris Bedingfield:

When we think of investment themes, we like to look for where there is a structural sort of demand and supply mismatch between tenant and landlord. Right now in many sectors across global real estate. That's kind of happening what we're seeing in Australia with limited new construction and strong tenant demand in the residential market. We're starting to see that in most other areas around the world, whether it be residential in the US or Canada or student accommodation in the UK. So residential for us is a big theme because that dynamic we're seeing in Australia, we're seeing elsewhere. For instance in Canada, Canadian population is growing even faster than Australia. It's growing at about two and a half percent per annum. They need to build around 500,000 dwellings every year for the next six years to meet their demand and they're running at about 250,000 dwellings a year.

So there is a big structural short for housing in Canada, and you can access the Canadian market unlike Australia, just through the REITs, and we've got a decent exposure there. Another big theme that we like is self-storage. This is a theme that we think will play out in Europe in particular over the next 10 to 15 years. Self-storage in Europe is really at its infancy, but it is growing and it is growing at quite a nice rate. There is about one square foot of self-storage space in Europe per capita compared to nine square feet per capita in the United States. So it's roughly a 10th the size of the US but almost 50% more population. So we see a big runway there. And then another big theme we like is ageing population, and I'm sure equity managers have play this one up as well. The population is getting older.

The way we play it in the real estate space is we like looking at areas like senior housing, particularly assisted senior housing as people get into their late 70s and early 80s. It's very needs based and that population, that ageing population's coming no matter what. Talk interest rates, we can talk fiscal policy, we can talk about who's going to be president or prime minister, but those people are getting older every day. That's needs based and it's coming. And the good news on senior housing, just like most other sectors right now, there's not a lot of new housing starts occurring because the maths just doesn't work. So we've got really, really tight supply and a big wave of demand coming over the next 10 years. We're really excited about that space, so that's a big theme as well.

Paul O’Connor:

And maybe on the reverse, what areas of the global real estate market concern you and that you're avoiding at present?

Chris Bedingfield:

A couple of the areas that we are a little bit concerned about would be... We've been out of industrial logistics now for quite some time. When I say out, we have some, but it's very small, it's quite targeted. We feel that that space has been a space where there's been an enormous amount of investor demand in the past that's pushed prices above replacement costs. There is a tonne of supply being built around the world, particularly in markets like the United States, and that will weigh on rents, that will weigh on prices going forward. So again, sticking to that overall philosophy, buying below replacement costs and staying away where things are trading above replacement costs. Local companies like Goodman are still developing industrial, still making margins that tells you everything you need to know about where prices are relative to costs. So we're wary of that. We are also wary about markets where demographics are working against us and not really for us.

And so one area that we're particularly wary of and we have no exposure to is areas like Japan where the population is falling. The population in Japan is declining by a hundred people every hour, and it will continue to fall by a hundred people every hour for the next 20 to 30 years. Prime age working population of 75 million people is forecast to decline to 45 million people in the next 20 years. That means there's a lot of empty houses, a lot of empty office buildings, a lot of empty shopping centres coming. That's one area that I think you've got to be very, very careful of I think. So we like to go where the population's growing, where there is incremental demand for our space. And what's even better, we like to go where there's not much space being built. And so as I said, those areas for us tend to be more in places like Canada, Europe, United States in senior housing and housing and self-storage.

Paul O’Connor:

What do you believe are the advantages of listed property over direct property and maybe some of the advantages also of global versus local rates?

Chris Bedingfield:

The big advantage of listed over direct, I think there's two, two very large benefits. The first is it's obviously liquid, which means that, for instance, our fund, we have daily pricing. You can come in and out whenever you want really. I mean, everything we own is traded in the market and so we can find liquidity pretty quickly and easily for people that want to redeem or people who want to come in. And so with that, you do get volatility, but you get liquidity. Over the long term, there is not much of a difference in returns. A building doesn't know it's unlisted. Tenants in a building when they're paying their rent, they don't pay more or less depending on whether the building is in a listed vehicle or in an unlisted vehicle. The cash flows are still the same despite the fact you get more volatility in the listed market. For patient investors, the returns are basically the same and there's tonnes of studies that sort of prove that up.

So you get more liquidity, you get pretty much the same return. But the other big difference, and this probably is a big difference between IREITs and global, some sort of segueing into your second question here, but it's also relevant. For the first is you get a wide range of opportunities in the listed market. So to cobble together a portfolio of self-storage facilities for direct investment and to cobble together single-family housing and have them professionally managed in scale for direct investment can take many, many years. And so a lot of these portfolios, which are very, very difficult to access to in the direct market, are readily available, already have track records in the listed market, are professionally managed and tend to... Certainly from our perspective, we invest in companies that have excellent management as well.

So it's very hard in the direct world. Usually, in the direct market, syndicates will have... They might offer you shopping centres or industrial or maybe an office building, but global gives you access to so many more things. Data centres, as I said before, things like student accommodation, manufactured housing, apartments in Canada, single family housing in the United States, triple net lease, ground leases. We haven't talked about ground leasing where you just own the ground lease and the tenant owns the office building or the apartment building. So it just gives you more significantly more variety.

