Property transactions are changing – new mechanisms reflect the increased maturation and competitiveness of the market. Exactly what is changing, what are the drivers and what does it mean?
In recent years we have noticed some substantial structural shifts in the way commercial property is transacted in Australia, alongside changes in ownership and dominant market participants. In this article, we explore what these shifts are and what the potential implications are.
Was it off market?
Investors and property journalists are always keen to understand when properties are purchased off market. It’s true we spend a considerable portion of our time chasing off market transactions, though often this is driven by the strategic attributes of property that is not on market, rather than pure ‘mispricing’ opportunity in off market transactions.
Notwithstanding, the advent of internet resources, social media and emails means that true “off market” purchases are becoming less frequent. There may well be assets that are not formally advertised, but quite often there is a dedicated and sophisticated, sales campaign going on behind closed doors via emails, data rooms and confidentiality agreements. Parties are invited to participate and there is a somewhat formal sales process but one which is conducted largely out of the market’s gaze.
It is also apparent that many assets that would have once been on market via a formal advertising campaign are being sold via this process. What this means is that networks and ongoing stakeholder engagement are critical to participating in the full breadth of market transactional activity.
Part shares and Fund Throughs
Active followers of the Australian property market will have noticed another recent trend – for transactions to be undertaken on a “Fund Through” or “Part Share” basis.
A Fund Through transaction occurs when a purchaser effectively buys an investment grade asset off the plan. A purchase price is struck for a fully completed asset and the vendor undertakes development of the property and transfers it to the purchaser once development is complete. Often Fund Through transactions are desirable to buyers so they may secure assets without the competitive pricing tension of a market sales process and to also minimise stamp duty.
Fund Through transactions were almost unheard of 10 years ago but they have gained in popularity in more recent times as market participants seek ever more inventive ways of securing assets.
Alongside Fund Throughs, sales of part shares of assets are increasing. This typically happens in larger, institutional style transactions, but it is slowly permeating through the market as people seek to gain access to assets that would not otherwise be sold.
Can’t buy the asset? Buy the business.
Another element we are watching with interest is the merger and acquisition activity within the marketplace. This is occurring both at the property fund level as well as the institutional investor (super fund) level. What this means is that these groups are becoming larger and more acquisitive as they seek further earnings growth (in the case of listed property funds) or the deployment of excess cash arising from contribution inflows (in the case of super funds).
Assets and capital are becoming centralised in a smaller group of major market participants.
As these groups acquire and merge with the competition they become larger, whilst reducing the number of counterparties in the marketplace.
Creativity is born out of limitation
The increase in these non-traditional transactions is driven by an ever-increasing desire to secure a diminishing number of investment grade assets available at any given point in time. There are a few key reasons for this.
First, Australia is a very desirable place to invest for offshore investment capital. Australia has had an extraordinary run of economic prosperity, and the robust legal and property title system combined with transparent markets attracts a growing pool of offshore investors, both private and institutional.
Second, the Australian superannuation system supports large and liquid investment groups that constantly scour the market for opportunities. The Australian superannuation system alone increased in size by $423 billion over the 12 months to 30 June 2021 and this money needs to be invested back into the market to generate a return.
On the basis that 10-15% of this is allocated to property, that is an additional $42 – $63 billion to be invested in property every year. Clearly not all of that will be invested in Australia, but to give some context, the average turnover of commercial property transactions in any given year is ~$40 billion.
Third, many institutional purchasers are “universal owners” meaning that they buy and rarely sell. Consequently, the level of investment grade assets is diminishing as these parties acquire suitable assets and effectively remove them from the market.
What does this all mean and where are the opportunities.
For reasons discussed there is ongoing pressure of major institutional investors to keep allocating ever growing capital resources to a diminishing investible universe. The rate of new asset creation or development is not occurring at the same rate as the growth of investment capital, nor the rate that assets are being acquired. As such, this creates a supply side imbalance that is undoubtedly part of the reason why yields have been driven so low.
It also means that these organisations are going head-to-head against each other chasing larger and larger assets and driving prices upwards. Conversely, they are vacating parts of the middle market which, once upon a time, may have been the domain of some of the businesses they have acquired.
With a condensing list of massive Australian superfunds and local market participants, the specific decision making of these groups can have very meaningful impacts across the market. An example of this is the issue of asset allocation. As the value of assets in all sectors grow, they need to acquire additional property to ensure asset allocation remains in balance. Conversely, when other markets contract (i.e. equities) they need to divest property to maintain this balance. This may influence the amplitude of the market cycle, resulting in higher highs and lower lows as the number of competitors shrink, but the market based competitive forces increase (excess capital, limited assets). Thus, there are likely to be some distortive effects to traditional market economics.
This to us is interesting, as it may be predictive to where the market based arbitrage opportunities lie.
We do not rely on macro forecasting to underpin investment decisions. Nevertheless, we believe that close consideration of unfolding changes on the ground, in real time, and how such changes may influence future cycles, is key to successfully navigating the risk and reward of investing. A lot of market outcomes are driven by behaviour, not fundamentals, and we think some of the market behaviours are telling about the likely future outcomes of the property sector.