Episode 1 - What’s really happening in real assets?

Release date: Tuesday, 1 August 2023
Host: Turi Condon
Guest: Darren Steinberg - CEO, Dexus

Nicole: [00:00:00] Welcome to The REAL Deal, a monthly podcast about what's happening across the real estate and infrastructure sectors. GRAB

(Darren): [00:00:08] I think an old mentor of mine once just said you get the best quality assets and you keep them appropriately levered and they will show great returns over many, many years. And that individual was exactly right. So that helped me in 2008 through the GFC and it's helped us a lot through COVID.

Nicole : [00:00:25] That's Darren Steinberg, Dexus CEO, offering some great insights during his conversation with host Turi Condon. And they're talking about the current state of the real assets sector from the impact of interest rates, investment, uncertainty and migration to trends overseas and at home in Australia and New Zealand. But since this is the inaugural episode of The REAL Deal, Turi starts by asking Darren what the podcast is all about.

Turi: [00:00:56] Well, Darren, this is the first REAL Deal podcast you've done it must be exciting for Dexus. What's it about and what can listeners expect?

Darren: [00:01:04] Yeah. Afternoon, Turi. I think this is all about giving people a real time perspective of what's actually happening in the real assets markets, whether it be office industrial, retail infrastructure. There's a lot of noise in the papers in the press at the moment on the radio news. We want to give people an understanding of what's really happening out there and not just reading stuff second hand in the papers.

Turi: [00:01:28] You mentioned Office and Industrial. Is that all the real assets? What does real assets mean?

Darren: [00:01:34] Real assets are assets that form the backbone of the infrastructure of the country really. It's the office buildings that people work in. It's the industrial sheds where product gets distributed from. It's the shopping centres that people go to, to get their daily needs, to get their fashion requirements. It's the airports on which the, you know, the people come and go through the country and interstate. It's the hospitals that people go to, to have procedures. You know, we're very fortunate at Dexus to have to cover a gambit of real assets.

Turi: [00:02:08] Can we talk about investors? It's, it's a climate of high interest rates. It's an uncertain economic forecast. What's really happening? Is it a good time to invest?

Darren: [00:02:18] Well, it depends whether you're a holder or a long-term holder. It depends whether you're a short-term trader. But obviously, we're going through an economic cycle. You know, there's been a lot of interest rate rises, inflation is running rampant around the globe. So if you bought some assets a couple of years ago when interest rates were virtually free before the inflationary impacts, you bought at what is looking like close to the top of the cycle. So you know, over history the world moves in economic cycles. So I'd argue right now is quite a good time to invest depending on where you're investing and what your long term return metrics are.

Turi: [00:03:00] Yeah. Well, I wouldn't mind you taking out your crystal ball and just telling me what you think is going to happen to asset values then.

Darren: [00:03:06] Well, what assets are we talking about here? So there's the question. So let's start with a bigger picture story. I think when you look at the interest rate cycle, as I said, if you go back a couple of years ago on the back of COVID, money was virtually free around the globe and as a result, you had assets being bid to total returns of say, 5%. And I'll use for these examples, I'll use real estate assets. So historically, through all cycles, real estate assets have been bid on a total return of, let's say, 7 to 10%, seven for the better quality assets and ten for the not so, you know, good quality assets and maybe even higher depending on the quality of the asset. What happened when money got free is that everyone sort of took out that equation and started to bid assets down, good quality assets to 5% total returns, which was sort of yields of two, 3% and some and some capital growth. So what's happening now is we revert back to a more normalized interest rate environment, is that the pricing of these assets is changing back to reflect the price or the cost of debt. So right now, you know, a total return for a good quality asset is probably going to be somewhere between 7 and 10 like it used to be in the old days. So if you bought an asset on a 5% total return, you're getting this revaluation movement coming through your through your asset. And that's what's going on in the cycle at the moment.

