TCorp is looking to invest more in global property to increase diversification and more in direct assets to capture an illiquidity premium, Brett Dillon, Head of Property, says in an interview with Florence Chong
TCorp’s $9-billion property portfolio has served its clients well over the years. Along with infrastructure, TCorp’s 10-year annual average return for unlisted property has been 9.2 per cent.
In no small measure due to its choice of assets, the investment manager for the NSW government and its agencies has maintained strong returns throughout the COVID pandemic, while market volatility sent shockwaves through the listed market.
In recent years, TCorp has tilted its unlisted property portfolios towards logistics, both in Australia and overseas, and to multifamily assets (known as build-to-rent in Australia) in the United States. Logistics has boomed because of exponential growth in online retailing, while increasing pressure on housing affordability has heightened demand for rental accommodation.
As part of its broader responsibilities, TCorp manages the property portfolio for the NSW Government ‘family’, including NSW Treasury, the state government insurance scheme, iCare, and the government’s defined benefit pension system for NSW public servants, SAS Trustee Corporation (STC).
Since a merger of the investment management and governance activities of these agencies to bring all investments under TCorp seven years ago, the state investor has lifted its allocation to real assets. Together, these now represent more than 15 per cent of TCorp’s $107 billion under management.
Investors globally have enjoyed double-digit returns for a few years now, and, in the year ahead, we would expect to see valuation metrics softening
But Brett Dillon, Head of Property at TCorp, sees short-term market turbulence ahead. Although both real estate and infrastructure have helped TCorp diversify equity risk to stabilise returns in periods of volatility, market conditions are changing as higher interest rates and inflation begin to bite.
Dillon says the property sector is entering a period of ‘price discovery’.
“The year ahead is likely to see returns from our property portfolios normalise,” he says. “Investors globally have enjoyed double-digit returns for a few years now, and, in the year ahead, we would expect to see valuation metrics softening.
“Transaction volumes have declined globally as investors, including us, monitor markets during this period of price discovery. We’re applying a disciplined approach to investment and, are preparing for selective investment opportunities ahead of the dust settling. One thing is certain: investors can’t rely on seeing cap-rate compression drive performance like in the past 10 years.”
Dillon thinks a softening in cap rate and discount rates is ‘inevitable’, but says it is difficult to predict the magnitude of the cycle given ‘we’re yet to see distressed sales’. Valuation weakness is expected to be tempered in sectors like logistics – where rent growth is strong and likely to continue as supply plays catch-up.
Dillon expects some distress in certain markets, and says this will lead to a shift in valuation metrics – which in turn will bring opportunities.
“We are confident that Australia’s prime property markets will be more resilient than many global markets in the short term. High institutional ownership in Australia and low levels of gearing should result in less stress than global markets,” he says.
“But in global markets with deep liquidity gearing is generally higher, so we do expect higher volatility – and with that comes opportunity. The year ahead should bring attractive deployment opportunities.”
While TCorp is broadly ‘at weight’ on property, Dillon says: “There is currently residual capacity for global investment, and we would anticipate that the year ahead is likely to see increased appetite as we continue to diversify into global exposures.”
Explaining the shift in focus to offshore markets, he says: “From a total portfolio perspective, our portfolio construction team is building resilience by diversifying away from Australia. That is driving allocations to our global property strategy.”
From a total portfolio perspective, our portfolio construction team is building resilience by diversifying away from Australia. That is driving allocations to our global property strategy
Currently, TCorp’s offshore portfolio stands at around $2.9 billion, including its recent purchase of a 50 per cent interest in a prime office tower in London and an ongoing programmatic investment in a build-to-core logistics strategy in the United States.
Dillon, who joined TCorp from Eureka-AXA IM Alts, where he was the Australian Head of Funds Management, told [i3] Insights: “Capital is allocated to property via two access points. The domestic point is TCorp Unlisted Property Fund (TUPF), and the international access point is Global Property Exposure (GPE).”
When considering illiquid allocations, he says TCorp’s portfolio construction team looks to real assets to access the illiquidity risk premium, inflation hedging characteristics and diversification through idiosyncratic risk, as well as sustainability characteristics. Exposure to global real estate enhances diversification.
On that basis, he says, there is currently ‘not a lot of appetite’ for increasing domestic exposure.
More than two-thirds of TCorp’s $9-billion portfolio is invested in Australia, some of it inherited from the three government agencies (TCorp, iCare and STC) when they merged.
