Prime office space and housing face tough times: Franklin Templeton

Wilson Magee joined Franklin Templeton in August 2010 as portfolio manager and director of global Reits. He is responsible for the management of listed real estate securities portfolios, and the firm runs a global and a US Reit fund.

Magee was previously president and portfolio manager for Colony Investment Management and, before that, a portfolio manager at Goldman Sachs Asset Management and Grantham Mayo Van Otterloo and an investor at AEW Capital Management.

He has managed US and global real estate securities portfolios since 1997. He has had experience in public and private property investments since 1981.

Magee spoke to AsianInvestor during a recent trip to Hong Kong.

What's been your reaction to the recent turmoil in Europe?
Fortunately for us, our largest underweight from a geographic perspective since the start of the year has been mainland Europe ex-UK, and we've been market-neutral UK. So we haven't had to shift our positions much following events in the past few months.

We're underweight European property to the maximum of our risk controls right now across most property sectors. However, within Europe, we're overweight retail, because the retail property companies have been doing much better.

Certain companies have dominant property franchises in Europe, such as Unibail-Rodamco in France. It's in our top 10 holdings and is our largest position in Europe. Unibail-Rodamco owns very, very successful, large and dominant retail centres, which have been seeing like-for-like rental growth and sales growth – not huge growth, but certainly positive.

How about UK real estate?
Central London is doing very well – particularly the West End. Our exposure in the West End has been through companies that have a much lower rent per square foot than the headline prime rent. By comparison, the two West End specialists we invest in have average portfolio rents ranging from £27–£36 per square foot annually versus the prime building rents of £92 per square foot. 

West End rents should hold up much better than office rents in the City of London, because the sub-market is much less financial services-orientated. Also, there's a bit more construction going on in the City.

That's been one of our investment themes – almost everywhere in the world, and particularly in office markets, there has been virtually no construction coming out of the financial crisis of 2008. For real-estate rents and prices, the most damaging trend is significant supply increases.

Even in Hong Kong, where you have a bit more building than elsewhere, supply numbers are way below long-term global averages, and way below peak supply years. The average annual grade-A office supply for the next five years is only 1 million square feet compared with 1.8 million square feet over the past 10 years [according to Savills Research & Consultancy]. And there's very little building going on in Central [in Hong Kong].

What are your views on Asian real estate?
From a supply-demand/rental growth perspective, the Asian markets are still very attractive, and that includes Hong Kong. But we're starting to see a few signs of slowing in the office market in Hong Kong's Central district. That doesn't mean rents won't grow; it's just that they were growing at such a rapid rate that those growth rates are slowing significantly.

We also like office space outside of Central where the rents are much lower and the demand has a different, less financial services character to it.

In fact, office markets in all the major financial hubs – Hong Kong, London, New York – are going to be a touch more challenging, with lower rental growth, because the financial services companies may cut expansion plans or even reduce headcount. That will become a factor in the next 12 months; it won't be as positive as it was.

What about sectors other than office property?
Retail property is more attractive than offices in Hong Kong; it's a very strong sector and projected to grow rapidly. Hong Kong retail sales remained very positive, up 29% year-on-year in August. Prime retail rental was up 8.8% year-to-date, according to Jones Lang LaSalle, and rental growth doesn't seem to be slowing all that much – although rents were rising so fast that it would have been impossible for them to keep growing at the same speed.

And how about residential property?
We are significantly underweight Hong Kong housing developers – with our preference being companies with exposure to the retail and office markets. We are also underweight Singapore housing developers, but overweight Singapore Reits. And we don't have much retail property sector exposure in Singapore.

Also, starting last year and continuing through this year we have eliminated almost all our for-sale housing development exposure in Australia, because it's gotten to be a much more difficult sales environment, despite the economy being relatively strong. This is partly related to the high level of consumer debt in Australia; consumer mortgage rates are variable there, so there's a fairly high cost of borrowing today.

We're also not invested in US for-sale housing.

Why are you underweight Hong Kong and Singapore housing?
We felt growth rates were better in commercial properties and a touch more sustainable, given the rapid price increase in the housing market following the financial crisis. Hong Kong residential prices have gone up more than 70% since the beginning of 2009.

Also, on the commercial property side you have leases in place, so there's a bit more security as to the underlying fundamentals. When you're selling housing, it's subject to policy changes, such as the recent price-cooling measures in China and Hong Kong. Interest rate changes also have a direct effect on housing prices.

Why do you have relatively little retail exposure in Singapore?
Because of supply. There were some new prime retail developments completed in late 2008, increasing competition for tenants and customers in this sector, thus making it less attractive. Suburban retail is more resilient, partly because prime retail is much more discretionary.