Why the "flight to quality" is a crowded (and often confused) investment

As any good bargain hunter (or shrewd investor) will tell you, quality can but does not always immediately command a premium price. 

In the equities arena, some stocks are considered to have high-quality earnings and top-quality management teams but do not possess expensive valuations. In fixed income, we often think of investment-grade companies having debt that costs more to buy, to begin with, because analysts perceive these businesses have far lower default risk. 

The same applies to commercial property. In the last two years, commercial property asset valuations have re-rated dramatically - especially in lower-grade or less premium office offerings where the death of the office has been sounded time and time again. 

But, as Colin Mackay of Cromwell Property Group would tell you, premium properties and premium valuations don't always go together. 

"I think if you conflate luxury or price with quality, then you're actually ignoring the needs of most occupiers in the market. Most occupiers are after a Toyota, not a Rolls Royce," he said.

So what does this analogy mean and how is it shaping the landscape for property investors? Find out in this episode of The Pitch.

EDITED TRANSCRIPT

Hans Lee: Firstly, how do you define the "flight to quality"? Secondly, how is Cromwell thinking about it?

Colin Mackay: The flight to quality has certainly been a popular phrase this year but we think it's been misconstrued as a flight to premium. We actually looked at the data and the premium segment of the market has actually seen the biggest increase in its vacancy rate since the pandemic began. We do agree that a flight to quality is occurring, but it's occurring across all grades of office, and not just the top end of town.

Lee: What are the types of things occupiers are now looking for?

Mackay: Some requirements stay the same. I think they'll stay the same, no matter how space usage evolves. That's things like the availability of natural light, accessibility to transport, and proximity to amenities. They'll stand the test of time.

Lee: Why are occupiers looking for these types of things? How have you been identifying the trend?

Mackay: I think they've really re-evaluated the purpose of the office and what they want to use that space for. So, with work-from-home being more prevalent, the purpose of the office has shifted much more towards collaboration, incidental interaction, and developing and building culture in the workplace. 

Maybe you don't need to house all your employees on one level. You may have three levels but across a smaller footprint, there is a better buzz about the office. But as I said, some of those things are linked to human nature. We all want natural sunlight. 

But on that point, with the use of space evolving, we are seeing greater demand for things like embedded technology. We need more technology in the space so that you can facilitate that flexible way of working. We're also seeing things like a greater diversity of spaces. Being able to facilitate focused work as well as collaborative work. It's constantly evolving.

Lee: What about ESG credentials, where do they sit in the pecking order and are they growing in prominence?

Mackay: ESG continues to rise in prominence. We're seeing it become more important across a range of stakeholders like investors, occupiers, and regulators. At the moment, the focus is on operational efficiency - water, waste, and energy consumption.

Lee: How is this manifesting in terms of the opportunities you pursue - can you provide an example?

Mackay: We continue to view A-grade space quite favourably. It's a bit cheaper than premium, so it appeals to a broader pool of occupiers. But you still typically get that really good access to transport, proximity to amenities, high-quality space, natural light, and things like that.

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