Why the true value of real estate comes back to the cost to rebuild

He notes that in a hot market, everything could look cheap compared to the last sale – but in reality might be expensive.

“The way we think about it is how much we’re paying per square metre relative to how much it costs to rebuild that very same property. If you think about it in that context, you’ve got a better chance of preserving the downside of your investment and capturing some of the upside over time,” Bedingfield says.

Quay applies a strict definition to the properties it invests in too. For example, there are no developers or real estate companies with a reliance on funds management.

“We’re looking for buildings that have been built, are preferably priced below replacement cost, where the tenants are in place and the cash flows are known,” Bedingfield says.

The possibility for a property to have alternative uses is also critical. He describes it as real estate’s “get out of jail free card” if something goes wrong with the original use.

In a challenging property market, now might be the time to get back to basics on global real estate investing. In this edition of Expert Insights, Bedingfield shares how Quay values and identifies properties, and the triggers he and the team use to know when to sell. 

Edited transcript:

What does the global real estate market look like?

Globally, the real estate market is incredibly diverse. It's around $2.5 trillion of market opportunity. Think of global real estate as being the size of the Australian Stock Exchange.

You have your traditional sectors like retail and office and industrial, but it also encompasses really interesting asset classes such as student accommodation, senior housing, triple-net lease, self-storage and data storage. These are asset classes that are really interesting and pretty unique in the Australian context, but also have a very powerful long-term global thematic setting behind them.

How do you evaluate properties to invest in?

In most cases, the best way to think about real estate is to think about it relative to its replacement cost. I think the big trap or the go-to methodology for valuation in real estate for a lot of people is you look at a comparable sale.

Using an Australian residential is a great example. 

You're going to buy an apartment. First thing you ask the agent is, "Well, what are the comparable sales?" You're trying to triangulate around that. That leads you a bit down the garden path, because if the market's super hot, everything looks cheap relative to the last sale. But everything could be absolutely expensive.

The way we think about it is how much we’re paying per square metre relative to how much it costs to rebuild that very same property. If you think about it in that context, you’ve got a better chance of preserving the downside of your investment and capturing some of the upside over time

What qualities do the properties you invest in share?

The way we define real estate is real estate that's been built and tenanted and has a history of cash flows. 

So we stay away from developers, not that that's a good or a bad model, it's not really rent-based, it's transactional-based. And we also stay away from real estate companies that rely on funds management income. Feels a little bit more like financial services than real estate.

We’re looking for buildings that have been built, are preferably priced below replacement cost, where the tenants are in place and the cash flows are known.

The other part of the way we define our universe is that real estate has to have an alternative use. It might not be a better use, but it has to have an alternative. 

That's how we define real estate compared to other sectors because there's a messy crossover between infrastructure and real estate. For instance, cell towers are in the real estate index. I have no idea why. We don't invest in them because it doesn't fit that alternative use criteria. If something goes wrong with the industry, you can convert the land into something else which is real estate's 'get out of jail free card' in many instances. 

Those are the two common threads across our investments.

What would lead you to exit a position?

Nine times out of 10, it's price. 

Our philosophy and our approach is a CPI +5 total return. If we feel that company no longer can deliver that, we will exit that position. Sometimes those positions are exited out of our hands. We've had almost 10 companies in our history that have been taken over. Sometimes we've been happy to see them go, sometimes not. But in a '22/'23 stock portfolio, there have been quite a few where it's not been up to us.

Other reasons include if the thematic changes or the story changes. Companies can sometimes change their strategy. That might not align with what you are seeking to achieve within your portfolio, so there are times like that you would exit as well.

Have you exited any positions in the last year?

We had a data storage REIT that was taken over around 12 months ago. Around six months ago, we had a triple net lease company called STORE Capital that was taken off our hands.

We've also taken the opportunity of a pretty strong rally in Hong Kong to reduce our exposure there. The demographics in China are turning, that's probably going to feed through to Hong Kong. And we took an advantage of some pretty weak pricing around the world to reallocate.

You hold a concentrated portfolio of 24 stocks. Why?

The research we've done is that once you get up to a 20 stock portfolio of truly random stocks, around 75-80% of all the diversification you're going to achieve is going to be at that point.

So when you think about portfolio construction, your very best idea goes in first. Your second best idea goes in second obviously, but it's diluting your first idea. But the benefit is you're getting some diversification. So there's a trade-off as you build your portfolio. Once you get to 20 securities, around 75% of all of your diversification is going to have already occurred.

It becomes a really high bar to start adding more and more stocks at that point. Once you get past 40 stocks, about 95% of all the diversification you're ever going to have is at that point. In our minds, it's somewhere between that 20 and 30 stock portfolio. We're at 24 today. We have been as high as 27. We've been as low as 20. That's where you get most of your diversification in. If you measure volatility by standard deviation over nine years, we're no more volatile than a 300 stock portfolio.

What are your tips for real estate investors?

Do the work. 

First of all, I think it's a really inefficient market. It is the size of the Australian share market. The number of people trying to analyse the Australian share market is multiple times the number of people trying to analyse global real estate companies. The opportunities are there, just be open.

Open your mind to different sectors and different geographies because those are usually the ones that are less picked over and offer the most interesting returns.

Investing in global listed real estate

Quay Global Investors, a Bennelong Funds Management boutique, focuses on the preservation and creation of wealth through innovative strategies in real estate securities. For more insights on global property, visit Quay’s website.

Managed Fund

Quay Global Real Estate Fund (Unhedged)

Global Property

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Managed Fund

Quay Global Real Estate Fund (AUD Hedged)

Global Property

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