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House view: Build a moat, or an experiential retail mall


MP Funds Management Head Mandi Prager shares her views on property markets, where to find value, and managing risk in the current investment environment. 

One of my long-time mentors owns a few commercial towers in Martin Place. Exceptionally conservative and a Warren Buffet disciple, his motto is “don’t risk what you have to get what you don’t have.” We meet every couple of months to talk through our respective views on the market, where to get the value and how to protect against downside risk. Invariably, he tells me to cool my jets.

During a recent visit I asked him about a “vanilla” regional shopping centre JV we were considering. He pointed out that historically every seven years there is some sort of crash or dip. We are now sitting at nine years since the GFC, so if history is anything to go by we are overdue. Quoting Buffet again, he said, “Always seek to improve the quality of the assets you acquire and seek to build that moat of quality around those assets because if the proverbial hits the fan, the secondary assets will be the first to go.”

A few years ago I took one of my more bullish investors to sit with this mentor to gain a more considered conservative view. This was a duty of care exercise before we embarked on investing this investor’s capital in a fairly aggressive mandate.

Needless to say, it was an interesting meeting as I sat with two outstandingly astute and successful investors of a similar generation but with very different views. While my mentor is second-generation wealth with a view to preservation, my investor is first generation, self made and highly entrepreneurial (yet also values preservation). After the meeting the investor said to me “Mandi I am here to aggressively grow what I have for my family. I can’t afford to wait for another cycle.”

And so we began. Since 2014, the portfolio we created for this investor – a combination of debt and equity, across multi-unit residential development construction funding, land subdivisions, equity in office towers and mixed retail as well as some pre-IPO investment – has returned an average IRR of 21% with each asset outperforming the target.

The point of this long-winded anecdote is that both my mentor and the investor have valid points. Regardless of the cycle, there is opportunity.

Building on great results

The last quarter of 2016 saw seven of our investments repay with an average blended net IRR of 19% across the portfolio. In terms of redemptions, in the first quarter of this year MP Funds Management has seen redemptions from four investments which included mezzanine financing for multi-unit residential apartment projects in Sydney’s growth corridors; co-investment in a North Sydney office tower acquired in October 2014 for $36 million and sold and settled in April this year for $70m producing an investor internal rate of return of c. 40%; and co-investment in a Brisbane CBD mixed use development which produced an investor internal rate of return of c.20%.

These investments originated in 2014 and 2015. The market has changed significantly since then, specifically with respect to availability of debt and increasing competition in the market for high quality assets. 

We continue to be on the look out for equity or debt opportunities across all property sectors, which gives us a high level of agility.

Investing in debt

Debt in the form of consumer mortgages as well as construction debt to build blocks of apartments is increasingly hard to find. It doesn't matter who you are, or what credentials you have. If the banks haven't shut shop entirely, they are harder to deal with and in most instances will offer a significantly reduced LVR. 

And it’s not just residential construction funding, even commercial or retail development assets with a significant pre-commitment are hard to fund with major banks now chasing those more mature annuity investment-type income assets, instead of any development risk exposure.

In speaking with global heads of institutional banks, the overwhelming message is that the banks [governed by APRA] are getting more and more selective and bank funding guidelines and restrictions are changing weekly.

Because of this, developers are relying on non-bank construction and senior debt. But with interest rates at 10-15% per annum development profit quickly disappears. Just recently we have started seeing a trickle of high-quality, well-priced, and well-located development sites come across our desk for sale, off market. It seems the cost of capital or construction debt is behind the emergence of these opportunities.

Changing face of property, consumer behaviors and new hot spots  

Retail is a perfect example of a model in transition. We are still looking at co-investing in retail assets in core CBD locations, but with a view to that retail asset as having some sort of attraction base and revenue model that isn’t reliant on traditional retail. The entry of Amazon in our market may be like the millennium bug and be nothing or it may disrupt Australian retailing entirely, rendering our valuable retail turnover shopping center tenants obsolete. It’s yet to be seen, and something to watch very closely.

Office space in Sydney has run through the roof. Rents have doubled in the Sydney CBD over the last few years and yields have compressed considerably with office towers being taken off the market due to the metro rail link as well as residential conversions. It remains to be seen just how popular the Sydney CBD is going to get with the closing of George Street, the metro rail line, and the world-class residential developments and retail precinct planned along Circular Quay by Land-Dream, AMP and Dalian Wanda. These projects promise to transform the precinct and create a further rise in values in the area.  

Anything in the residential apartment construction funding or development space in the CBD or eastern suburbs of Sydney will continue to be looked at as an opportunity. 

Pricing of risk

The investment market is increasingly competitive due to low global bond and interest rates. The hunt for return is becoming very aggressive and as a result, risk is becoming cheaper.

A good example of this in play was a recent deal we attempted to close. Earlier this year, we were about to issue a terms sheet for a mezzanine loan to two very impressive young developers on a small project of about 20 apartments in the Shire with circa 35% profit margin. The project was DA approved and there were almost but not quite sufficient presales to cover the bank debt. Our facility was to be a secured mezzanine facility at an interest rate of 20% + per annum. 

After we had verbally agreed terms on the project, one of the developers called with an apology because they had found a high net worth investor happy to fund the whole mezzanine position at an interest rate of 12%.

Some residential apartment developers are offering preferred equity products which they are syndicating to external investors, with target investor IRRs of 14%. In my view this is not pricing the risk in. We wouldn't fund any of the above at these sub 20% rates suggested.

Our long-term view hasn't changed 

Well-priced, well-located high quality residential projects continue to sell, with projects like AMP’s Loftus Lane selling out within two hours of launch. Secondary stock has come down in price and some Chinese groups are sitting on their hands with respect to government restrictions on capital outflows. Whether this is real or just a show of being conciliatory remains to be seen. 

Our focus for the medium to long term is on well-located residential land subdivisions from a development or development financing perspective; themed income producing assets like retirement development assets; and well-located core plus assets where there is income and opportunity to improve and strengthen the moat.

Important Information

This MP Report is for general information purposes only.  It is not and should not be construed as or relied on as, advice (including financial or investment advice).  The information in this MP Report has been prepared without taking into account your objectives, financial situation, risk appetite or needs.  Therefore, before acting on this MP Report, consider its appropriateness for your personal circumstances, verify information provided and seek appropriate professional advice.  While MP Funds Management has made enquiries into the subject matter of this MP Report, except where the subject matter relates to MP Funds Management itself, MP Funds Management relies on information provided by third parties that may not have been verified and hence further enquiry is required.

This MP Report is not a recommendation to buy, sell or hold securities or financial products in any company or to buy, hold or sell any other assets or investments.

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