Investment Podcast #1 – REITs and Real Assets – Transcript

James Whelan
How are you now and welcome to the ensemble investment podcast brought to you by Morningstar. My name is James Whelan, VFS Group Investment manager, and I’m here to represent you, the humble advisor doing their best to walk the line between client interests and asset class selection. Were trying to find the things that are not only appropriate, but actually do work, and maybe try and find the right time and the right weight for your clients. So get set, because myself and Morningstar are going to do our best to answer some of the questions that have come up on the ensemble platform. And obviously, all information contained here is general in nature. So here we go. In a year in which we have seen lady stand up on planes and ask us what is and is not real. And if you don’t understand that reference, and look it up, because it’s hilarious, I can assure you that was 60% chairs that my guests in front of me are in fact real, but the assets in which they speak are very much 100% real, and it is the holding of set assets that makes up such an important part of portfolios, but where to hold how much also why, or why not. Therein lies the game. This week, we’re all about REITs and real assets, and I couldn’t think of two better guests to get into it with I am joined by Jody Fitzgerald, head of institutional portfolio management and solutions at Morningstar and James Maydew you Global Head of listed real estate at Macquarie group, formerly of ANP before the sale of the global equities and fixed income business to Mac bank in 2022. Jody, James, how are you now?

Jody Fitzgerald
Good, thank you. Good. Thank you for having us.

James Whelan
Fantastic. AMP to Mac bank. That’s that’s that’s that’s quite a jump, I imagine culturally, that the shift would have been significant. Now. We won’t go into that too much on there. But let’s just start. James, I always ask the similar question of anyone that comes through what do you do and how do you make money?

James Maydew
Well, thank you for the opportunity. Yes, it’s a change, moving from a&p to to Macquarie but really happy and privileged to be at the organization. And what we do simply is invest in real estate, which is liquid. That’s how we think about the REIT asset class. And we do it on a global scale investing for clients all across Australia, New Zealand, and the rest of the world.

James Whelan
Okay, so if we break it down, what is an either please either of you jump in, what actually physically is a REIT? Just so that we’re all in the same context and the same boundaries in which in which we are considered for the purposes of this podcast? Jody, you’re jumping to this one?

Jody Fitzgerald
Yeah, sure. Okay, so a REIT or a real estate investment trust effectively what it is, is a collection of property assets in a listed vehicle. So you’ll hear the phrase a REIT, which refers to Australian rates, G rate global rates, very, very inspiring acronyms there that people have come up with, but in effect, what you are doing is getting a listed version of an unlisted assets. Those assets could consist of Office property, industrial property, retail, etc. And yeah, so that’s a reach they usually play an important role in portfolios because even though they’re listed and therefore have equity type characteristics, there’s also a yield characteristic and they do behave differently in some points of the market cycle. So, they are an important diversifier in a multi asset portfolio.

James Whelan
Well, okay to the average Australian, and let’s talk about the average Australian, which we know many of them. They some of them are my best friends, to the average Australian property means residential, to many advisors, probably minutes residential, and factories and office blocks, but it’s actually much more complex sector than it, isn’t it? So can we sort of drill down to specific, just a bit more with? What are the various types of investable property that there are James looking at you?

James Maydew
Yeah, great. So when we think about the the asset class, I like to step back, you know, why was an asset class created. And the reason for that was to give mum and dad investors in the 1960s exposure to the economic benefits of real estate, which is too large for them to invest in. And so it started with office buildings and shopping centers. But over time, particularly in the last decade or so has really evolved into other areas, health care, aged care, digital real estate, shelter, real estate, it is getting access to necessity, real estate that exists, which is perhaps disconnected from the near term economic cycle that perhaps it used to be back in the day. So it’s less about office buildings and shopping centers today. And it’s more about the necessity real estate that I just spoke about,

James Whelan
yeah, let’s go into some of those necessity real estate sides as well. And this is something I do actually want to drill into for myself too, because I’ve been, I’m just going to say data centers. And I’m just gonna let I’m just gonna let you talk on data centers because and if you want to stretch it out, but I’m gonna say that the artificial intelligence revolution has has really brought data centers to the fore, how big a REIT, a REIT gives an investor a chance to invest in property, actually, real assets and real estate, various places offices around the world with an expert in charge, in the expertise that that you’re seeing, how is artificial intelligence changing the investment shape for what we’re actually filling buildings with? Do you understand I

