This article originally appeared on PERE and has been reproduced here with permission.

In a recent interview with PERE, fund managers Brad Collier (DWPF) and Andrew Jeffs (DWSF) discuss the evolving role of core real estate, the importance of active asset management and why Australia continues to attract global investor interest.

The discussion explores portfolio construction, liquidity, supply constraints and the increasing importance of asset selection in generating investment performance.

Australia’s population, stability and constrained supply continue to draw international capital, but success in today’s core market depends less on allocating to the right sectors and instead selecting the right assets, say Dexus’s Brad Collier and Andrew Jeffs

Core real estate remains the cornerstone of institutional portfolios, but its role is evolving in an increasingly selective and supply-constrained market. Stable income is the goal, but portfolio management requires more active asset management and greater flexibility on liquidity, explain Brad Collier, fund manager of Dexus Wholesale Property Fund (DWPF), and Andrew Jeffs, fund manager of Dexus Wholesale Shopping Center Fund (DWSF). Investor priorities are shifting, yet Australia continues to attract capital as disciplined asset selection and operational expertise reshape the definition of a resilient core real estate strategy.

Q How is the role of core real estate evolving, and how are investors redefining core portfolio allocations today?

Brad Collier: Core real estate has traditionally been viewed as the foundation of institutional portfolios. International investors, in particular, are attracted to a diversified core fund when making their first investment into Australia because it gives them instant, tax-efficient access to the market. Plus, these core assets are tightly held, so it is not easy to get this type of exposure. Domestic investors like large Australian super funds are using core pool funds to create beta exposure and achieve their allocation outcomes. Core real estate continues to play an important role in portfolios, but with an increased focus on asset quality, resilience and long-term cash flows versus broad exposure.

Andrew Jeffs: Traditionally, core real estate delivers stable income, and that is something our investors continue to value. Long-term value is driven in the core space by income growth and high levels of occupancy. Our shopping center fund, DWSF, is around 98 percent occupancy, which means we can deliver consistent income. The other side of the equation is the major supply constraint in real estate. We have a lack of new supply because a lot of construction workers are put towards infrastructure projects. That impacts all real estate; there are no meaningful deliveries across the retail sector, and we expect that trend to continue. So, investors invest in these funds to get access to the assets. Even if investors have capital to deploy, it does not necessarily mean they can buy a high-quality core asset because of constrained availability.

Q How are managers balancing core portfolios between traditional asset classes and the growing range of alternative property types?

BC: DWPF has had a focus on gaining exposure to alternative sectors for over five years. We recognize that multifamily, especially in the US, is a large part of the institutional real estate sector. We expect Australia to evolve in that direction. We believe alternatives are becoming more institutional and are playing a larger role in the Australian market. The increase in construction costs and high levels of private investor ownership have made build-to-rent difficult. There are helpful thematics, like population growth, and there is strong desire to get exposure to the living sector in Australia, but it is difficult to find the returns. Like other parts of the world, Australia has an aging population, so healthcare and senior living will benefit from that trend over time.

AJ: Our retail assets have large land holdings and are situated in metropolitan locations. The benefit of that is they have development sites that look like car parks, but are really an opportunity to introduce more mixed-use offerings, such as medical or residential uses. Construction cost is a major challenge, but when we look at feasibility studies, holding the land makes it much more feasible than an open market deal. There is strong synergy between residents and shopping centers. From an income perspective, this has the potential to deliver greater growth for our investors.

Q How has the approach to portfolio construction changed over the past few years, particularly as economic conditions and investor priorities have shifted?

AJ: We have continued to refine our portfolio, divesting assets that no longer meet our strategy. What we are seeing now with a higher quality portfolio is that these assets are somewhat immune to the impacts of online retail, with retailers in these assets adopting an omni-channel approach for their customers.

BC: Development is very difficult because of high construction costs. In office, economic rents are 20 percent above market rents. It is almost impossible to start construction of a new building unless you can find a tenant to pay a premium. This market dynamic will support rental growth. Over time, there is a real opportunity for funds with embedded development opportunities. Maintaining development exposure has been a key part of our strategy. Around 45 percent of our portfolio is either the product of ground-up development or has gone through major redevelopment.

Q How important is geographic diversification in the current environment, and what role does Australia play within a global real estate allocation for core investors?

AJ: Geography is a key dimension of portfolio construction. Offshore investors – in particular those from Europe and Asia – see Australia as a way to expand their diversification. Foreign capital remains attracted to Australia, driven by a number of favorable demand drivers. One is the population growth, which is four times the OECD average. Political stability is another key factor, supported by strong governance. That is an absolute positive. As a region, Australia screens well.

Q What are the biggest liquidity challenges facing core real estate portfolios today, and how are managers adapting?

BC: Liquidity has become a central topic for many investors and they are placing increasing value on flexibility. At the end of the day, real estate is a somewhat illiquid asset class. We have had some redemptions over the last three years, and we have resolved those through strategies including secondaries and a small amount of debt where required. One main strategy here is divesting assets that are less desirable, which has allowed us to maintain the quality of the portfolio and only use a small amount of debt, all the while maintaining our performance. We are in a part of the cycle where the secondary market plays an increasingly important role in facilitating liquidity for investors. Over the past 12 months, more than half of the fund’s redemptions have been satisfied in the secondary market where we have seen a billion dollars of units taken up by both existing and new investors. We expect the secondary market to remain an important component of the fund’s offering going forward.

Q Where do you see the greatest opportunities to create value through active management today?

BC: Active asset management has become more valuable in a higher-cost, lower-growth environment. Over the past 12 months, we have seen office, retail and industrial each have a period of stability in terms of yields, in addition to strong rental growth in quality assets. There is some recognition that we are at the bottom of the valuation cycle, and so performance is going to be about asset selection rather than sector allocation. There is no immediate upside of cap rate compression, so you need to sweat every asset as hard as you can. Active asset management can drive returns at all levels. Property management, superior leasing outcomes, prudent cap-ex and identifying development opportunities are what drives performance. Real estate remains a local game requiring on-the-ground local knowledge and market insights.

Our office building Gateway at Circular Quay in Sydney has been in the fund for the full 30 years since inception, yet it continues to achieve some of the highest office rents in Australia. That is because of the strategic approach to reinvesting in the asset and creating a diversified tenant profile. We saw a super cycle in industrial during the pandemic, and we remain focused on capturing the positive rental reversion opportunities available.

AJ: In our high-quality retail assets, our department stores have been downsizing. We see that as an opportunity to introduce new tenants into the centers. Quite often, those are international retailers or successful domestic retailers moving to larger stores. We have seen the performance of those assets increase.

Q How can decisions around sector exposure, geography, liquidity and asset management ultimately come together into a core investment strategy?

AJ: Our focus is on maintaining and driving the assets hard. On top of that, we layer on two very important things. One is executing on a development pipeline, and the second is having strong partnerships in the market to unlock opportunities others are not able to – for example, through our joint venture with Scentre Group (Westfield). Then, it is all about asset selection, making sure an asset ticks all the boxes. If it will be relevant in the future, if it can adapt to emerging technology, if it can take advantage of expected population growth, or if it has embedded development opportunities.

BC: Our research combines top-down thematics in every sector with bottom-up, asset-level modeling. This is key to identifying where the next opportunities for rent growth and performance exist.

“Performance is going to be about asset selection rather than sector allocation”

BRAD COLLIER

“Long-term value is driven in the core space by income growth and high levels of occupancy”

ANDREW JEFFS