How to set a property portfolio for a defensive position

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Heitman, the US-based private real estate equity and debt investor, has recently financed the purchase of an office building in Brisbane’s up-and-coming Fortitude Valley. It is now in deep analysis over another property in a similar area. The big property-orientated manager likes Australia for several reasons.

Australia stayed afloat during the global financial crisis, Mary Ludgin, a Chicago-based managing director and global head of research at Heitman said last week on a trip to Australia with local managing director, Beau Titchkosky.

“Australians understand property better than most,” Ludgin says. “The conversations we are having are about the stage in the cycle, especially for US property, and how we adapt our portfolios accordingly. We anticipate a downturn in the US within a 2-3 year period, but of course we don’t know exactly when.”

Heitman, which has a rapidly growing local foot print is looking to set up portfolios to be more defensive, using the “specialty sectors” which trade at slightly higher yields and are more “de-linked” to the economic cycle. Heitman was one of the early adapters across these sectors, which can diversify returns and add defensive characteristics to client portfolios.

An example is student housing. The firm already has one student housing property in Melbourne, in a joint venture with an operator. Ludgin says that student enrolments actually tend to accelerate during economic downturns, which was the case in the US after the tech wreck of 2000-2001and also in 2009.

Student housing has the added advantage of including other services for students, providing more than just a place to live, which is why having a joint-venture partner is good.

Similarly, self-storage tends to have a different cycle, with demand usually being triggered by life events, such as one of the ‘Ds’ – death, divorce or deployment (as with the military). “We like the non-cyclical aspect of the demand there,” Ludgin says.

A relatively new sector is medical office buildings alongside hospitals and other medical facilities. The hospital owners – often governments – tended to build these in the 1970s and 1980s but then by the 1990s realized that they didn’t need to own them and started to sell them to specialist property investors, such as Heitman.

Leases for medical office building tend to be long which allows the manager to underwrite a lower level of risk for the landlord. “It’s a good place to put your capital,” especially late in the cycle,” Ludgin says.

Aged care, about which a lot has been written, is a “terrific” sector in theory but has suffered in the past from oversupply. Because the baby-boomer demographic had been well documented and predicted, facilities tended to be built ahead of the demand. There has actually been a decline in demand since about 2015 in the US. The concentration of new supply has tended to be in the 10 major cities but “people age everywhere”. Ludgin says: “We have to be careful on behalf of clients. We like to do it through loans rather than buying the properties. You also have to be careful about the supply side to make sure everything lines up.”

Titchkosky said that across the 18 meetings they conducted with local pension funds, it was clear that investors were looking for greater diversification and new opportunities for growth outside of Australia. Because the US is later in its cycle, there is also an increased interest in Europe and the firm’s US Debt strategy at the moment.

According to Ludgin: “You need to understand a local market or you can stub your toe… Just because people speak the same language doesn’t mean that there aren’t important cultural differences.”

– G.B.

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