The kind of property you'll want to own as rates rise

Andrew Schwartz, Group Managing Director and Co-founder of Qualitas, suggests that, while apartments won’t be immune, they may have less room to fall. And with good reason. Apartment living is growing in popularity for a range of reasons and we currently have a housing supply shortage. In fact, supply and demand has even changed the financing dynamics.

“Groups like ours have to take a more open view on the ability to finance large-scale projects with less pre-sales than we normally would have liked. It feeds into the fact that once buildings are completed, you tend to see very rapid sell-down of completed apartments,” he says.

In this edition of Expert Insights, Schwartz discusses the trend toward apartment living, why prices may not fall much, and his tips for exposure to the sector.

Can you discuss the trend toward apartment living?

We’re seeing increased demand for apartment living and it’s because it plays to the affordability of the actual dwelling itself. The fact that most apartments are located within the inner ring of major capital cities can represent a really exciting way for people to live. 

It’s as much about the amenity of the buildings as it is about the actual apartment itself. 

For those reasons, I think we’re seeing a continuing trend toward people who really desire that type of living.

Did the COVID-19 lockdowns result in any change to the trend?

COVID really forced people to look at the type of dwelling that they most wanted to live in because people were forced to live at home. Therefore they had to think about the size of the actual living areas they were currently occupying. Interestingly, the statistics for household size have been reducing since COVID and one of the reasons for that is people stayed home so they wanted more area to live with. It probably changed the lens through which people were looking at apartments. I wouldn’t want to overstate that, but I think that’s one of the effects of COVID.

Will apartments buck the trend of falling property prices?

I wish I had a crystal ball to answer that. I’ll give you my personal opinion. I don’t think they’ll be immune to a general systematic fall in prices. I think that would be an unrealistic comment to make. What I do think is that, if you look at the price gap between houses and apartments, it’s very large in favour of houses.

If you go back to 1974, the relativity between a house and an apartment was about 1.3x. If you fast forward to today, that same relativity between the capital value of a house to an apartment is about 2.3x. 

Houses have grown with a much greater upside relative to apartments over the last 40-50 years. Due to that gap, apartments have less room to fall than traditional houses.

I also think the lack of supply in the market and the need for further development of apartments means that development will be difficult unless values hold, if not increase. My personal belief is that falls in apartment prices will be more limited. My longer-term view is quite positive on that asset class but in the short-term, there is a bit of recalibration there.

What has the trend towards apartment living and supply/demand challenges meant for investment returns?

In the past to get a lot of these projects off the ground, you had to pre-sell apartments before you start construction. At the moment, we’re in an environment where construction company costs are going up in price for all sorts of reasons. Increases in raw material costs, difficulty of labour, the need to price in risks of COVID lockdowns.

Prices have been going up and therefore developers are more reticent to lock in pre-sales prior to actually having a construction contract in place because your revenue based on your costs may not actually be feasible.

What we’re finding at the moment is groups like ours have to take a more open view on the ability to finance large-scale projects with less pre-sales than we normally would have liked. It feeds into the fact that once buildings are completed, you tend to see very rapid sell-down of completed apartments.

We’re relatively comfortable looking at those situations. There are ways of structuring our positions and investments to grow with pre-sales over time, but also looking for a different debt-equity mix in the projects so they can sustain a lower level of pre-sales. That’s the theme going forward.

Can you discuss some investments you have in this space?

We’re a very large construction financier. Outside of the banks, Qualitas would be one of the largest alternative financiers for project finance. 

For us, it is about large ticket funding of new constructions and that’s a wholesale institutional product. At the lower end, it’s about providing investment loans for those whole portfolios of assets and our ability to take a more flexible approach to those investments.

What recommendations do you have for investors looking for exposure to this sector?

My main recommendation is to go with managers you feel have the depth of experience through multiple cycles and assets. Real estate assets behave differently whether there are high interest rates, low interest rates, lots of liquidity, or low liquidity. It varies depending on investor sentiment. Work with managers who have seen different asset classes – office, residential, hotels – and how they perform in these varying dynamics.

Ultimately when you give a loan to a borrower, you will traverse economic cycles and understanding how your asset will behave is really important in terms of your loan sizing.

My biggest advice is to pick a manager you feel has that type of multi-decade, multi-cycle experience.

This is the final part in a three part series of Expert Insights with Andrew Schwartz from Qualitas. You can read the other two parts below:

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