James Maydew
mean, I do I do, I do. So, you know, investing in anything is, it should be about what you’re trying to achieve. And if you think about the data center market, it is a building that has the infrastructure within it to connect people and industry to the internet very simply. And we’re trying to invest in the datacenter assets that are, are at the at that at that connectivity point between those, those two areas. So it’s the gateway to the internet. So it’s been relevant, it’s been around for decades. But obviously, in more recent times, with the change in how we’re doing things, we’re not in office buildings as much, where we’re not in shopping centers as much, you know, we are doing things over zoom, there’s podcasts, for example, how you listen to your, your own content demand through Spotify, or watching a movie through Netflix, that’s all being facilitated by an asset that could well be in our portfolio, which is a datacenter, located here in Sydney. But with AI, it’s, it’s changing everything. At the end of the day, companies globally, don’t yet know how important AI is going to be. They don’t yet know how they’re going to use it or how meaningful it is going to be. But there’s one thing for certain when you see Nvidia and their sales go absolutely crazy, there is going to be one key beneficiary of that, because the chips that NVIDIA are making are being put into the data centers that we’re talking about. So, again, when we think about the asset class, think about how can you get exposure to how your life is changing and evolving. And if you’ve been on a zoom call, if you’ve been downloading a Netflix movie, you’re helping and contributing to the demand. That is the datacenter market.

Jody Fitzgerald
And I think also the evolution of any asset isn’t specific to real estate. So leading on from that effectively, if you think about just from an global equity perspective, if you think of what a standard tech stock was, during the tech bubble, it was you know, someone in a garage somewhere with no cash flow. Today, it’s a very different cash flow, you know, cash cow huge amounts of you know, they’re very different. So all assets evolve over time in terms of their characteristics. So what’s super important is understanding the evolution of those characteristics. And what do you need to understand to determine whether or not an asset is worth investing in

James Whelan
the reason why I brought that up isn’t to talk specifically about AI, although it fascinates me and the companies within in the office and the necessity for the pipes and plumbing that is that the reason I brought that up is so that it could evidence that you’re on top of and and the idea of going into a race is so that you can invest in those real assets with an expert who is actually deciding the shape of what it is that’s investing underneath it. That’s the advantage of it.

Jody Fitzgerald
Yeah, absolutely. And being able to actually take advantage of understanding the old assets, I guess, in terms of that used to be quite popular and how they’re evolved. And you know, office is probably the case in point in that most of us work from home. have a couple of days a week, and so forth. And you know, there’s been, you know, very well broadcast businesses that are struggling to get people back in the office in the US, it’s extraordinarily hard to get people back into the office. So that has a significant impact on, you know, the role that office might play from a real estate or what you might be expecting from a return profile for that investment. But then also, what those office buildings need to do to attract people back. So the idea that they’re actually having to Greenify the offices and evolve these spaces to make it more appealing for people to come back in. So understanding that and the impact from a return perspective is important. James, maybe you can dovetail into that

James Whelan
you’re just going to sit back and drink more coffee.

James Maydew
Yeah, that’s a great segue. So we’re concerned about office buildings, like like many are because office is an asset class that is cyclical in nature. And it’s predicated on essentially white collar employment. And if that is not growing, then you’re therefore not going to see the necessary growth within your rents, and in your valuation to justify the risk that you’re taking. That’s a comment you can make at any point in a real estate cycle. And we’re at a point now, where rates have risen dramatically, we are seeing asset values in office starting to come under pressure. But you also have this line in the sand with technology has really changed the way we do things. So it’s no longer just the cyclical discussion. It’s the structural element. And I can guarantee every CFO globally, is having a conversation around how they can save costs. Yeah, the economic environment we’re in is more challenging than it’s been in a decade. And therefore, you need to look to where you can save costs, the fact that most buildings are, at best 50 60% fall on a Monday and a Friday suggests to us that CFOs and CEOs and and anybody who has any influence over the cost line is looking at where they can pulling their costs. Now, that’s the office markets. And I do think that when people talk about commercial real estate, they kind of start there. And they think about Office, because it’s the most visual, you know, you see the start of a movie or you see, you know, star of a television program, you’ll typically see a cityscape, which is going to be office buildings, the reality is in the real estate market office accounts for a very small portion of what we’re doing, and how we’re thinking about the opportunity. So it’s about, you know, investing in real estate sectors that are growing with the evolving economy. So think about that delivery that you received last week from Amazon, or from Woolworths, or Australia Post that’s come through a industrial facility that has been built for the purpose of servicing you as the customer. That’s a large part of what we’re doing on our portfolio, as is the rental property that someone is living in. And simply they perhaps can’t afford a mortgage right now, we don’t have enough savings to be able to put down a deposit, that real estate for residential is a necessity form. And investing for us in that area is somewhat defensive. So we run the full spectrum of real estate. And to be clear, you know, the office component of that is a very small part of it.