Paul O’Connor:

There's been so much talk about the so-called commercial real estate crisis. Are these concerns real? And what are your thoughts on the topic, Chris?

Chris Bedingfield:

I'd just frame it slightly differently. The word crisis is obviously used to attract people in the modern media world.

Paul O’Connor:

Yes, yes [inaudible 00:42:30].

Chris Bedingfield:

There is a commercial real estate lending issue, selective lending issue in certain parts of the world, there's no doubt about it. But the thing that I find interesting is that the press unintentionally in my view probably conflate commercial real estate with things like office. And so there are certainly asset classes like office in the United States that have suffered from the headwinds of the work from home sort of a theme. Office buildings that obviously are cash flow challenged because of that and also having to face some steep refinancing headwinds. So there are going to be office buildings, and I think maybe also apartment buildings that will struggle and those buildings will be handed back to the lenders, whoever the lender may be.

But being a widespread problem or being something akin to a GFC, which is what the panic was last year, we just don't see the same issues that some office markets are actually doing quite well and some office markets are doing pretty poorly. And again, when you're thinking about commercial real estate, as I mentioned before, that includes all variety of types of asset classes like industrial, self-storage, manufactured housing, triple net leasing and like. And many of those cash flows are substantially higher today than where they were pre-COVID. So the refinancing of those types of assets won't be much of a problem. Sure, the owners of equity again may take a little bit of haircut on the equity, but the cash flows well and truly support refinancing. So you're going to see some headlines, you're going to see some assets in distress, there's no doubt about it.

But commercial real estate's massive, it's massively diversified. The lending is massively diversified. Less than 50% of loans to commercial real estate's actually in the banking system, roughly half of it's outside the banking system, just private investors, who may or may not take the loss. I would call it a commercial real estate issues, but it's very selective. It's not as widespread as I guess the press would make you to believe, but there's going to be headlines for sure that mean there's trillions of dollars of real estate in the United States. It's not going to be hard to have a headline every now and again about a certain fund or a certain building being handed back, but I just don't see it being as systemic as what it was 15 years ago when the housing market collapsed.

Paul O’Connor:

My key take out there is I promise I will not use the word crisis again in this podcast. I do agree with your comment, it is probably the most overused word in the commercial media, but moving on, what do you think then is the future of office property? Will there be any further structural changes or...

Chris Bedingfield:

Yeah, we're pretty constructive on office. I say that despite the fact we have very little office in the portfolio. We did have some office in the portfolio. This time last year, we actually just sold out of it and we made... It was our best performing stock. There you go, office. Last year, best performing stock. We're pretty constructive on it generally. I think where we're going to end up, it will be that work from home is going to be here to stay in some shape or form. I think that it suits both employee and employer to have that sort of flexibility. But at the same time, I think that tenants need to be mindful that they need to have as much space for the maximum number of employees on any particular day. And what's becoming really clear thematically is that most work from home days tend to be the Fridays or the Mondays. You probably see it yourself. I think a lot of people that come in on the city on Fridays and Mondays find it's a lot easier public transport wise than on the Wednesdays.

And what that means is that when tenants come to renew their lease or think about their space requirements, they have to think about the maximum number of people coming in, which would be the Tuesday, Wednesday, Thursday. And that I think ultimately means that they're not actually going to be reducing their space that much because close to 100% of your employees could very well be in on that Wednesday. So we think that there is a lot of uncertainty right now. Tenants are still trying to figure out their needs and still trying to figure out how their work from home's going to work into their business. But ultimately, that's where we see it's settling. We see it settling that tenants are really probably not going to cut back their space too much. The market will stabilise and normalise. Right now, it's very hard to make new office developments work, so there's not a lot of new supply coming for the next three to five years. Populations will continue to grow and office I think does have a future.

Paul O’Connor:

Yeah, well I think the key takeout for mine as you were responding to the question there, Chris, is it doesn't matter if you're in the office 5, 4, 3 days, even 6 days a week, you still need office property, and you need seats for all your employees. So I tend to think that the doomsdayers talking about office property are probably won't be correct over the long-term. If people have their own house or investment property, do you think having an exposure to global real estate still makes sense?

Chris Bedingfield:

I think it does. I mean, I could be accused of talking my own product a little bit here, but I'll answer this question two ways. I think firstly, when people think about the ASX, the composition of the Australian Stock Exchange, you are kind of exposed... Let's say you have an index exposed to the ASX, you're kind of exposed to the housing market there anyway. Our banks, 63, 65% of their books are written against real estate, residential real estate. And they're basically... When you think about a loan against real estate, which what our banks do, they basically put options against real estate. There's not much upside on the loan. The best-case scenario, they get paid back. But if we ever have a big decline in real estate values, you're going to cop the downside if you own the bank. So being in equities, you're kind of exposed to real estate to some extent anyway.

