Mai Platts:
Welcome to the latest instalment of our Quay Global Investors podcast series. My name is Mai Platts, I'm one of the Account Directors with Bennelong Funds Management. Joining me today is Chris Bedingfield, Co-Principal and Portfolio Manager of Quay Global Investors. Chris, welcome.
Chris Bedingfield:
Hi Mai, how are you?
Mai Platts:
I'm well, thank you.
Look, we've got some interesting activities in the market at the moment, some interesting headlines, so keen to get your insights on those. To start, we've just come through reporting season. Were there any surprises from your side, from the results that came out?
Chris Bedingfield:
I think we're just sort of finishing up the results now and our, I guess, observation is the results have been positive, probably on balance, slightly positive relative to our own expectations. Our expectations were probably a little bit more optimistic than the market, in that if you go back three months when companies were giving guidance for 2023 at the beginning of the year, they were, in our view, being incredibly cautious in their assumptions. Retailers or the retail landlords were essentially expecting zero nominal sales growth, elevated bankruptcies. We saw the expectations were, from the residential guys, a material slowdown in rental growth and even in the industrial side, a pretty meaningful slowdown in terms of rental growth there as well. And that hasn't transpired as yet. So it's not surprising that the results have been pretty good because the expectations we thought were a little bit undercooked, if you will.
But having said that, we were sitting above the market anyway and they've sort of come ahead, slightly ahead of where we were going. Where we're probably most excited right now is senior housing, it really feels like there's great momentum in that space right now. Occupancies are ticking up quite nicely even during the low leasing period of the first few months of the year, we're seeing some good momentum on the leasing side. And just as a reminder to some of our listeners, one of the great things about real estate sometimes is if you can buy a portfolio of assets that is 20% vacant on the same sort of multiple as the rest of the market, you get some pre-upside when that vacancy gets leased up. But that's not always the case. Office is a good example, you can debate whether that 20% vacancy gets leased up, but in senior housing where that is the case, you do have that 20% kind of vacancy, but you've got a great demographic story of the ageing population, which is really starting to kick in now and very, very low deliveries of new supply. There’s a nice little sort of momentum story building now behind senior housing, which we think will last many, many years. And the beauty is we're not paying really big prices for that space right now.
Mai Platts:
And with those observations in mind, Chris, how is the portfolio currently positioned and where do you see opportunities going forward? You mentioned senior housing, any other areas of interest?
Chris Bedingfield:
Yeah, I think another area that was again a little bit ahead of our expectation and where we've got a very sizable exposure to the portfolio is residential. We were certainly expecting a deceleration in residential rents and that's been happening in some parts of the market, but they're holding up way better than even we thought, particularly where we've got our big exposures, which is single family housing or standalone housing in the United States, where rental growth, particularly on new leases, are still holding up, high single digit type rent growth. We are seeing a collapse in new starts in the housing market and so rents are continuing to grow slightly ahead of our underwrites.
I think from a sentiment point of view as well, one of the things that we've noticed, and we wrote a paper on this about the global residential markets, we know the Australian residential market has turned around in the last few months, I think that's caught a few people by surprise. But the direct market of homes in the US is starting to turn around as well. Monthly increases are now being reported by the major indices, Case Shiller, Zillow, and we're starting to see that price growth occurring in the US market, just as much as we're seeing it in the Australian market, and we're also seeing it in Europe and also Canada as well. And this totally flies in the face of the conventional wisdom that interest rates, high interest rates is bad for residential. We push back against that quite a lot, particularly for longer-term investors, supply and demand really does matter and we are seeing that supply and demand in balance in residential markets around the world right now, not just in Australia, but in those other markets I've mentioned. And when you look at our portfolio we have, apart from the senior housing aspect, which we're excited about, we have a very meaningful exposure to that residential side of the market and we're pretty excited about that.
The other areas where the portfolio is positioned and we've taken a bit of a hit over the last 12 months, but it's really been sentiment driven rather than fundamentally driven, has been the European self-storage, we're continuing to see some very good occupancy and rent gains in those markets. Fantastic medium-term earnings growth, great long-term earnings growth, but from a sentiment point of view, Europe is very challenged, particularly the UK, and so from a sentiment point of view, that's kind of hurt performance on a rolling 12-month basis. But we have very high conviction in the European self-storage story, European self-storage is massively undersupplied relative to the Aussie market, relative to the US markets, and so we see great long-term gains there notwithstanding it's been a challenging pricing market. The way the share prices have performed, it's been challenging, but operationally they've been totally fine.