James Whelan
Yeah, that’s where do we actually see the work from home trend settling? And this is a nice conversation to have. And we’ve had many conversations actually, just as well, before we came into the podcast, we’re talking about the various areas where we live, how often we come into work annoyances that we have with various people that we work with, were just part of the fun and the enjoyment and we did miss it, I missed. I missed the people that I didn’t like working with during COVID. I want to get back to so that I can remember what it was like to not to not be with you anymore. But where do we sort of see that? Sadly,

Jody Fitzgerald
look, I think that’s a tough question to answer. I think the one the one positive to come out of COVID, if I could say it in there are as follows was the so while for a long time, the technology has been there for people to work from home, it really didn’t get any sort of traction effectively. So I think the one positive is that now because we were forced to work from home, businesses have recognized actually people can be productive from home. And if they’re not productive from home, that’s a staffing issue as opposed to a productivity issue with regards to technology and so forth. So I think the one of the real advantages is and as I say this is a woman right? So because the it’s usually been historically women who had part time roles because of you know, childcare and so forth. It now makes it really feasible for people to actually interact with the workforce more. But doing it from home and I think that’s a real positive. I would be surprised if we ever go back to Philly five days a week in the office, because I think some of that flexibility is also what’s attractive to staff, particularly younger self coming through who have, you know, a little bit of a different view of what the work life should actually be. But yeah, sort of in general, I find At the heart sort of reversing, I do think it is important to get into the office though our CEO made a statement, which I thought was actually brilliantly defined, which was, innovation doesn’t happen over zoom. So while while you can certainly be productive from home, and you can do a lot of things, if you want to actually innovate, face to face is so much better. And I think the other element, as a manager that’s really important is we sometimes forget the younger grades, and the younger people coming through how much they learned through osmosis. So if they’re not sitting in the same environment, as us and being able to absorb the conversations, and so forth, it really slows down their learning. So I think as managers, we have a responsibility to make sure that we have our teams physically together at least a few days a week.

James Whelan
And that is true. James overthinking your opposite number over at Invesco. I was talking to him about a year and a half ago, he had an amazing quote, which is that if you want to do your job, you can do it from home. And obviously, he’s talking his own book on this one, because he needs it. He’s big on on residential stuff, sorry, on the commercials on the commercial space. They said, if you want to do your job, you do it from home, if you want to get promoted, you need to come into the office. Yeah. And I do honestly believe that that’s true. That if you’re going to what’s your what’s your view on the future of commercial,

James Maydew
that taking a global lens to its, it depends on where you are really. So in Asia, culturally, being in an office is a lot more important. And as soon as the opportunity to be back in the office was there, most people did it. So Japan, for example, is is now almost back to normalize levels. Where we have more, you know, less influence from a cultural input for even start, I think it’s up for debate. I don’t disagree with that statement. And those that are more visible are clearly, you know, setting the tone about what they want to be achieving. Now, at the end of the day, talent is the most important factor in this whole discussion. And when the balance of power sits with talent, then that’s going to ultimately determine whether they are going to be wanting to come into an office environment or choose to go elsewhere if you enforce that. Now, the other level or area of discussion that probably needs to be brought into this is in the United States, we are seeing perhaps the most challenging return to Office profile. Yes. Some of that is actually related to safety. They’re also in some major cities in the US, they have changed the legislation, because there’s such a backlog that you are able to take anything from a shop under $1,000. And you cannot be prosecuted, prosecute.

James Whelan
Yes, yes, I’ve heard of this. And corporate corporate policies are actually changing to not to not pursue people who are taking from shops as well,

James Maydew
which is crazy if you stop and think about that as a concept, what it does for the streetscape, what it does for the how people feel in being in an office environment, which is surrounded by stores. And you know, you are seeing those tenants of those retail stores pulling out because they don’t have the required security to manage this process. So in what we’re having is, employees in some US city saying I frankly, don’t feel safe coming into the office, that’s a very different conversation saying, Hey, you should get back to the office because you know, your chances of being promoted a lower safety is, is a real concern and defund the police in the US has obviously been a factor in that, that

James Whelan
if you can’t insure, I mean, definitely in Australia, imagine if you couldn’t insure your employee safety on the way to and from work that everything would just stop spinning. It would be a nightmare. But there’s another example not to get too specific. Another example of the expert who’s running the portfolio, making those decisions. And that means that those are the advantages that you have as an investor in as opposed to doing a direct social shift, social shift, legislative shift in a different country, changing the way that the investment is made underlying. That’s, that’s why you would invest in right now. So if

