‘Amazing’ gap in property fund returns sparks correction fears

“We need to see evidence in the real world,” he says. “Who blinks first? Is the listed or unlisted market correct? There will be more clarity in December as we see more transactions.”

The combined value of funds managed across both sectors is approximately $107.5 billion.

Unlisted property funds were the top performers for the year to the end of June, the only positive non-cash performer returning 0.2 per cent, according to the latest Property Council of Australia performance results.

Returns in other asset classes ranged from losses of nearly 16 percent in fixed income to a negative 11.7 percent in global equities and a 6 percent drop in Australian equities, it shows.

rental growth

Rising rents and avoiding the sell-off affecting listed property funds and other asset classes have fueled growth, according to the Property Funds Association, which represents the country’s wholesale and retail unlisted property funds.

Top sectors included industrial and logistics real estate (for warehousing, goods distribution or order pick-up), which produced returns of more than 20 per cent, while retail real estate performance rebounded by almost 8 per cent following the disruptions of COVID-19.

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Rental growth in the industrial, office and retail sectors in the second quarter also boosted returns.

Dan Cave, Senior Investment Analyst at Zenith Investment Partners, adds: “Rent increases will be a strong confidence driver for the real estate markets in the coming quarter, particularly for industrial and retail.”

However, Cave warns of increasing pressure from rising debt as a result of rising interest rates and a slowdown in the number of properties being bought and sold as the cost of capital rises.

Some investment professionals claim that the outperformance of the unlisted category is due to the fact that assets have not been fully revalued to reflect the impact of recent interest rate hikes on property values.

Chris Brycki, managing director of online investment advisor Stockspot, says: “Unlisted property stocks are not yet reflecting the magnitude of rate hike expectations. As a result, anyone investing in the unlisted real estate sector could be paying more for that stock than someone investing in a listed real estate investment trust (REIT) with a similar underlying real estate portfolio.”

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The value of most property sectors, such as residential and commercial property, fell as the Reserve Bank of Australia hiked interest rates from 0.1% to 2.35% for five consecutive months.

Further increases expected

Markets anticipate further gains as the central bank seeks to ease inflationary pressures, leading to lower valuations for most property sectors in general.

“The listed REIT sector expects further rate hikes and a slowdown in the Australian economy,” says Brycki. “This has caused REIT prices on the ASX to fall because interest rates are the most important factor in property valuation,” he says.

Listed and unlisted REITs are popular investments to achieve a diversified portfolio of assets across a range of real estate investments ranging from commercial and retail to logistics.

The funds are similar in that investors contribute capital for a portion of the assets in either shares (for listed) or entities (unlisted).

Investors receive income (known as distributions) and, when the asset increases, a capital gain on their original investment from either the appreciation of the share price (for listed ones) or the sale of the asset (for unlisted ones).

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Unlisted real estate funds rely on regular valuations and are not valued daily by the market like their listed peers.

“There are two problems with this,” says Brycki. “Valuations of unlisted funds are often delayed and the interest rates used to value unlisted real estate may not reflect current market expectations.”

According to Rainmaker’s Dunnin, proponents of unlisted real estate argue that the higher yield is the reward for illiquidity.

“They would also claim that their valuations are based on sound economic reasoning and a deep understanding of the real estate market,” he says.

“While we can fight this battle over what we think are fair valuations, that doesn’t really get us anywhere because we’ll never know the true ‘price’ of an unlisted asset until someone has to sell it,” he says.

This means investors have no choice but to rely on independent external experts to provide the valuations. “Funds need to be transparent about who is doing their reviews,” says Dunnin.

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