Dillon on Logisitics and Multifamily
For TCorp, logistics has been the preferred investment property in Australia and overseas, with multifamily preferred in the US. Multifamily is invested through three global funds, which gives TCorp exposure to the US, Europe and Asia. The US fund has a high weighting to multifamily, which has underpinned recent strong performance.
Logistics and multifamily account for roughly 65 per cent of TCorp’s global portfolio. Domestically, logistics represents almost 40 per cent.
In 2020, TCorp and LOGOS, a pan-Asian logistics property group, bought two distribution centres in Sydney and Brisbane from Sigma Healthcare for about $170 million. This mandate was a precursor to TCorp’s entry into the booming logistics sector.
Dillon had just joined TCorp, in December 2020, when he became involved in the acquisition of Sydney’s Moorebank Logistics Park (MLP) from Qube Holdings in a LOGOS-led consortium that includes AustralianSuper, Ivanhoe Cambridge (the property arm of the Canadian institutional investor, Caisse de depot et placement du Quebec (CPDQ) and AXA IM Alts.
TCorp took a stake just shy of 20 per cent in MLP, which was acquired in July 2021 for $1.67 billion. “Moorebank Logistics Park was the last domestic transaction we did with the available capital we had at the time,” Dillon says. “And it was the first major direct investment as TCorp began a strategy to improve the liquidity of its property exposures.”
While TCorp participates in a ‘club’ arrangement to own the Moorebank asset, Dillon says he went to ‘great lengths’ to negotiate in a governance structure that gave TCorp the liquidity characteristics of a direct investment.
“By direct investment, we’re targeting exposures where we have control over the major investment decisions,” he told [i3] Insights.
Similarly, TCorp has joined a club of sovereign wealth funds to back the US$2-billion LPC Logistics Venture One in the United States, managed by the Chicago-based Logistics Property Company. The deal was finalised late last year.
In February this year, TCorp acquired an Amazon robotics sortable facility, developed by Mountpark Logistics, in Yorkshire in the UK in a £233-million deal, co-ordinated locally by Arrow Capital Partners on TCorp’s behalf.
Globally, Dillon enthuses, the performance of the logistics sector has been ‘quite exceptional’. He notes that in the markets where TCorp has invested, vacancy rates for logistics space are below one per cent.
Equally, multifamily has been a strong performer. TCorp has recently targetted recapitalisation opportunities in the US, but Dillon believes more opportunities lie ahead.
Multifamily and logistics give him comfort. “Despite softening in valuation metrics, underlying rent growth is expected to provide support to valuations in these two sectors,” he says.
We will be looking to rebalance our domestic portfolio. That means we will focus on high conviction fund exposures and reallocate capital from other funds to direct investment
TCorp is ‘very selective’ when it comes to office, and currently does not own any office assets directly in Australia (outside of the State Super portfolio). It has, however, made its single-largest direct investment in the Deutsche Bank Building in London’s Moorgate.
Dillon says: “We were fortunate in many respects in terms of pricing, where extended negotiations during a period of volatile debt markets facilitated significant, favourable adjustments.” TCorp holds a 50 per cent share in the asset, which transacted at a price of $807.5 million.
Dillon is laser-focussed on quality, amenities, wellness and ESG credentials when it comes to selecting office for investment. “These are assets that we’re confident will perform better, in a relative sense, through market cycles,” he says.
TCorp has limited exposure to retail in its domestic and global access points, although its State Super portfolio includes four assets, including the Melbourne-located Westfield Knox Centre, jointly-owned with SCentre Group.
“The smaller convenience-based assets have performed reasonably well,” says Dillon. “We are working with our manager and co-investor on repositioning Westfield Knox, with the objective of recapturing market share lost to competing centres that were redeveloped over the last 5 or 6 years.”
The regional centre in Melbourne’s east is undergoing a $380 million facelift, featuring new community-focussed uses, such as a 2,000 sqm library, co-working, a swim school with a 25m pool and a basketball court.
Over the medium term, Dillon says, TCorp will seek to improve the liquidity of its TUPF portfolio by rebalancing its exposures where around 70 per cent of the capital is currently invested in wholesale funds.
“We’re looking for more control over our exposures domestically,” Dillon says. “One of our key strategies for both domestic and global property is to increase our weighing to direct investment.
“We will be looking to rebalance our domestic portfolio. That means we will focus on high conviction fund exposures and reallocate capital from other funds to direct investment.”
Dillon is sector-agnostic, but the broad strategy is to invest in core, core-plus and build-to-core exposures.
“Future investment in Australia will be direct and will be based on where we see relative value and how each asset fits into the fund’s overall portfolio context,” he says.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.