Jody Fitzgerald
I can just jump in and dovetail off that Governor, I think if we can almost sum up the entire conversation we’ve had at the moment with regards to risk. So whether it is risk of structural change, interest rates, which we haven’t gotten to yet and cap rates and so forth. You know, if you go back over the last sort of 1015 years, with perpetually falling interest rates risk has not been appropriately priced in the market for a very, very long time. We are now stepping into an environment where that is no longer the case. Mainly because a we’ve had some structural shifts, some social shifts that obviously change the dynamics of whether it’s properties or whether it is any other asset that we’re looking at. And at the same time, we’re having risk being repriced, from from an interest rate perspective. So I think understanding that what might have worked over the last decade is is not potentially going to work in the next decade. And that’s the real importance of, you know, having experts who understand the asset class who are sort of looking at it. Actually, I think sorry, also, well, I missed,

James Whelan
when should you change I was about to make? Yeah, we probably because if we are going

Jody Fitzgerald
to get into interest rates, I think it’s really important. We’ve probably defined cap rate. Yes.

James Whelan
I’ve always had to do in the past.

Jody Fitzgerald
Because I know a lot of people like you’ll hear people say our cap rate expansion. But what does that mean?

James Whelan
It hasn’t really been relevant until last year. So it’s, yeah, absolutely. So what is it? Sorry.

Jody Fitzgerald
So simplistically, like some people might have in their mind, it’s the interest rate. And well, yes, that’s an element of it. But it isn’t, it isn’t, what you’re effectively looking at is, the cap rate is trying all capitalization rate, as the actual word is, is it’s effectively the annual operating cash flow yield that you expect from the asset based on the price that you’ve actually paid for the property. So the calculation for it is effectively your net operating income. So that becomes important with regards to the discussion we’ve just had in sense of, can you get the same income out of a commercial real estate versus an industrial, etc, etc, that used to be able to minus the operating expenses. And that’s where the interest rate element comes in as the operating expenses, given that a lot of these assets may have significant levels of debt that have to be refinanced to higher levels of interest rates. So it’s the operating income minus the operating expenses divided by the value of the property, etc. So yes, we’re talking about interest rates, but we’re also talking about the ability for them to generate income and how that can be shifting in that go forward environment as well.

James Whelan
If I use the term hurdle, would that make it a bit more easy to sort of understand that? Yes, that’s what you need to jump over to make money while Exactly. If it’s not worthwhile, then don’t do it? Yeah.

Jody Fitzgerald
So going back to that comment around risk is that when you had falling interest rates, right, as you can, if you think of that formula, income minus operating expenses, or a lot of which is going to be a debt servicing your divided by the property value, you can see that that was quite beneficial for for real estate assets. But as debt as the the issue, and James, you’ll certainly be closer to this with regards to individual case rates, is that in an environment of very low interest rates, if rates have got all the businesses have gone in and actually taken up debt, and they’re at the point now where they’re going to have to actually refinance, effectively, then they’re going to have to refinance at higher interest rates, and that’s going to be impactful on their their net operating income effectively. So that needs to be taken into consideration. From you know, from an investment perspective, so all these trends we’re talking about in terms of, you know, data centers, office, etc, it boils down to what income can they bring in?

James Whelan
Well, it’s in generally speaking, without putting too much of a timestamp on this. What do you what is the Morningstar view on interest rates for the next 12 months?

Jody Fitzgerald
We don’t forecast anything. And the reason why is because there’s one thing on if a certain, any forecast, I’ll give you all so that I know for certain, take that one to the bank, and anyone who claims that they can forecast what’s going to happen in next 12 months with any certainty, I would suggest run away from there. Yeah, but you know, it’s all my best. Okay, you need some new friends. Yeah. But the reality is, we operate in a world of uncertainty. And there are a lot of different paths that we can take from here. And as investors, what we need to do is understand what are the probabilities of the different scenarios that could play out? And how can that then impact the valuation of the assets that we’re looking at? With regards to where we’re at the the narrative in the market has really changed over the last few months now, over the last 18 months, 12 months? It’s all been about what’s the peak rate going to be? When are rates going to peak? The narrative is now shifting to how long will we be at peak rates? And I think that’s kind of a really interesting shift. Because if you go back, you know, a few months ago, the market was pricing in and he’s actually pricing in for 2024 rate cuts. And the question is whether or not the market is actually getting a little bit ahead of itself. We’ve actually had, you know, 10 year yields hit a peak, a high that we haven’t seen since 2007. So there’s definitely some sort of shifts happening in there. So I think there’s two parts from here. The reality is we still have it’s really the whole reason why interest rates have been on the rise is central banks are trying to put a lid on inflation. And while there’s been a lot of discussion around inflation being associated with COVID, and you can war and supply issues, the reality is a lot of it at this point in time is actually demand where we have a good old fashioned overheating economy, really low unemployment, you know, strong consumption that is starting to slow, etc. The only way unfortunately, to get wage inflation, which has been a problem in places like the UK, the US less so here in Australia, under control is to raise interest rates and deliberately slow the economy and that is exactly what has been happening effectively. However, it hasn’t been as effective as you would have think. So the yield curve has been telling us that for the last year, we should be heading into a recession we’ve already had, it’s been the most televised recession to come that hasn’t eventuate it, it could already be here. And the reality is, it’s really hard to ignite a recession when you’ve got low levels of unemployment. And that’s, that’s just sort of a reality of it. And that’s another thing COVID did is it really shifted the participation rate. So it’s,

