Commercial property values are likely to fall as asset buyers look for higher returns from their investments to offset the rising cost of debt, according to Darren Steinberg, who is leading ASX-listed property heavyweight Dexus as it expands from real estate into infrastructure.
Mr Steinberg’s frank appraisal of the real estate environment came as Dexus announced it had finalised binding agreements to take over a large part of AMP capital’s funds management business, including close to $8 billion in commercial real estate and more than $10 billion in local infrastructure funds.
Dexus will have exposure to renewable energy such as Macarthur Wind farm in Victoria.
That exposure into infrastructure – the incoming funds include investment in renewable energy, schools, student accommodation and airports – is timely for Dexus, with institutional investors wary about commercial real estate as an anticipated reset in property values works its way through the market.
“We’re seeing very strong interest in the infrastructure space,” Mr Steinberg told The Australian Financial Review.
“While there is a lot of caution particularly in real estate, with regard to where valuations are going to sit and what is a good deal and a bad deal, there is still a very strong appetite for infrastructure.
“And as far as capital allocation globally, Australia is still seen as a very positive destination because of population growth, economic growth and its position in the global context.”
The AMP Capital deal will cost Dexus $225 million as long as AMP can sort out regulatory issues associated with a funds management company it set up in China which is to be excluded from the deal with Dexus. But if AMP fails in that condition by September 30 next year, it will forfeit a further $50 million it was due to collect from Dexus.
Led by Mr Steinberg, Dexus has been steadily diversifying its platform, into alternative real estate sectors, such as healthcare property, and into funds management. The AMP capital deal should boost Dexus’ recurrent earnings through funds management fees as well as its exposure to infrastructure, a sector which many investors allocate into as part of a broader real assets strategy.
As previously separate categories of infrastructure and real estate are brought under a single real assets banner, Dexus will be in a position to respond to more of its wholesale investors.
“It’s a pivotal day for Dexus to finalise this transaction,” Mr Steinberg said. “It is basically a step change for Dexus, confirming our transition to a fully integrated real asset manager with over $60 billion assets under management across Australia and New Zealand.”
Commercial real estate values have come under renewed attention in the past week after banking crises in the US and Europe turned the spotlight on the issue of the losses crystallised when long-dated assets – such as bonds or real estate – are marked to market.
Mr Steinberg said Dexus had effectively bolstered its balance sheet to accommodate the changing conditions, selling down $9 billion of assets – $5 billion from its balance sheet and $4 billion from its managed funds – over the past two years.
“We got ahead of the curve in that respect and are appropriately geared to deal with the impacts of valuations, moving forward,” he said.
The era of cheap debt had emboldened investors to bid up the value of real estate, effectively squeezing total returns to between 5 per cent and 6 per cent in recent years, Mr Steinberg said. But as the cost of debt rises investors are expected to reduce the prices they are willing to pay, and according to Mr Steinberg total return expectations for real estate would revert to their long-term average of about 7 per cent to 9 per cent.
“If the total return changes from 5-6 per cent to 7-9 per cent in line with long-term averages as a result of normalised interest rates, then that is telling you that valuations will soften.”
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