The second way I would answer this question is that when you invest in global real estate, there's no law that says that the owning real estate in Canada and the United States is going to be correlated with that in Australia. In fact, if you look back at 2008, 2009, 2010, Aussie property housing prices held up pretty well and the US crashed a lot. And then if you look a few years after that, Aussie real estate sort of moved along sideways a little bit, and then the US housing market, the residential market came roaring back. So they're not necessarily correlated, they are really are different asset classes. And so you might feel like you're doubling up, but you are investing in things that are quite different to what you may have in Australia. I think the currency diversification is well worth having as well, although you can get that through global equities or global fixed income as well.

And you also get access to different types of real estate, not just as I said a moment ago residential, but through us, you can get exposure to things like self-storage or senior housing, which are not correlated with Australian residential property at all. And I will just say one more final point, if you look at the total investment class universe of Australia right now, if you were to benchmark Australian assets right now around two-thirds of Australian investible assets is residential property. The ABS says that residential property in Australia is worth about 10 trillion. I think the ASX has a market cap of about two and a half trillion, bond market's about a trillion. If you were to asset weight your portfolio based on the investment universe in Australia, if your assets are less than say two-thirds or 70% real estate, you're probably underweight real estate to some extent. So global real estate can help you top up on that, and it can also give you that diversification as well.

Paul O’Connor:

So maybe to even give you a bigger opportunity to plug your fund. What do you think's the buy case for global real estate right now?

Chris Bedingfield:

If you look at the long-term returns of global real estate, if you look at since 1970 through to today, US real estate, US REITs has outperformed US equities on a total return basis. US global REITs over the last 30 years has outperformed global equities. So over long periods of time, global real estate has performed as well, if not better, than equities. That might surprise a few people, but that's the data, they're the facts. And now, if you look at what's happened to global real estate over the last few years, it's meaningfully underperformed. And if history is a guide, that does not last forever. And so if you are thinking about looking for a sector that if you've done quite well in AI, or you've done quite well in a few other areas, global real estate is a sector that has got great track record, it's got the runs on the board, but in the last few years has been hit pretty hard more through sentiment than anything else.

We've got stocks in our portfolio whose earnings are up close to 50% over the last five to six years and whose share prices are still the same as they were to five, six years ago. They are trading at very, very steep discounts to replacement costs. The thematic that we're seeing in Australian residential where demand and supply squeeze is causing accelerating rents, we see that happening globally across other asset classes as well. So I think it's a combination of great long-term track record, recent underperformance, very, very solid underlying fundamentals. And in most cases outside of areas like Japan or logistics, you are buying the underlying assets below the cost to build. And if you're a patient investor, that means your downside is very limited, and you've got a good opportunity to capture some reasonable upside as well.

Paul O’Connor:

And we all know that markets will mean revert. So at some stage, yeah, I guess what you're saying is there's a real opportunity or potential for a re-risk rating and a re-pricing of global rates.

Chris Bedingfield:

And I can't emphasise this enough that the underlying rents of our investees are keeping pace with inflation sometimes even more than inflation. So the earnings of our investees are growing very nicely. Right now it's really just macro that's creating these near term headwinds or relative underperformance I'd say. I mean, still had a pretty good year last year. I think we did 17% return last year, but that was off a pretty very tough year before. The returns are still there. But yeah, I think when mean reversion occurs, prices have to come back a long way if we're ever going to see another development cycle again, and that's what we're banking on, that's what we think will happen.

Paul O’Connor:

Maybe to finish, Chris, on the last question, do you have any thoughts on the portfolio characteristics of listed property and the role it can play in a diversified portfolio? And I know you've mentioned lower volatility and more consistent income. Any other comments or thoughts?

Chris Bedingfield:

Well, yeah, it is a different asset class. Real estate has always been seen as a different asset class. The correlation with equities is very, very high in the short term. And it might make one think that you're not getting much diversification in the short run, but longer term that correlation tends to break down, real estate does very much beat to its own drum. We find interestingly that global managers tend to not have much real estate in their portfolios. So if you're allocating to global, and you're picking your favourite global managers, you probably don't have any global real estate in those portfolios. It's just too small for them I think. So if you really want to play those mega themes that I was mentioning before, things like the rental squeeze we're seeing in residential or that senior housing squeeze that's happening. If you really want to play those, global real estate's a fantastic way to play it to get access to those themes, but have that physical real estate backing that sort of that lower risk ownership of physical real estate backing. That would be my main argument from a portfolio point of view.

Paul O’Connor:

Chris, thank you very much for joining us today on the Netwealth Portfolio Construction Podcast. I think it's been a really educative and interesting discussion, and I guess I hadn't considered that global rates can offer patient investors the opportunity to purchase an asset actually below its market value, and you've certainly also dispelled a few myths on the commercial real estate. I won't use that word crisis, but the, I guess, changes that have been going on and particularly in the office property markets post-COVID. And I think you've also well articulated the return potential that this asset class can offer investors and particularly an allocation within a diversified portfolio. So thank you very much, Chris, for your time and your insights.

Chris Bedingfield:

Great. Thanks, Paul.

Paul O’Connor:

And to the listener, thank you for joining us again on today's instalment of the Netwealth Portfolio Construction Podcast. I hope you enjoyed the discussion I had with Chris Bedingfield from Quay Global Investors. I hope you have a great day and I look forward to you joining us on the next instalment of the podcast.