James Whelan
as you were just mentioning, about the whole fleet of people who weren’t in the workforce, in any real proportion. And now, front row setup.

Jody Fitzgerald
Yeah. And then there’s a lot that believe it or no, there’s a lot of other people, people who are in there, baby boomers who were getting close to retirement who got through COVID Just went done, right, life’s more important, and if tapped out, particularly the US participation rate has actually fallen quite substantially. And it’s not clear yet, whether that’s a structural shift, or whether that will actually whether that will change. So from here, you know, the reality is, is that even with, when you still have strong demand, and low levels of unemployment, it’s quite feasible that the neutral level of rates or the level of rates that we need to see on on average, over the remainder of this cycle will be a lot higher than what the markets anticipating. The flip side of that, though, is that as inflation starts to fall, what really matters for economic activity is the real level of rates. So the nominal minus inflation. So if inflation starts to fall fall, the real level of rates could actually start rising. And that would actually be quite restrictive on the economy. And that’s not the remit of central banks. So it’s feasible that they might start to calibrate interest rates for where inflation is landing and what the real rate is. But it’s really hard in the current market environment to see why or how any of the central banks globally could start cutting rates significantly from here, given low levels of unemployment and the possibility that inflation could surprise on the upside. That’s the risk from here,

James Whelan
I love it, that you could not have put it any better. God, thank you so much for that. So let’s go. Let’s get down to the brass tacks then, based on what you’ve said, If hurdle rates stay higher for longer, and the risk free rate stays the same, it means that safer assets can be invested in for less risk, which is the entire point of what good investing is all about. Where do rates fit into portfolios?

Jody Fitzgerald
Yeah, so we think REITs play an important role in portfolios from a diversification perspective. So you know, my role, I’m a multi asset portfolio manager. So our portfolios will have an allocation to REITs. The size of that will vary through the cycle, depending on where we’re at. We have a strong focus on valuation. And so that’s not to say we’re value but valuation. So in other words, your is the probability of gain higher than the probability of loss based on the risk for us at the moment. We are we think that the the outlook for rates is improving, definitely. And there’s been a lot of correction in the price so far. But we’re still underweight. So we still think that potentially, even though there’s been a lot of devaluation already, the question is, is it enough given some of those structural shifts that we mentioned before, given the change in operating income that may come through, given the fact that some of these rates need to roll debt over at potentially higher interest rates, and if the market is assuming that rates will start falling, which was what they were assuming, sort of 12 months ago, I think was naively so then they may not have discounted enough into the price of rates. So we are closing out our underweight but at this point in time, we are still underweight.

James Whelan
Okay, and so James, same question, you know, in a higher for longer environment, where do they fit into portfolios, keeping in mind that this is what you do for a living? So yeah, absolutely.

James Maydew
So, recognize everything that we’ve just, we’ve just spoken about. So for us, understanding where you can achieve real growth in your cash flow to offset increasing interest costs to offset against greater inflationary pressures is really important. So we absolutely want to look through and understand where can we sustainably achieve long term growth in cash flows from these assets. We also are laser focused on ensuring that high quality is at the center of everything that we’re doing. And therefore that dovetails into leverage ratios. And so unlike 2008, the companies that are in the stock market today, globally, investing in real estate, are a lot more focused on managing their overall leverage into a rising rate cycle. And what we are therefore seeing is well capitalized businesses that are in a position to take advantage of any dislocation that may or may not happen in private business. dateland Because when you look to the US in particular, you will see certain participants in private markets that are over levered to reliant on one or two regional banks have a very localized regional portfolio, that simply won’t be able to get refinancing as and when it rolls. That is a phenomenal opportunity for a well capitalized REIT that has been sitting there waiting for that opportunity. So what we are seeing is not only the growth in cash flows from the sectors and the stocks that fill those sectors that have structural growth to them, we’re also seeing a bolt on acquisition opportunity that is likely to present itself, which will set them up for the next decade or so

James Whelan
for us so that there’s opportunities out there, which sort of comes back to the same thing that that I’ve mentioned before, many times in the past that in times of trouble or trouble, the times have changed and uncertainty is so similar to what we have now that it’s better to be with the smart guy instead of just being sort of the to the overall buy and hold despite the market sort of situation, more important to make sure that the manager that you are investing in is good at what they do, which they assure you mentioned inflation, James, I don’t want to ask it like this, because I am legitimate this, these are questions that have come off the ensemble platform. And so there’s sort of bits and pieces in here, this is a bit of a leading one rates as a hedge against inflation. I’m just going to leave it out there. And let’s just sort of see how this goes.