Turi: [00:04:35] And how will interest rates change that? We keep hearing it's getting close to the peak of the cycle, but I'm sure a lot of people don't feel like that. You know, I know my mortgage has gone up. Does that mean, you know, when can you expect to see interest rates coming down? And if they do, what's that going to do with asset values? Yeah.

Darren: [00:04:51] So if I knew exactly when interest rates were going to come down, I probably wouldn't be sitting here doing this podcast with you. I'd probably be sitting on a boat somewhere in the Med. So I think from what we can see today, I think from what I can gather that there will be probably one, maybe two more interest rate rises here in Australia. You've seen some data coming out of the US lately that they think they're getting close to the end of their cycle. You know, different countries at the moment across the world are at different levels of their economic recovery, shall we say, or fight against inflation. So I think from an Australian perspective where I can sort of speak with the most authority, probably 1 or 2 rate rises, I'm hoping that these rates will then stabilize over the course of the next year. I don't think we're going to be back to 2% rate rises anytime soon. But I think what investors are looking for and what we're looking for is a more normalized interest rate environment and more stable rates. So I'm hoping that we'll have 1 or 2 more rate rises. As I said, we'll then stabilize maybe somewhere between three and a half and four base rate and then from there we can start investing with more certainty again.

Turi: [00:05:57] So that's all about certainty really for investors.

Darren: [00:06:00] Yeah, look, there's a lot of uncertainty if I think about where the, you know, on our platform we have many investors. So if I think about retail investors, I'll start there. You know, you've got, as you mentioned earlier, you've got big increases in mortgage rates, a lot of negative press, a lot of negative journalism coming out about the state of the economy and where the future’s going to lie and a lack of disposable income. So I think there's a lot of nervousness there and a lot of nervousness in the planning community that actually helps them allocate their capital. So they're definitely going to want to see some stability. The big pension capital and the pension funds that invest in across the Dexus platform. Now there's a lot of capital sitting there waiting to deploy, but no one necessarily wants to be the first one to buy in this kind of an environment. So they're waiting to see more valuation evidence. And as a result, you know, where prices are going to sit for various assets before they start to deploy. So the pleasing aspect is there is capital waiting to deploy. And Australia as a nation, as an economy is screening super attractively compared to many countries across the globe as a place to deploy that capital. So once we do get some stability and some certainty as to where we're at in the interest rate cycle, there will be a lot of capital that will be deployed into the country and and hopefully into the real assets.

Turi: [00:07:21] When you talk about pension funds, you're talking about overseas investors. So why do they and local and local and local so and the super sector. So why is Australia so attractive to those overseas funds particularly?

Darren: [00:07:33] Yeah. I think when you look at the underlying fundamentals behind our economy and I'll point to one in particular which is the migration levels, I mean it's been well stipulated. We've got about 400,000 migrants coming to Australia this year over history. When you look at periods where we've had strong migration, it's really helped. To drive our economy well and from a real estate and real asset perspective. You know, more people coming in will stimulate the economy to provide retail sales. New houses will need to be built. And as a result of that, our economy tends to gather great traction.

Turi: [00:08:07] And do we see some of those trends playing out overseas? Are the markets very different over there? I hear you've been traveling, you've been to Singapore and London and the US. What are you seeing in those markets and how different is it to the Australian, say, office market?

Darren: [00:08:21] Yeah, look, I've been very fortunate over the last where are we now six, seven months to be sort of back on the, you know, back flying around to meet with investors and actually see what's happening in some of these markets on the ground. So the office market is intriguing because, you know, the trend of, you know, Tuesday, Wednesday, Thursday is the key work days and more flexible work is a global phenomena right now. It's playing out in the States. It's playing out in the UK, Singapore, Hong Kong. I can't talk about Japan yet because I haven't been up there, but I hear it's not dissimilar there. But what is playing out a lot differently is the usage of office space. So America has as a whole lot of different factors impacting its office markets than what someone like Australia has. For example, in New York, I think only 8% of office buildings have been built that are less than sort of 60 to 70 years old in that market. They haven't got a lot of the new office stock that you see here in Australia, new sustainable office stock. You've also got a lot of other fundamentals that are played out in the US market. People have gone back to the home states. People tend to be a lot more transient than they are in Australia, where people sort of live in Sydney, Melbourne, Brisbane, Adelaide, Perth, those main sort of markets. You know, you don't get the same kind of movement. So in the US, for example, you know, a New York investment banker can go back to his home state, not have to pay the very expensive New York taxes and have earned the same money in the post-COVID world. As a result, they've really had troubles getting people back into the offices there.

