In property-speak, Australia’s real estate clock is inching towards midnight, nearing, or perhaps already at the peak of the current cycle.
Which is why property investors are hedging their bets, battening down for the eventual downturn.
Padraig (Paddy) Brown, Head of Real Estate, Pacific at Mercer is among those exercising caution.
“Property is unlikely to continue to deliver the strong capital growth of the past five years,” he says. “It has done extremely well post-global financial crisis.”
Brown oversees Mercer’s $2.2 billion Australian property fund, one of a number of building blocks that together provide exposure to real assets, fixed income and equities.
Together with infrastructure, valued at $1.5 billion, real assets account for about nine per cent of the $40 billion that Mercer manages (including the $25 billion Mercer Super Trust) on behalf of Australian and New Zealand clients, ranging from super funds to university endowments and insurance companies.
We generally buy in cities where the population is growing and densifying. With these demographic tailwinds, we see values being driven up over time as well-located land becomes increasingly scarce
Rather than capital appreciation, says Brown, the focus has shifted to assets capable of producing long-term, sustainable income growth.
“We choose assets that have the ability to grow income at a rate higher than inflation over time. We generally buy in cities where the population is growing and densifying. With these demographic tailwinds, we see values being driven up over time as well-located land becomes increasingly scarce.”
His three markers: Location, densification and gentrification.
A property portfolio acquired on these fundamentals will continue to grow and deliver income irrespective of the economic cycle, says Brown.
“We are very focussed on core to core-plus real estate investment, including ‘build to core’. We invest in large liquid markets and select assets which are resilient through economic cycles.”
Even the now much-maligned retail sector will throw up centres that can be productive and provide a positive addition to a portfolio, he says.
Mercer owns a $550 million portfolio of three sub-regional and neighbourhood shopping centres, in Sydney and on the NSW Central Coast, some 100 km north of Sydney, which are thriving.
Another large national retailer is about to take up space in Bateau Bay Square, a sub-regional shopping centre located on the Central Coast and which already houses Coles, Woolworths, K-Mart, the German supermarket chain ALDI, five banks and a building society.
The 80 plus retailers who trade from Bateau Bay Square are chalking up sales growth, bucking the national shopping centre retail trend, Brown says.
With its fund manager, Charter Hall, the Mercer property fund bought Bateau Bay Square from Stockland for $164 million in 2012.
The attraction was the prospect of gentrification of Bateau Bay, with the Central Coast being an increasingly popular destination for families priced out of Sydney while seeking a coastal lifestyle.
In Maroubra, a beachside suburb in Sydney’s eastern suburbs, business is also brisk at the local shopping centre, Pacific Square.
“In the past 12 months, we have seen sales growth of 12 per cent there, one of the highest rates in the country,” says Brown.
Pacific Square was acquired from private investors for $137 million in 2015. It has an immediate catchment area from 600 apartments occupying the airspace above it.
There are only a handful of shopping centres which tick our boxes. They would be located in middle rings of cities, where there is population growth, and would have the potential to be repositioned.
The trading pattern in Bateau Bay and Pacific Square is testimony to the importance of location and catchment area. These underscore what Brown sees as two defining factors in the success of the centres – gentrification and population densification.
“To be located in the right place serving the right demographics can make or break a retail centre,” says Brown.
“Pacific Square and Bateau Bay are among the top 10 performing shopping centres nationally in their categories.”
Mercer and its co-owner, Charter Hall, have invested over $35 million over the years to upgrade and freshen the centres to keep them relevant to their shoppers.
And yes, Brown is prepared to look at buying more retail assets.
“There are only a handful of shopping centres which tick our boxes,” he says.
“They would be located in middle rings of cities, where there is population growth, and would have the potential to be repositioned. If they are available at the right price we will look at them.”
Brown’s acquisition decisions are strongly research-backed. He looks for new trends uncovered in research by Mercer’s internal team and the teams employed by his specialist investment partners: Investa, Charter Hall, Dexus and Goodman.
He credits research produced by Investa for Mercer’s significant investment into 420 George Street, in Sydney’s central business district.
That research pointed to a strong recovery of the Sydney office market, saying that the withdrawal of office buildings to make way for Sydney Metro stations would create a shortage of space, recalls Brown.
Mercer partnered with the wholesale Investa Commercial Property Fund (ICPF) to directly acquire 25 per cent of the prime 420 George Street office building for $150 million in 2016.
And it has had a double bite of the building. As well as co-investing with Investa to have a direct holding, Mercer is the single largest unitholder in the $5.6 billion ICPF entity, which owns 15 prime grade office buildings, primarily in Sydney and Melbourne.
“When we bought 420 George Street, the government was demolishing buildings for metro stations,” says Brown.
“We could see withdrawal of a huge stock of property from the Sydney market at a time when there was strong demand growth and vacancy was shrinking. We thought the stock withdrawal story was real.”
Brown committed his fund to its biggest outlay on a single investment, a call that was soon vindicated. Sydney experienced the world’s strongest office rental growth in both 2017 and 2018.
“We traditionally invest in real estate mostly through commingled funds and target co-investment where we see high risk reward trade-offs,” he says.
When we bought 420 George Street, the government was demolishing buildings for metro stations. We could see withdrawal of a huge stock of property from the Sydney market at a time when there was strong demand growth and vacancy was shrinking.
Brown is also invested heavily in logistics, again based on research that has pointed to exponential growth in online shopping and demand for warehouse facilities.
Mercer is invested in core logistics funds managed by Goodman Group, the second-largest listed global logistics property group, Dexus and Charter Hall.
Today, logistics makes up around 22 per cent of the Mercer property portfolio, positioning the investor to ride with ongoing growth in the sector.
Unlike many industry super funds, Mercer also invests allocations from clients who want to invest in a specific asset class, for instance property and infrastructure.
“We have deployed more than $1 billion in the last five years into Australian real estate,” Brown says. Over that time Mercer has also sold assets worth $300 million – often at premiums to valuation, in order to rotate the capital into other assets with higher forecast returns.
As the steward of capital invested with his fund, Brown says investment has to align with both the firm’s and the clients’ philosophy of responsible investing.
The bulk of the Mercer portfolio, he says, are scored highly by the domestic agency NABERS, which ranks assets on the environmental performance of buildings, and from the global GRESB, which sets benchmarks on the sustainability performance of real assets.
“We are focused on governance and are represented on investor committees to have regular dialogue with management and boards in the groups which are managing our money,” Brown says.
While Mercer’s real estate investment is mainly in Australia, and to a lesser extent in New Zealand, Brown says more than 80 per cent of Mercer’s infrastructure investment is overseas.
He does not see investing in real estate outside Australia or New Zealand as an option in the near future. “Real Estate is a local game and domestic investors generally get the best deals,” he says.
“We are a global firm, however, and are constantly monitoring real estate trends around the world. We will wait until we see strong relative value offshore before making an allocation.”
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