Jody Fitzgerald
Okay, it’s gonna say depends and handed over to you.

James Whelan
That’s good enough, I’m gonna listen.

James Maydew
It does depend. So it depends on your time time horizon, in the short term REITs are listed on the equity market and therefore are at the whim of the pricing of risk, we’ve seen interest rates move at the fastest rate that we’ve ever seen on record. And that gets repriced immediately in liquid assets, because the most important component that’s going into the valuation is going to be the risk free rate, which is up dramatically over that period. So in the near term, listed real estate REITs, any form of risk asset didn’t play the inflationary hedge that you would like it to do. Now, it also means that in real estate, you get with linkages to inflation protection in your leases, they are backwards looking. So when you have a very high period of inflation, it’s going to be in 12 months time that you’re going to see that protection come through. And we’re now starting to see that hitting the cash flows. So those that have inbuilt inflation protection into their, into their leases are now starting to see that being delivered. So it really depends on your timeframe. So in the short term, it’s not going to be an inflation hedge, but over the medium to longer term, it absolutely is. Because if you have an asset, which is real, its physical, it’s going to be a pretty good place to protect against the scourge of, of rising inflation, just generally, I think we’d all understand that over the longer term, thinking about, you know, our parents when they bought their homes and the numbers that they pay for those homes, you know, that’s the economic and growth and it’s the inflationary environment that’s delivered that growth. But then to take that to the next stage. If you have an asset that’s linked to leases that are linked on a year by year basis to inflation, then you are going to get that protection coming through. And it will happen. And so you have to make a call on whether can that tenant afford to pay that new increased rent? Yeah, so that’s where your underwriting of the credit quality is important. And that’s key to what we’re doing understanding the tenant understanding the commercials, understanding their ability to service, rising rents, and that goes to the heart of what we’re talking about in some sectors. And in some industries, they simply won’t be able to take higher costs, because they’re in cyclical headwinds, or they’ve got a straight instructional decline. So that’s why it’s really important to understand the asset. We have a team in five locations around the world, Hong Kong, Tokyo, Sydney, London and Chicago, boots on the ground, kicking the tires, understanding the risk dynamics to really showcase and find these opportunities. Because real estate is a local asset class and understanding the local dynamic is really important,

Jody Fitzgerald
I suppose. I’m just going to pull it back to a general portfolio construction comment as well, because the other questions probably been asked in, in the sense of how do I inflation proof my portfolio and, you know, coming out of 2022 traditional diversifies didn’t diversify. And I, you know, to the point that over the short term, no, because they are, you know, equity linked to the market and therefore linked to the risk free rate. I think it’s just really important for everyone to understand that You know, 2022. And well, the last, you know, 12 to 18 months has been an unusual period, because we effectively had asset class bubbles in every asset class. Because for the best part of the decade, central banks read the risk free rate and held it at zero. So when the risk free rate is zero, that has profound implications for the way risk is priced across all asset classes. So all asset classes had to have a capitulation, as risk was repriced that’s occurred now,

James Whelan
going into 82 was really enjoyable here.

Jody Fitzgerald
So I think, you know, it’s important to separate, you get those three standard deviation events every now and again. And that doesn’t mean that that portfolio construction doesn’t work, there’s going to be times where it feels painful. But when you’re looking at it over the longer term, there is a role and it can provide inflation hedge just depends on how it’s priced at that point in time. The other point I would make actually, is that people keep talking about inflation. We need to remember that inflation is a rate not a level.

James Whelan
So it’s just a comparison to a previous number. Yeah. So

Jody Fitzgerald
that huge amount of inflation that’s already come that’s baked in. So if these REITs have been able to increase their they’re not going to reduce it, right. So as inflation starts to fall, are they likely to actually go back and say, well, we’ll take that 10% increase, and we’ll reverse it, so that they could actually put them in very good stead for have that sort of inflation protection flow through Excellent. Once actually, the cap rates and so forth, the interest rates have actually been repriced in.