Darren: [00:09:55] So there are different nuances in offices across the globe. So what became evident on the trip is that Singapore is virtually back to normal. I know Japan, the offices are very busy. London, where I was a couple of weeks ago, Tuesday, Wednesday, Thursday, really busy. Monday, very quiet. Friday, very quiet. I think they have a thing called “Thursday Thursdays.” Everyone comes into the office on Thursdays and they go to the bars and drink in the evenings. It was quite bizarre just seeing how busy it was on the Thursday. Reflect back into what's happening here in Australia. Sydney is probably the core of Sydney is super busy right now. Like if you look at some of the transport stats and other sort of statistics that have come out, you know, Sydney is probably as busy now or busier than it was pre-COVID, but it's really busy in the super core. So super core, I'm talking Circular Quay up George Street across Westfield and back down Macquarie Street. People are coming back to work. Offices are going to be a key part of the workplace and there's a lot of statistics now about productivity of the workforce, which is why many CEOs and management teams are trying to encourage their workforce back. And I and I think as we play out from here, what we are sort of seeing is a normal sort of office cycle. There's a lot of doom and gloom talk about offices at the moment, but history will say that's probably a good time to invest in the good quality office stock if you can acquire it today at the kind of discounts to where it was sort of 2 or 3 years ago.

Turi: [00:11:27] So despite the cost of living, that's why I can't get a book in a restaurant, is it? Well, people coming back in Sydney.

Darren: [00:11:33] It goes to it goes to where the amenity is and why that core CBD that I spoke about is full because this whole trend that we saw pre-COVID of, of businesses relocating to the CBD for better amenity to attract the best staff, that trend is still alive and well and we're seeing it now many, many businesses relocating in from the suburbs. They might take a bit less space. They might be using their space differently, but they're coming in. Why? Because the transport links that have been put in by various governments over the last few years are coming to fruition. So it's easy to get in and out and you've got fantastic amenity for your staff once they're in here.

Turi: [00:12:07] Yeah, so Darren, you mentioned the different cities in the US playing out differently. I saw that in a story in the Financial Review this morning about a McKinsey report, and that report also referenced different types of space. So in different cities it seems there's better premium space and that's playing out quite differently to the B grade or the C grade space. What's happening in Australia?

Darren: [00:12:29] Yeah, look, it's not a dissimilar story. You've got a lot of push now towards by tenants on the back of countries going to net zero and better sustainability reporting across the globe for listed entities. Companies want a more sustainable office, a more modern office with better facilities. And so as a result, you're getting a lot more lift into the A and premium end of the of the business or the office sector. You know, notwithstanding that, as I said, location is really important to these tenants as well. So even within I'll use the Dexus, this isn't a podcast just about Dexus, but I'll use another example, 56 Pitt Street, one of our, you know, let's say a B grade tenant in a superb location is running full. Why? Because over the years we've spent money on making sure it is A it has got the right sustainability metrics and B, it's in an excellent location. But you know what I wouldn't want to own right now is A, B or C grade building in a non-prime location. That's where you're really seeing the valuation impacts. They're the ones that are going to be empty because they're going to be really hard to lease and they're probably going to have dramatic valuation impacts when it comes to trying to trying to sell them.

Turi: [00:13:41] So from a big picture perspective, what happens to those buildings? Can they be turned into apartments or is that just too hard because we don't want to see empty cities?

