CONTRIBUTED ARTICLE by Chris Bedingfield*. In five years of running a boutique global property fund, we’ve learnt a few important lessons.
A key one is not to accept “common knowledge”. I can’t count the number of times we’ve been told that it’s “common knowledge” that real estate will perform badly when interest rates rise.
We chose to reach our own conclusions: while real estate may be sensitive to interest rates in the short term, the correlation is rarely static. The relationship was predominantly positive between 2004 and 2014 – global real estate prices rose as bond yields were increasing – but over the longer term the correlation between interest rates and unhedged global real estate is zero.
Essentially, for long term real estate investors, rising interest rates are the least of your concerns. In fact, rising interest rates are usually a sign of a pretty good economy.
For us, the important macroeconomic headwinds for real estate returns are excess supply and the general economy.
Another lesson is that conservatism can be risky. As investors focused on capital preservation, we allow a margin of error when modelling the underlying cashflows of prospective or existing investments.
But being conservative has its own risks – it can also lead to missed opportunities. Link REIT was a big lesson for us – we believed its asset enhancement program wouldn’t last beyond the disclosed pipeline, and conservatively assumed it would last two or three years and then normalise. We liquidated our position and, while we made a profit, we missed out on significant upside.
The lesson learnt was that it’s okay to be conservative, but we need to be wary not to leave returns on the table.
A third lesson was to reconsider the usual approaches to hedging. When researching our strategy we found that almost all global real estate strategies were currency hedged, while hardly any global equities strategies were.
Our analysis found that for an Australian dollar fund, an unhedged strategy was a lower risk proposition for investors. There are several reasons for this, not least that in periods of market stress, the AUD generally depreciates (while USD and Yen appreciate), offsetting near term losses with our individual securities. In addition, while interest rate movements have no long term impact on real estate performance, they can impact in the short term. They can also impact currencies in the short term, but in the opposite direction – again providing a buffer for AUD returns. And finally, hedging can precipitate liquidity issues, especially during times of economic and market stress. Remaining unhedged means we can be patient during such times, and not forced to sell positions at distressed prices to meet a margin call.
This article was originally published in The Sydney Morning Herald.