This interview was by Layton Holley and first published in Green Street News Australia: Q+A: How a Dexus fund turned the corner after two tough years - Green Street News

After a bruising two years marked by rising interest rates and declining property values, Dexus’ $1.9bn Wholesale Australian Property Fund has reported a turnaround. For the 12 months ending March 31, the unlisted fund delivered a 7.22% return, with a 2.36% return recorded in the first quarter. That follows returns of negative 8.77% in 2022 and negative 2.87% in 2023.

Green Street News spoke with fund manager Christopher Davitt about how the fund turned the corner, the opportunity it sees in retail properties and why it is less excited about the office sector.

Tell us how the fund has turned things around over the past year.

If you go back to 2023, that was the point where we saw the global outbreak of inflation. Interest rates adjusted quickly. We’ve now had around 20% to 25% cumulative inflation, but construction costs are up more closer to 35% to 40%. Because rates have risen, values have come back.

That sets up an interesting outlook. Fundamentals like low unemployment and strong population growth are still good. Portfolio occupancy is strong, giving around a 6% yield. With fixed growth built into leases, you should get around 2% capital growth. So if you’re doing 7% to 9% through the cycle, we’ve now come through a rough period and wouldn’t be surprised to see us at the upper end of that range to make up for lean years.

What specifically has driven the 7.22% 12-month return?

One is that we get all our properties valued quarterly. We haven’t had our head in the sand. We hit the bottom early, and valuations have been growing for the past 12 months. The properties we invest in – $20m to $200m – have more transaction volume, so it’s easier for valuers to track the market.

We’ve sold older properties and exited some smaller markets like Canberra and North Sydney. At the same time, we’ve brought in newer assets, like The Mill in Alexandria.

What’s interesting about that asset?

The Grounds is a pretty unique hospitality offering. That’s the marquee tenant. But it also includes retail – Lululemon, MJ Bale, etc. – and those tenants are doing very well.

The largest tenant is AbCellera, a Canadian biotech group. They’ve got about 150 scientists working in a P2 lab on new medicines. It’s not just an office with a Petri dish – it’s a proper lab, with all the infrastructure. That’s the kind of alternative asset we’re looking at.

Tell us more about the strategy behind asset sales and acquisitions.

As rates rose, some investors wanted to leave. Providing them with liquidity within 12 months became a priority. So we sold older assets and those in smaller or tougher markets. At the same time, we held onto all our retail – great income yield and 98% occupancy even through Covid.

We’ve brought in newer assets too. In Brisbane, we acquired two industrial properties on the Trade Coast. One is leased to Visy for 15 years. They’ve invested more than the building is worth [$95m]. That facility was opened by the Pratts in late 2023. It’s bulletproof cashflow.

What lessons have you taken from the past few years?

The big event at the moment is clearly all this uncertainty around “Liberation Day.” I think there are a couple of things that have come out of that.

Firstly, having assets that are regularly valued but not daily valued can chop out a lot of the volatility – and that really counts at the moment.

But the less obvious thing is the volatility on income. We’ve got 300 and something tenants now. With an event like this – doesn’t really matter what it is – none of us could have foreseen 9/11. We didn’t foresee the pandemic. We probably didn’t see Liberation Day playing out the way it has either. So no matter how good your tenant is, they can always be vulnerable to some sort of shock that no one sees coming.

Their profits can be impacted immediately, but their lease obligations – and having that security of income that’s attached to a lease, with a staggered profile – those are the sorts of things that take a time like now to really value.

How does defence play into your strategy?

Defence is a really interesting one. Outside the eastern seaboard, we’ve only invested in Adelaide, and that was to play a theme of aerospace and defence. We bought a property in Mawson Lakes seven or eight years ago. And to me, that’s coming to pass now.

If it weren’t for the tariffs, I think defence spending would be the mega-theme of 2025. Countries around the world are looking to shift their spending from about 2% of GDP up to about 3%. You’re talking trillions of dollars having to move to accommodate that.

There doesn’t seem to be any opposition in any country – including domestically – to that shift. You might debate what the money’s spent on, but broadly there’s bipartisan support. On top of that, we’ve got Aukus coming, and that’s going to bring not just the shipbuilding but all the required R&D, workforce development and infrastructure build-out.

The asset we’ve got over there really plays into that. The tenant has that mindset and that kind of customer base. It’s a long lease, but more than that – it’s aligned with a national priority.

Where are you most optimistic in 2025?

That replacement cost gap is the key theme. It’s most pronounced in Southeast Queensland. There’s infrastructure spending ahead of the Olympics, population growth and pressure on residential. We like retail in that region. Revenue has risen through inflation, and with low unemployment and rate cuts coming, retailers are in a stronger position.

You’re coming into a period where retailers’ revenues have gone up just based on inflation – cumulatively around 20% Typically, rent is a function of turnover. In many cases, gross occupancy costs have come down, which suggests there’s room for rents to grow.

Anywhere you’re avoiding or more cautious about?

We’ve reduced our office exposure from 36% to 37% to around 15%. We’re happy with what we’ve kept, but there’s no rush to dive back in. I don’t think there’s the investor demand that would want us doing that in any meaningful way soon. You still have to make tough decisions and ration your capital.

What’s the outlook for 2025? Is it a year of acquisitions?

I think we’ve turned the corner. There’s confidence that the inflation dragon has been slayed. We’re confident – for good reasons and bad – that interest rates have peaked. Now investors are thinking about front-running cuts and getting invested ahead of that.

We’re doing what it says on the tin – returns around 7%, and improving. But the last couple of years, cash and private credit have been attractive. Now there are cracks appearing in that market.

I suspect you’re going to see a return of investors back to the sector because they’re attracted to the tangibility of real estate. It’s something they know and trust. They can understand a lease to Coles or Woolworths or a state government tenant. That tangibility matters, especially in a time of huge uncertainty – economically, financially and geopolitically.