Darren: [00:13:51] No, look, it's going to be very asset specific and it'll depend on the planning rules on where it is in Sydney. Some assets do suit themselves for repurposing, but it also depends on the floor plate lifting, car parking, etcetera, etcetera. So, you know, there is no one size fits all here. It's not the great panacea to cure the ills of what's happening. And it really does go back to landlords. And many landlords have just been collecting the rent without putting the capital back into their assets. And I think history will show and you can see it globally again, those that have put capital back into their assets and manage them properly and proactively are in a better position than those that have just been sort of leased, leased, leased, never put any capital back. And now they're going, what the hell am I going to do with that building now?

Turi: [00:14:35] What do you think they will do?

Darren: [00:14:38] Well, some will be repurposed and turned into residential or other uses. Other others may well be repurposed by banks and sold at very cheap discounts, at which stage it may make more sense to convert them to residential. Maybe we'll see some logistics. You know, you might even see in some very, you know, some very sort of different circumstances. There's new technologies that have see people growing, growing strawberries and lettuces in car parks. So you might see some of that playing out as well.

Turi: [00:15:07] So I won't have to go too far for my fruit. Hopefully not. We talked about the uncertainty and what's happening in the world. Do you think that makes investors nervous? Do you think they'll think that maybe demand for office space or industrial space may not be there in the future?

Darren: [00:15:22] I think what's really evident and I saw it even talking to some of my staff. You know, it's been a long time since there's been a downturn. There were people inside, you know, in the business community that have worked for 10 or 11 years and they haven't seen a downturn. They haven't seen asset prices move. They haven't seen vacancy rates move up. They haven't seen rents go backwards. So I think, you know, being very clear, this is a normal business cycle we're going through. Yes, it may have been exacerbated a little bit by COVID, but, you know, asset prices do not keep going up. Rents do not just keep going up. This is a normal business cycle, an economic cycle that we're going through. And as I said right at the start of our discussion know this may prove to be one of the great times to buy assets, you know, not just sell, sell, sell.

Turi: [00:16:08] So what have you got your eye on?

Darren: [00:16:11] Very good question. So, look, we have an opportunistic fund. So what have we been investing in in that fund? We've been doing some repurposing of industrial land and some industrial subdivision and buying some land and rezoning it to industrial and some good areas in Melbourne and Sydney. We've been investing in debt and residential debt inner city, stuff close to the major CBDs. We've been, funnily enough, we've been doing some office debt as well to help fund an office development down in in Melbourne that has its leased 80% underpinned by a major international tenant. But look, debt’s a good way to play this cycle if you have the right terms and conditions and the right assets.

Turi: [00:16:56] And what do you think are some of the pockets of growth that will emerge in the next year or two?

Darren: [00:17:02] Yeah. Look, I think it's all about the buying and about the quality of the assets. So if you can buy very good quality assets at a discount to valuations over the last couple of years, it's time to start thinking about that and doing some work on that. I think you can see residential taking a five-year view. It could be quite lucrative if you can get in at once again at the right price. Logistics, we're getting fantastic rental growth. There's very low supply while there's low supply. That should mean that value should hold. And even if cap rates move a bit, as we've seen evidence in our last lot of re-evaluations, the rental growth is more than covering. Office, as I said, it could be a very good time to get set in quality office in the CBDs. So that's definitely one to watch. Retail should be steady and it all comes back to the buying. It all comes back to the buying. I think the other thing that we really like the look of is infrastructure. Some of the fundamentals you've got government backed CPI linked for infrastructure, whether it be in health, whether it be in airports, whether it be in some of the rail companies that we run, that's looking extremely attractive as it through the cycle investment as well.

Turi: [00:18:12] So does that say that there's a bit of a play in diversification because you've named quite a few sectors there?