James Whelan
Okay, well, I tell you, we’re just gonna blast through a few of the questions that are here, some of them, some of them are sort of interesting. And some of them we’ve sort of already covered anyway. So I’m gonna skip over some of those ones, just to make sure that we’ve covered all the bases from the advisors and the people on the ensemble network, who asked all of the questions that they can. I got one here, and it relates to the the officers James, that you mentioned just now that that you have boots on the ground around the area. I’m just gonna read the question. Everyone knows the phrase, location, location, location, how important is that in a commercial property context?

James Maydew
Well, it’s an important factor, because at the end of the day, the most important component in real estate is having a tenant and their willingness to pay a rent, which is increasing over time. And when you have real estate cycles, then some of the more questionable locations, when you’re in the early part of a cycle, the mid part of a cycle are more acceptable around for tenants, because they have, you know, they don’t have as many options, when you’re at the latter part of a real estate cycle, then they you have a ton of options, and therefore that’s when tenants make the move. So you will see tenants moving from peripheral locations in the Sydney CBD into the major core assets in central central Sydney. And that is the same for any location around around Australia. And so you know, it’s a core, it’s a core factor, it’s important. And but in real estate investing, what it drives is the security of cashflow that that’s the most important factor. So location is one of them, then understanding the quality of the Covenant, the tenants, how much rent can they pay, How sustainable is that rent? What is the trajectory of growth in the industry, and sector you’re investing in. So if we look at telecommunication towers, for example, you know, we’re investing in the shift from 4g to 5g, we’re all using mobile technology at a faster and growing rate. And that’s a global trend that is in a sweet spot for growth over the next five or so years. It’s the same with data centers, the shift to cloud computing, and on content demand, before we even talk about AI that’s going to see growth. If we think about Amazon and the growth in E commerce. Yes, you know, we’ve seen a great deal of growth in that industry. But we were transforming from a marketplace where you had no other option other than buying your goods in a shopping center 20 years ago to one where you can sit on your couch and get the same product, probably cheaper. So that just changes the entire dynamic. And we think there’s there’s a ton of runway for further growth in that area. So that’s a long way of saying in everything that we’re doing. Location is vital, but you need to understand all of the other moving parts that go into choosing that location.

James Whelan
Now, how much does decarbonisation I know this is something that you’ve mentioned a few times, just in our in our preparation shots podcast, how much does decal, like I said, decal can sound like a funky like a hipster. How much was just ASG go? Yeah.

James Maydew
It’s table stakes. Yeah. So if you are not focused on the E, the S and the G as a corporates, you will be left behind and you simply won’t be able to fill your portfolio with tenants. And it’s not negotiable. And tenants also have you know, their corporates, targets that they’re looking to achieve and They will say I’m not going to occupy your building because it doesn’t fill the requirement that we need as a tenant to fulfill

James Whelan
how many stars are we up to now? Is it seven stars, because they’re just made up?

James Maydew
It’s six stars in Australia, but that’s a great point because governments won’t take occupancy of office buildings below or below a certain star rating. Yeah. And so this is a well trodden path. I would say the Aussies are some of the best globally in this them and the Europeans and the Kiwis. Some other parts of the world playing catch up, and there’s a long way to go. So we’re likely to see regulation over time, which makes the real estate you can call it a carbon, decarbonisation, or other factors of sustainability in the environment is going to get increasingly more important.

James Whelan
Does that mean that sorry, Jonah, you go and then

Jody Fitzgerald
about to say, I think it comes back into that whole, it’s important to be on top of these issues. So the the greening of buildings, right, so that if we go back to early conversation about people working from home, so I’m specifically talking about Office here, obviously, trying to get tenants back in it is about having, well, Gen Zed, they want to know that they’re working in a building that’s green there, you know, the way that buildings need to be fitted out to be, you know, more inclusive for people coming back into the office. So you kind of have a green premium, but you also have a, you know, a brown discount, as it’s called. So your office buildings that are not, you know, don’t necessarily have that sort of gratification or decarbonisation element to it. But I think that’s also really interesting in the sense of, so that can help you attract tenants. But if you have to actually repurpose or refit an office, or change, you know, the, you know, so in London offices will have gas, and they’re trying to change that to electric and so forth, there’s a cost associated with that. And that that fit out that change has to then now also be financed probably at high debt levels. So understanding the both sides of that in terms of you may need to do the greening of your building to attract a tenant, but that is going to cost you money. Can you do it in a cost effective way that actually ensures that you can still return a decent cash flow return to investors?

James Whelan
Yeah, that’s, uh, James, do you find that, you know, in the necessity in the requirement to pursue something that’s greener, that you are hamstrung from chasing some of the opportunities that might be available around the world? No, that will

Jody Fitzgerald
pay for exactly all of that price.

