The ability of superannuation funds to take sizeable positions in offshore assets has opened up new avenues for holding investments that offer distinct advantages over the traditional vehicles favoured by the industry.
Real estate operating companies (REOCs) are one example. This proven investment structure allows funds to build a position in US property that captures the dynamics most likely to drive returns while affording super funds similar benefits to direct ownership.
In simple terms, an REOC is a private real estate company in which an institutional investor holds either a majority or minority share alongside an operating partner. Such an approach gives the investor a higher level of control in two ways. First, investment control is optimised via a seat on an REOC’s board, and second, shareholders have oversight of operational considerations such as staffing levels.
Investments held via an REOC could deliver attractive risk-adjusted returns which would typically be higher than a single asset purchase or joint venture structure, depending on the property sector and strategy that underpins the portfolio.
The expanding opportunities in REOCs give super funds the ability to build a customised allocation to the fastest-growing sectors in the global property market, including those which are not well represented in Australia real estate.
This includes relatively well-known sectors which have captured headlines in recent years – such as logistics, data centres, medical centres, and grocery retail. It also includes all form of affordable housing – a part of the US market expected to perform well due to an acute housing shortage and demographic tailwinds.
Let’s consider single-family build-to-rent projects. This is an established market now gaining the attention of institutional investors.
Such projects typically will consist of 160 to 200 small freestanding homes of 1,200 to 1,800 square feet, catering mostly to 30-to-40-year-olds with families. The targeted cohort typically no longer want to live in apartments but can’t yet afford to purchase a home themselves.
Single-family build-to-rent developments instead provide them with three to four bedrooms and small backyards, alongside community amenities such as a clubhouse and pool.
The US SFR market is comprised of less than 5 per cent institutional ownership and given strong projected demand fundamentals for this property type, the market is likely to experience strong rent growth – potentially exceeding multi-family rent growth over the next five years.
An REOC is an ideal platform for a super fund to gain exposure to this sector as it grows in prominence alongside multi-family build-to-rent, as well as exposure to other parts of the US market as it moves towards a potentially better 2024.
An REOC could deliver more exclusive or permanent access to real estate transaction pipelines, rather than forcing investors into a queue and sometimes missing out. It also allows a super fund to tailor solutions which meets its appetite for financial leverage or tax efficiency.
As super guarantee contributions push total superannuation assets ever higher, it’s likely more funds will have the US$250–300 million minimum investments necessary to add REOCs to their investment arsenal.
An REOC is a 10-to-20-year investment, though this long-term ownership resonates well with US stakeholders seeking a semi-permanent source of capital and certainty of execution. And an ultimate exit from an REOC via an initial public offering or trade sale may create enterprise value to supplement the gains from property investments.
Of course, the ubiquitous risks that come with any investment structure must be considered. As an investor is the majority shareholder in an REOC, it also bears responsibility for its workforce and the obligations that come with it. This requires boots on the ground in the US to ensure the entity is run efficiently and properly governed.
But, generally, the potential extra returns more than compensate for these risks. The US$18 trillion US commercial property market is perhaps the most diverse and liquid in the world. And super funds are one of the few entities with sufficient firepower to maximise its benefits through REOCs.
Rod Vogel, senior managing director, Principal Asset Management
