By Victor Yeung
When Australia’s Property Funds Association held its annual meeting in April, the conference title was “New Horizon: Exploring property opportunities”. As traditional real estate classes have rallied in the last several years, some institutional investors and their real estate asset managers are now looking to invest in other real estate classes, such as student housing, multifamily, and healthcare. These alternative asset classes provide additional yield, but more importantly, they have the ability to become institutionalised over the next investment cycle.
Decades ago, commercial properties included two main sectors, office and retail. These property types had a relative stable cash inflow that is often tied to other major companies. For example, an office lease to a major bank is effectively a “bond” with the said bank. And since real estate sees its income grow over time, often correlated to local inflation levels, institutional investors have been willing to invest in the sector to gain exposure to high-quality lease income that is said to be an inflation hedge. Capital appreciation, through buying and hold over a long period or through value-added strategies, became an investment goal after institutional capital entered the sector.
Nonetheless, once institutional investors began investing in some forms of commercial assets, it does not take long for other asset classes to become institutionalised. The most famous example has been logistics assets. As they automated their operation, the logistics operator found that their robots need very specific assets to operate well. For instance, badly placed columns would block robots in a way that would not affect human operators. In addition, once a logistics operator settles in a logistics hub, it would be costly to move as the company would need to reroute its entire operation.
Thus, it was to the operator’s benefit to commission logistics centers from where they could operate for decades. Some REITs and landlord operators, including the once Singapore-listed GLP Group, took advantage of this demand by offering build-to-suit projects. In the simplest sense, the REITs offer to build a logistics center to the logistics company’s specification, and in exchange, the logistics company signs a multi-decade lease before the start of the project.
For the said REIT, a project with guaranteed high-quality tenants, operating risks will be mitigated. After the project completion, the assets became like the office and retail assets, with a long, stable lease with often a major listed operator. These build-to-suit projects thus attracted institutional investors’ demand, and over time logistics assets were seen, and eventually valued, as an institutional real estate class.
For many real estate managers, this institutionalisation process is attractive because, as institutional investors allocate capital to the sector and hence investment demand grew. Sometimes, there can be some cap rate compression that is independent of the wider real estate market movements. And the cap rate compression would lead to what is often a one-time value appreciation. Thus, institutional investors and their managers are often interested in finding the next asset class to institutionalised.
In Singapore, hotel and data center REITs may see a similar trend. In 1993, the Marriott Group split itself into Host Marriott, a hotel REIT that owns the physical assets, and Marriott International, an operator that owns the brand and know how. This allows hotel assets to be traded amongst institutional and other investors that have little expertise in operating hotels. Instead, they can engage a hotel operator (such as Marriott International) to run the assets. The Singapore-listed hotel REITs came into being when multiple groups listed hotel assets. Some of these are operated by sister companies, but some also being operated by third-party operators.
Data centers, on the other hand, represent a sector institutionalised by the growth of demand. From banks to technology giants, a range of large companies need to operate their own server farms. Many will have specific requirements on the asset. For example, a bank server farm is likely to hold private and sensitive information, and thus, the data centers they lease will require special safety features. Thus, similar to logistics assets, REITs and other real estate operators, including a Singapore-listed data center REIT, are increasingly willing to engage these companies like the logistics REITs did twenty years ago.
Generating rental income is often the initial reason to invest in REITs or rental commercial real estate. However, as the sector diversifies and alternate forms of asset classes become more mainstream, investors are well advised to look at more than just office and retail in their asset allocation.