Darren: [00:18:18] Yeah. I think, you know, the one thing that has come out of COVID is the power of diversification. I think, you know, I even look at some of the funds that we had that were invested in airports and student accommodation, and you would have thought in Australia those two things take into account, you know, we are the most, you know, with a nation that does a hell of a lot of flying because of our location in the globe. But who would have thought that those two elements would have been impacted the way they were by COVID? So the power of diversification is something that we take very seriously here in Dexus, whether it's diversification within a fund or diversification with how we think about our balance sheet. And I encourage all investors to just think about the power of diversification within their own portfolios.

Turi: [00:19:01] So not just buy a second house?

Darren: [00:19:04] No, no, I would not be doing running out and just buying two houses in the same suburb. That's not diversification.

Turi: [00:19:10] Okay. Now, we've seen some incredibly volatile times. You just raised COVID. We now have a war in the Ukraine. I'm not suggesting you're clairvoyant, but are there any potential left of field events that you're planning for at Dexus?

Darren: [00:19:24] Look, I spent years talking about the Black Swan event and then sort of we've had the geopolitical risks and then COVID comes out of the blue. So I think any, any good management team is always planning for the, you know, what do they say, plan for the worst and hope for the best. So, look, I think the team we have here has been around a long time. Unfortunately, now we've seen a lot. And I don't think any management team that has managed through COVID could sort of prepare for a worse event than what happened there. So, you know, I'm not saying we're perfect in any stretch of the imagination, but, you know, we did a lot of risk management and a lot of planning for bad outcomes. And, you know, hopefully they don't occur again.

Turi: [00:20:06] Let's hope so. And I'll ask you one more question. You know, I said you're not clairvoyant, but I would like you to take out your crystal ball and just pick the three big trends that you expect in the next 1 or 2 years.

Darren: [00:20:18] The trends are interesting. So I think there's a couple of things there. I think the first of all is this long-term view. I think in the world of Instagram and podcasts, funnily enough, Turi everything wants to be quick and five minutes long. So I really would encourage investors to take a long term view. As I said before, this could be one of the great buying opportunities over the next couple of years as the interest rate cycle normalizes. And we and we work through what looks like to have been the impact of cheap money for a long time. So taking a 3 to 5 year view rather than a 3 to 6 month view is something I'd encourage investors to look at. Secondly, a focus on quality. I think an old mentor of mine once just said you get the best quality assets and you keep them appropriately levered and they will show great returns over many, many years. And that individual was exactly right. So something I've always tried to do in the companies I've run is get the best quality assets I can and keep them appropriately levered. That helped me in 2008 through the GFC and it's helped us a lot through COVID. And if you actually look at Dexus, yes, the share price may be going up and down, but I think we were one of the few groups that actually delivered the same income right through COVID because we had the best quality assets. And the third the third trend, I think as you look at some really successful companies, they really focus on growth thematics, something that has the tailwind on your side if possible. So I'd look at the thematics that are playing out around the globe and try and invest in line with some of those trends. So normalized interest rates, whether it be in Australia and the migration and what are the impacts of that migration, what sectors are going to be impacted? I'd be looking at some of the trends like that around the globe and backing them.

Turi: [00:22:05] Well, thank you, Darren. It was really interesting to get a sense of what's happening in real assets and what you think some of the key trends are going to be. And great to be here talking to you for the first episode of the Real Deal podcast.

Darren: [00:22:15] Excellent. So, Turi, let's hope the first isn't the last and hopefully we'll have some good guests over the over the coming episodes that we do.

Turi: [00:22:22] So what are we doing next time?

Darren: [00:22:24] Well, Turi, what we will have is some talk on infrastructure and sustainability, and we'll also be open to taking any questions our listeners may have.

Turi: [00:22:32] Absolutely. So listeners can send their questions to the realdeal@dexus.com That's realdeal@dexus.com. And thanks, Darren, and thanks everyone for listening.

Nicole : [00:22:45] You've been listening to The Real Deal, a podcast for Dexus. Listen to the Real Deal at dexus.com forward slash the-real-deal and follow free on Apple Podcasts, Google Podcasts, Spotify or wherever you listen to podcasts.