The property sector where it pays to focus on the basics

 

For all the enthusiasm surrounding investment in social infrastructure, it is the property fundamentals such as interest rates and strength of tenancy that drive much of the value.

Rob de Vos, the managing director of the $1.3 billion Arena REIT — one of Australia’s best-performing listed social infrastructure funds — is conscious of the challenges facing his sector.

“In an environment of increasing interest rates, we see the likelihood of yield expansion in real estate markets, including in the social infrastructure property sector,” he commented in the A-REIT Survey 2022, released in November by global advisor, BDO.

De Vos also warned his annual shareholder meeting that Arena’s “tenant partners” — which includes the operators of more than 250 early learning centres — faced challenges including “wage pressures and staff shortages”.

The comments are a reminder that for all the enthusiasm surrounding investment in social infrastructure — after investments such as the Darlinghurst Healthcare Centre in Sydney changed hands on yields of less than 4 per cent last year — it is the property fundamentals, such as interest rates, quality of the real estate, location and strength of tenancy that drive much of the value.

“Social infrastructure has not been immune to the uncertainty facing capital markets broadly in 2022,” says Noral Wild, the Australian head of alternative investments for global real estate group JLL.

“Although sector fundamentals remain robust, transaction activity has slowed largely due to a mismatch in pricing expectations — a challenge facing many real estate sectors.”

To underline the point, RetireAustralia, the nation’s fifth-largest for-profit retirement village operator with 28 villages under management, was withdrawn from sale last year by owners Infratil and NZ Super, seemingly due to a gap between buyer and seller expectations.

Worse, some managers seem to be taking advantage of private investors’ enthusiasm for, and lack of knowledge about, social infrastructure, particularly specialist disability accommodation — a $2.5 billion sector forecast to grow to $10 billion by 2030.

Ryan Banting, the executive general manager, social infrastructure at Australian Unity, warns of property spruikers selling “badly located, poorly designed and cheaply operated [specialist disability accommodation] property” to retail mum and dad investors on the promise of unrealistic or even guaranteed returns.

He says such offers are a risk for the investors, who face capital losses; for the disabled residents, and for the future of National Disability Insurance Agency funding.

Such schemes have also caught the attention of the Australian Securities and Investments Commission. Last year, ASIC Vice-Chairman Sarah Cort told the Australian Financial Review’s Jonathan Shapiro and Max Mason that investors should be aware that such schemes are not government-sponsored, saying: “Unrealistically high returns,” he warned.

For JLL, social infrastructure is an $85 billion subset of the alternative asset real estate class. The social infrastructure sector, which focuses on “supporting quality of life and well-being”, includes shelters dedicated to the disabled, aged care, private hospitals, medical centers and child care facilities.

JLL’s Alternative Investments Outlook 2023 noted that institutional investment in social infrastructure was driven by reforms, with “increased expectations for quality of basic services and provision of adequate housing for groups in need”. It claims to have been driven by an increase in government policies in recent years: driving, supported care, disability care, and child care for the elderly.

Of course, government involvement in social infrastructure makes investors vulnerable to changes in government policy.

JLL said many investors traversing the aged care market were “putting acquisition plans on hold due to uncertainty about the impact of the new aged care financing model,” adding that “the business can lead to confusion,” he said.

Nevertheless, in times of change, social infrastructure offers real estate investment in growth sectors through long-term leases and government-subsidized rental use, as opposed to traditional real estate investments such as office towers and shopping malls. increase.

“Investors continue to be drawn to attractive demographic tailwinds across the social infrastructure sector, along with the goal of achieving the ‘S’ of ESG,” said JLL’s Wilde.

Beyond these basics, an additional attraction is providing social benefits. As Charter Hall Social Infrastructure REIT puts it, “We believe real estate needs to meet the ever-changing needs of society.”

The sector is generally doing well. Arena leads the rankings in the 2022 BDO A-REIT Survey, with rival $1.2 billion Charter Hall Social Infrastructure REIT ranking ninth out of 47 real estate investment trusts evaluated by BDO.

The unlisted suite of Australian Unity Unlisted Social Infrastructure Fund is a similar story.

In a tough 2022 fiscal year, his $1.2 billion Unity Healthcare Property Trust in Australia posted 12% of his total return. The Australian Unity Specialist Disability Accommodations Fund, with a US$226 million pipeline commitment, generated a total return of 5%. The Australian Unity Child Care Fund had $81 million in funding or commitments, with a total return of 4%. Also, the $35 million Australian Unity Retirement Village Property Fund delivered a 14% gross return to investors.

The US, which has long-standing healthcare REIT listings, presents a balanced view. In the 2022 calendar, the FTSE NAREIT All Equity Index’s 15 healthcare REITs hit hard alongside his legacy REIT, recording a negative total return of 22.8%.

So what are the important factors for investors?

Wild says that the quality of social infrastructure real estate is more important to operators and thus lessees than it is to the traditional real estate sector.

“The ability to perform medical procedures in any medical facility is highly dependent on meeting standards for certain building and equipment features,” she says. “For childcare, amenities and fit-out style can have a significant impact on occupancy.”

Obviously, the ability to obtain often complex government licences is critical.

Wild also warns that despite the macro-demographic tailwinds, investors need to understand the local dynamics and competition.

“This is why sophisticated investors mostly choose to invest into platforms of funds which include exposure to an operator, or where there is a strong ongoing relationship with experienced operators, as opposed to making individual asset investments,” she says.

The Charter Hall Social Infrastructure REIT aims for further capital growth by acquiring modern assets with limited competition and low substitution risk, in strategic locations with high underlying land values and with triple net lease structures.

(Under a triple net lease structure, the tenant pays for most costs, so capital expenditure on the portfolio is minimised.)

Australian Unity’s Banting, whose Specialist Disability Accommodation Fund is the largest such housing fund in the country, warns that specialist disability accommodation is an institutional asset class and that the direct ownership of individual SDA properties is “risky and not advisable”.

“Australia Unity has engaged asset class experts to help the fund navigate the nuanced schemes that optimize outcomes, opportunities and manage risk,” he says.

Like all real estate investors, Banting is looking to increase rents and to generate revenue from additional services such as speech-language pathology, nutrition programs and additional out-of-hours care on properties such as childcare pointing out opportunities.

Originally published at https://businessdor.com on January 24, 2023.