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David Harrison on the hot spots in property

David Harrison is Managing Director and Group CEO of Charter Hall (ASX:CHC), which manages $30 billion in property assets across office, retail, industrial and social infrastructure assets. It is a leading direct property fund manager, including open-ended funds available to retail investors, as well as manager of the listed Charter Hall Education Trust (ASX:CQE), Charter Hall Retail REIT (ASX:CQR) and Charter Hall Long WALE REIT (ASX:CLW).

 

GH: In 14 years, Charter Hall has gone from $500 million to $30 billion in assets under management. Are there two or three big decisions or milestones that created that growth?

DH: I joined the Group in 2004 when it was a private company. We had traditionally managed wholesale funds for major clients, plus a high net worth syndicate business. We needed to list on the stock exchange to give ourselves a balance sheet and allow coinvestment with large super and pension funds. After listing, we launched a series of large wholesale funds that created a growth platform for core, stable investments.

The other major event was in 2010. Banks were exiting the ownership of property and property funds managers, and we bought the Macquarie real estate platform. It had about $7 billion of assets, but half were offshore. We used its listed REITs (Real Estate Investment Trusts) to refocus purely on investments in Australia.

Then we realised that we could become the largest Australian provider of ‘stabilised’ (Ed, stable, long-term income) commercial property to the main sources of equity flow in the world. The clients in large super funds, global pension funds and insurance companies represent 65% of our funds under management. In unlisted assets, our retail high net worth business includes almost 30,000 investors and SMSFs.

GH: How should an investor decide between the types of product you offer, in your listed funds, unlisted funds or separate syndicates?

DH: We don’t make the asset allocation decision. SMSF investors, advisers, high net worths, large super funds, asset consultants – they make those decisions. So we give investors a choice.

We run our own listed funds management business, the Charter Hall Group, plus three listed REITs: one in non-discretionary retail, one in the childcare sector, and the third is realistically the only diversified long WALE (Weighted Average Lease Expiry) trust listed in Australia. Other trusts are far more diversified, while ours has a long lease, low risk profile of assets from office, industrial, retail and social infrastructure.

In the unlisted space, we have two open-ended (Ed, this means open for ongoing investment) funds in the office sector (Charter Hall Direct Office Fund or DOF and Charter Hall Direct PFA Fund or PFA) and plus one in the industrial sector (Charter Hall Direct Industrial Fund No 4 or DIF4), and recently we created a diversified consumer staples fund (Charter Hall Diversified Consumer Staples Fund or DCSF). Following the acquisition of Folkestone, we now have the Charter Hall Maxim A-REIT Securities Fund, which offers investors access to a portfolio of listed A-REITs.

GH: Do you have any advice on how investors should choose between sectors?

DH: I encourage investors to look at diversification. Some don’t want an office or industrial fund, they prefer a more diversified fund. Some people like to make the sector allocation decision because, for example, they might already have an exposure to shopping centres so they choose an industrial fund.

GH: If you look at Listed Investment Companies (LICs) generally, most of them are trading at a discount to NTA (Ed, the value of Net Tangible Assets). But if you take your Long WALE Fund, that is at a significant premium (currently, share price $4.84, NTA $4.01). Why is that?

DH: One reason is that some LICs are ‘fund of funds’ with double fees. You're paying a manager to invest in companies or funds that already have a management expense ratio. Other LICs are investing in listed companies that have their own volatility. The NTA now might not be the NTA in the near future. In REITs, the trust itself owns the direct real estate, and there's only one set of fees.

GH: Most people more familiar with residential leases don’t realise how commercial leases work.

DH: Yes, especially the various ‘net lease’ structures (Ed. a net lease is where the lessee pays some or all of the maintenance or other costs on a property), such as on our diversified REIT (ASX:CLW), or Bunnings Warehouse Trust (ASX:BWP) or the two pub trusts (ASX:ALE and ASX:HPI) or the recent additions such Redcape (ASX:RDC) - although I think that's a combination of both opco and propco risk (Ed. operating company and property company) so it’s not quite a REIT. And you have sector-specific REITs such as the Viva Energy service station REIT (ASX:VVR).

