Capital's shift into alternative real estate

JLL Report suggests that it is inevitable that institutional capital will move into new or ‘alternative’ real estate sectors as core sectors simply will not create enough new assets.

July 30, 2018

JLL is predicting that the movement of institutional capital into ‘alternative’ real estate assets such as retirement living, private hospitals, self-storage, data centres and renewables will only grow over the next decade.

Analysis by JLL in its Report, ‘New Frontiers: Capital's shift into alternative real estate in Australia’ highlights some of the mega-trends underpinning demand fundamentals across many alternative sectors longer-term.  The report also examines the benefits to major investors of adding cashflows to their portfolio that can be very stable and less correlated to core sector incomes. 

However, it is a shortage of asset creation in the core real estate sectors of office, retail and industrial that JLL believes will make the shift to alternatives inevitable. 

The report estimates that capital flowing into Australian real estate will most likely grow at a rate in excess of 7.5% per annum, but the stock of core real estate investments will grow at best by 4-5% per annum. 

JLL National Director of Research, Leigh Warner said, “At present, office and retail investments comprise over 85% of institutional investment in Australia. Structural and secular trends currently impacting on both sectors means that we simply will not need as much new office and retail space as we have done in the past.”

JLL’s National Head of Alternative Investments, Noral Wild said, “Consequently, investors will be faced with three choices – continue to pay more for core real estate, go offshore or find new alternative real estate sectors to invest in. The most likely outcome will probably be a combination of all three options, but we believe that there is little doubt that institutional investment will have to move into new sectors long-term.”

Mr Warner said, “There is always some question of whether movement into alternatives is just a late-cycle trend when strong capital markets crowd many investors out of the core market. But abstracting from cyclical factors, we firmly believe that the long-term drivers of capital into alternatives are strong.” 

Ms Wild said, “This will create opportunities for early movers, both institutional and private, to capitalise on this long-term trend, but investors need to realise it will not necessarily be a smooth ride at all times and they will have to invest time to learn the idiosyncrasies of each of these emerging sectors.”

The JLL report analyses the strengths, weaknesses, opportunities and threats for the alternatives asset sectors of retirement living, aged care, private hospitals, child care, self-storage, student accommodation, agriculture, data centres, build to rent residential and renewables.

Alternatives sector life-cycle and the path to maturity

The JLL Paper also analyses the path to maturity for alternative real estate assets.

Ms Wild said, “With institutional investors having ever-increasingly large amounts of capital to allocate, the ability to achieve scale is a very important determinant of an alternative sector’s potential to institutionalise.

“The potential to institutionalise is lower for sectors where the total size of the market is relatively small and fragmented ownership makes them hard to aggregate.  Nevertheless, these sectors that remain niche can still provide private and smaller investors, which are increasingly being pushed out of core sectors, with a good opportunity to invest or develop more competitively.”

“History in Australia and other markets shows that some markets will never grow beyond niche, while the path to maturing can be a bumpy one,” said Ms Wild. 

However, according to Mr Warner, “For those sectors that can facilitate institutional investment, one of the major attractions for large investors is the stability and counter-cyclical nature of cashflows. In the core sectors, cashflows are all generally highly cyclical, so adding in more stable or counter-cyclical income streams can add portfolio performance benefits.”

The megatrends influencing alternative sectors

The JLL report analyses the megatrends influencing the rise of the alternative real estate sector in Australia and has classified by sector which big-picture themes the rise is playing to.

Greater urban density and population growth is the biggest driver influencing the rise of alternatives, followed by an ageing population, housing affordability and technology.  Rising Asian middle class demand is also having an effect.