James Maydew
It’s all about price, it goes to the core of investing in quality real estate. And the the best management teams globally of the companies or the rich that we’re invested in, have been on top of this for a very long period of time. And, and you’ll see that in the results, the best managers get the best out of portfolios. And investing in sustainable buildings is a point of difference. That will be a performance differential between you and those that haven’t

James Whelan
not, though you’re okay, next question we’re going to get to is the specific role or nonspecific advantages of owning a rate, especially for a self managed Superfund, particularly, no, I’m not sure who’s over quality of expertise to be able to answer this question. But if we could just sort of keep it general, I’ll answer the question. And hopefully this will help someone on their way.

James Maydew
So I’ll take it from a very high level perspective, we’re

James Whelan
not giving any obviously no specific or tax advice is exactly the question that I have to ask. And it’s an answer that we’ve got, of course, you know, I’m

James Maydew
certainly not a tax advisor. I’m an investor in real estate globally. And it depends on what you’re seeking to achieve. listed. Real estate is a diversified way of getting access to the economics of buildings and industries around the world. And investing in a global capability allows you to get access to the likes of Japan, the likes of Spain, or France, Switzerland, Canada, the US, Mexico, and Australia. So it depends on what you’re trying to achieve. But the creation of the REIT asset class is in its very nature, a tax efficient vehicle. So being tax efficient, allows these companies to enhance their overall growth over the longer term. So if you think about it, not to get too deep here, if you think about Charles Darwin, and you think about how

James Whelan
exactly we’re gonna go there. It’s not what I was expecting for that pause,

James Maydew
sir. And you think about how what we’re doing here is investing in real estate assets that is there for everybody to see, every analysts around the world can analyze the real estate fundamentals of the companies that we’re investing in, that leads to the weak getting found out very quickly, not having a cost of capital and not being able to grow. That means strong, get stronger, and they take advantage of that. They take over the weaker and they grow and evolve and advance. So what you end up getting in the real estate asset class that is listed is a high quality exposure to the underlying asset class because As the improvements have just honed over time. And so when we look at it today, you can get access to all of these sectors, all these trends, all these themes, that’s all very great. But at the heart of it is the sustainability of cash flow driven by some great management teams

James Whelan
God, so question of workers, and then I think it’s about time that we wrap it up.

Jody Fitzgerald
Sure. Yeah. So when we think about asset allocation, there’s a reason why we split out REITs and infrastructure as well even listed, so we don’t just say, well, that’s Australian equities, or that’s global equities. It’s specifically an allocation to REITs. And even though over the shorter term, it will take on some of the volatility and the characteristics of the equity market. over longer term, it does have different behavioral elements that do offer diversification benefits in a portfolio. So we, we use rates across all risk profiles, within our portfolio’s do think it’s extremely important to have an exposure offshore as well as domestically. Obviously, within our strategic asset allocation, we have a higher Global Allocation than then domestic simply because of the depths, right, you get more depth, more diversity, different types of properties, etc. So I think that’s really important. Listed version, though versus unlisted, I think is probably a question that some people would have kind of just depends on the client. So obviously, there are some clients that advisors might have that come to them with existing property holdings, whether it be you know, a warehouse somewhere or an industrial site, etc. And understanding I think, from you know, generally, that’s probably something you can’t liquidate. So you then need to build a portfolio around it, understanding that particular asset and what it is linked to. So what part of the market cycle is it linked to? And then understanding what else you have in the portfolio from a listed side? And is there a high level of correlation between those risks that you need to consider. But in general, the listed version of real estate assets is beneficial to most people because of that liquidity profile, particularly as individuals move into retirement, most people will have to draw down on capital as a part of their retirement, and not simply rely on the income that is coming out from any of the investments. So therefore, understanding that and knowing that you can still sort of draw down on that capital on a tax effective way in retirement is advantageous versus having an unlisted property that you can’t liquidate.

James Whelan
That makes sense. All right. In the final seconds of the show, I always have a last deads is your last chance to speak now forever, hold your peace. Otherwise, I’ll wrap it up. I just like to talk about Charles Darwin and be more fantastical Charles Darwin. On the Beagle, look, the beagle is going to come into shore. Thank you so much for joining us. Jody Fitzgerald, head of institutional portfolio management and solutions at Morningstar. And thank you the Charles Darwin of real estate investment trust James major, Global Head of listed real estate at Macquarie group. Thank you so much, both of you for joining us. And I think that we’ve learned so much. If you want to know more, check out the ensemble platform, Morningstar or Macquarie will be able to help you out there. We’ve got links to everything at the end of it. Thanks for having us.

James Maydew
Yeah, thanks for time. Appreciate it.