GH: Can we come back to other ways your listed and unlisted funds are different, because many retail investors would have less knowledge of the unlisted space.

DH: OK. There’s no pure-play listed office REIT available anymore, arguably no pure-play listed industrial REIT of any scale, or not of the scale and style of our unlisted funds. Our flagship unlisted direct office fund, DOF, has $2.2 billion in assets. Our unlisted industrial fund, DIF4, has about half a billion in assets with a WALE of about 10 years.

Investors should not get sucked into the idea of a liquidity premium. When you invest in anything listed, yes, you get liquidity, but with that comes volatility. If you're a student of Sharpe ratios and risk adjusted returns, you want a slightly higher return for listed than unlisted to compensate for the volatility. But there are purists that say you should accept a lower return for the liquidity. It depends whether you're a long-term investor or whether you're just trying to time the market.

GH: With all these sectors to choose from – commercial, industrial, office, retail - do you have a current favourite which you think has the best prospects? What are the trends?

DH: Our house view on a five-year outlook is that office and industrial will outperform. We think large shopping centre REITs and retail will be under more pressure. Fortunately, we don't play in the top end of shopping centres like Westfield, nor in the discretionary end of the retail market. Less than 5% of tenants in our shopping centres are now fashion and apparel.

GH: Has that been a deliberate tenancy decision by you?

DH: Absolutely. We’ve stayed away from large regional shopping malls and we prefer smaller, convenience-based retail. Our retail fund (ASX:CQR) or SCA Property (ASX:SCP) have outperformed and are trading at 10% premiums to NTA, whereas Scentre Group (ASX:SCG) and Vicinity (ASX:VCX) are at heavy discounts.

On demand for office space, a reason we have not seen a contraction is that both employers and their people don’t want to work from home. I took my entire board to the US to see Amazon and Google. Despite all its technology and new ways of working, Google does not encourage people to work from home.

GH: Why is that? What about the inefficiency of long commuting times?

DH: They think it's far more productive to have people working in a collegiate team environment than having them on Skype or video-conferencing from home. The reality is we just have not seen the reduction in workspace ratios due to working from home.

GH: In the wholesale business, are you seeing the large super funds move to internal asset management, such as AustralianSuper recently withdrawing billions from Australian equity mandates. Is that happening in property?

DH: It’s definitely happening less than in the listed equities environment. As the CIO of AustralianSuper said, a lot of Australian equities managers have hugged the index and there hasn't been enough differentiation. It’s more difficult in property. I’ve got 550 people on the payroll, it's difficult to replicate that, including the intensity of development activity.

GH: You’re not just buying CBA or Woolies shares.

DH: Exactly. I've been through lots of cycles over 30 years and I haven't seen too many insourced direct property models work very well. It’s different for listed equities managers.

Another difference is that all of our funds with performance fees are absolute IRR performance fees (Ed. fee calculated on the positive returns). There's none of this rubbish that if I’m a better loser than everyone else, I still get performance fees. I absolutely do not agree with that. There's got to be an absolute hurdle for positive returns.

GH: Many property funds went into the GFC with high levels of debt and crashed. Have the lessons been learned permanently, or will the excesses come back in the next cycle?

DH: Yes, it’s a permanent change. Look at the average gearing across listed REITs at about 27% or in the $100 billion unlisted wholesale sector, average gearing about 16%. Interest cover ratios - because of the low cost of debt – are up to four times higher than in 2007. There are still some syndicates gearing at 60% and that's a warning. Gearing is fantastic when asset values go up, but not so good when they go down. Risk is also amplified if the underlying assets are not backed by long-term, blue chip tenants with solid cash flows.

GH: If you had to identify one favourite sector, what would it be?

DH: I don't have favourites. I'm a big believer in diversification. But with the growth of ecommerce, unlisted industrial logistics funds will perform well over the next decade or two. The opportunities in distribution centres near large population centres catering for ecommerce are very promising.

 

Graham Hand is Managing Editor of Cuffelinks. Charter Hall is a sponsor of Cuffelinks. This article is general information and does not consider the specific investment objectives, financial situation or individual needs of any particular person.

For more articles and papers from Charter Hall, please click here.

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