Mai Platts:
Excellent. And just to circle back and you mentioned with the rental growth in the residential market, we're obviously in this challenge of combating inflation across the various central banks. Where do you think that's going to level out?
Chris Bedingfield:
Yeah, I think it's really hard to say because it's all very different depending on the markets. You have very, very strong rent controls in Europe, particularly places like Germany, you have moderate rent controls in places like Canada – where we see both of those markets being structurally undersupplied for the foreseeable future because of those rent controls. They've been undersupplied in the past and we think they'll continue to be undersupplied going forward. The US is the interesting one because one third of US CPI is driven by residential rents and so anyone that's interested in the macro story right now, which seems to be all about interest rates and inflation, we have a fairly good idea what we can expect in terms of residential rents. They are coming down, they're decelerating from their high sort of mid double-digit type growth last year. They're now, as I said, the single family housing is getting towards that high single digit.
But then if you look deeper into those markets, particularly towards the south in the apartment markets, we're starting to see rents year on year start to print zeros and close to negatives. And so relative to last year, there has been meaningful deceleration in US residential rents. And because of the way the CPI is calculated, there is a lag between the rents that are being printed today and when they'll sharpen the CPI, that's typically about nine to 12 months. So I think anyone looking at the macro inflation story, you could probably pencil in some pretty decent sort of lower inflationary numbers driven by the residential side of the CPI over the next six to 12 months.
Mai Platts:
Thank you. And I know that you did address this in your Investment Perspectives in April, banking failures in the US and the potential impact on commercial property. Is this something that should concern investors?
Chris Bedingfield:
Well, I mean, anything to do with the banking system should concern investors and it should concern all investors, not just people in real estate. The banks, an extension of credit is the lifeblood of every economy, and as I said, goes well beyond real estate. What's interesting about the current situation is the market seems to be worried about real estate, but nothing else, which seems really strange to us because it's either going to affect everything or affect nothing. There is certainly, within the real estate space, very, very highly geared real estate in the system. Those assets are likely to, some of those assets will default at some stage, but that's not unusual in the banking market, certainly in the US banking market. The question is how manageable is it? And I think if you're in the listed real estate space, all you'd need to do is make sure that your companies have well-spread debt expiry profiles and are moderately leveraged, and those sorts of concerns, unlike 2008, should be not as big an issue this time around compared to last time around.
And that's really where our portfolio is. We interestingly, through the latest set of results, and remember the banking crisis started to occur in March, our companies by and large, were still able to access the debt markets, they've still been able to access credit through their banking relationships. We haven't seen any real major disruption yet in terms of what our companies are able to do. Not that they're doing much anyway, about 4% of our investees’ debt is up for renewal this year and much of that has been addressed by the first quarter already. So they haven't had much to do, but those markets and credit availability is still available certainly to our investees.
Mai Platts:
So what other concerns do you have, Chris, that keep you up at night?
Chris Bedingfield:
There's always the macro that you do worry about. I mean, as we're recording this, and maybe it will be resolved by the time it comes out, there's the, I suppose, the standoff on the US debt limit, I think that should be concerning everyone. I don't think anyone really has a full grasp as to what that would mean if the US was to default, and that's completely out of our hands, but it does worry me a little bit. I think at the investee level, the thing that always worries us is management decisions. And so we keep a pretty close eye on management behaviour and making sure that they do what they say and say what they do, and when they veer from that, that's usually when we start to have a look at that position and start to move out. So one of the things that does worry us is that, and we saw this during COVID, is you can get some management teams that panic and raise equity at the wrong price, sell assets at the wrong price. There's nothing we can do to stop them making those decisions. They lock in permanent capital loss when they make those decisions.
So they're the things that we worry about the most. I suppose we balance that by making sure the portfolio is nicely diversified across a number of names, so that any one bad decision doesn't hurt us too much. But that's at a macro level, I think, the US default is certainly top of mind, not that we can do much about it. What we can do is stay on top of our investees and monitor their actions and try and manage around any sort of decisions they make that we think creates a permanent loss of value for our investors.
Mai Platts:
Great. We might just wrap it up there. Thank you for your insights there, Chris. And thank you for listening today. If you do have any questions about Quay Global Investors or any of the funds, please contact your local account directors or contact the Client Experience team.
