What makes a superior unlisted property fund?
Louis Christopher, Managing Director and founder of highly regarded investment research firm, SQM Research, shared his insights into what makes a superior unlisted property fund at the PFA 2024 Conference at the Gold Coast recently.
Interestingly, SQM Research started its investment research in property, and has since grown to cover all asset classes.
When addressing what researchers look for in a superior property fund, Mr Christopher said the starting point is the people behind the fund. “The people are number one factor, always have been and always will be. Funds need a highly experienced, well-resourced team.
“The portfolio managers need a minimum of 10 years’ experience in property portfolio management, preferably including experience elsewhere.”
The health of the business, and the governance arrangements are also critical. “Governance must be demonstrably strong, with independent representatives sitting on the investment committee and board.
“A superior fund manager is also one that is profitable.”
The manager’s investment philosophy and process must also be clear. “The strategy must be clearly outlined. For direct holdings there needs to be strong research done on the local market.”
Liquidity and exit strategy are also important considerations for unlisted investments. “When rating an unlisted investment we like to know what the exit strategy for investors looks like. We can still rate a fund with a seven year lock-up highly provided they have an exit strategy which is clearly articulated.
“It’s okay if liquidity windows are infrequent but well planned, with plenty of liquidity when they are open.
“We’re less enamoured with funds that may have 30% in liquid investments and promise funds will be available at call to investors. We all saw how that can go wrong during the GFC.”
Other key factors for the underlying investments include valuations, quality of assets and diversification. “We want to see at least one independent valuation done by industry recognised valuers.
“Regarding the quality of the asset, we want to understand the quality relative to cost. A C-grade asset can be okay, but what are you factoring in for cap-ex and maintenance? What is the acquisition yield, and what is the demand for the asset?
“Diversification is not critical for property syndicates but important for diversified direct/hybrid funds, with geographical diversification more desirable than diversification via sector.”
How a fund markets its returns and distributions will also be considered. “We want to see risk-adjusted returns because we fundamentally believe returns must be commensurate with the risk taken.
“When it comes to distributions income is important, and there could be issues with income returns below 5%. We want to see income between 5-8% for office, industrial, retail and healthcare.
“A key question regarding the income is the stability of the income, and potential tenancy risk. How secure are the tenants? What is the potential risk for rent reversion?”
A superior property fund will communicate with investors, provide regular updates and be transparent regarding changes to the fund. “We need to know immediately when there are any changes, and we want to see timely updates to stakeholders, particularly regarding any changes to management strategy, PDS, and for acquisitions/disposals.”
Fund fees for direct and hybrid funds are an interesting one, and Mr Christopher says there is a sweet spot for fees. “We have seen fees come down over time, which is concerning. There is a sweet spot where fees are not too much, and not too little.
“Performance fees are okay provided the hurdle rates are sufficient, and the performance fee isn’t more than 20 per cent. Acquisition and disposal fees are okay provided they are not gouging – we could consider normal as somewhere between one and two per cent for direct/hybrid funds.”
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