What does the Financial Newswire / SQM Direct Property Fund Manager of the Year look for in an industrial property asset?
At Trilogy Funds, we employ a yield-for-growth approach to building a portfolio of industrial properties. In essence, we’re looking for strength and stability in rental income, but we also seek modest enhancement of capital values, particularly through tenant-led expansion, and to the extent possible, seek to protect the overall portfolio value from market forces such as cap-rate softening.
Strength and stability of income
The strength of an industrial property portfolio begins with its ability to generate rental returns. There are key factors we look at in assessing an asset’s ability to generate a sustainable yield over the cycle of asset ownership. These factors include the strength of the tenant, terms of the lease, relative bargaining power of the tenant given the location, ability to relet the asset to an alternative tenant and the asset replacement cost.
Strength of tenant
At Trilogy Funds, we look at both qualitative and quantitative drivers of tenant strength. We favour tenants who are operating in sectors that have strong tailwinds, have a strong brand and hold strong positions within their area of operation.
Existing blue-chip tenants in the Trilogy Industrial Property Trust include Bega, Reece, Amart and Tempur. A full list of tenants can be
Strength of the lease
Lease terms vary across assets. We naturally favour leases that are longer to expire, because it gives a longer period before we need to start negotiating new terms to retain the tenant or look for alternative tenants.
At the portfolio level, we try to keep the WALE (weighted average lease expiry) reasonably long, but also stagger underlying asset-specific lease expiries so that all the leases in the portfolio aren’t expiring at the same time. Portfolio WALE and other statistics can be found on our website.
Location: relative bargaining power of the tenant
One of the key considerations when assessing the location of a potential acquisition is the availability of similar stock, as well as empty land on which similar stock can be built. It is important that if we acquire a high-quality asset with a high-quality tenant, the owners of other assets in the area are not in a position to compete for the tenant when it comes to lease renewal time.
Similarly, if there is an abundance of land available in the area, we will consider the likelihood that new assets can be built and offered at competitive rents to attract tenants away from an asset we wish to acquire.
Put simply, tenant strength gives us confidence in a tenant’s ability to pay rent through the life of the lease. Considering the bargaining power the location affords them, enables us to assess the likelihood of lease renewal.
Re-letting an asset
While we seek to maximise the chances of lease renewal, we also seek to maximise our ability to re-let an asset to a new tenant, should a tenant out-grow a property.
The possibility for an asset to be repurposed and become appealing to a wider range of potential tenants improves the prospects for re-letting the asset, which also helps us manage income stability in the portfolio. Conversely, if an asset is highly unique and would be very unlikely to work for any other tenant, this would affect its attractiveness as a potential acquisition.
Buying below asset replacement cost
As mentioned, one of the risks to tenant longevity is the possibility for new assets to be built in a nearby location that could attract the tenant away from our investment. This is of particular concern in areas where there is a lot of vacant land available, such as non-capital city regions.
Assets acquired below replacement cost help to shield against this risk. If it would cost a competitor significantly more to build a competing asset compared to the price we paid for our asset, then the competing asset would likely command much higher rent and therefore be less appealing to our tenant.
A preference for high yielding stock
At Trilogy Funds, we have the resources and expertise to manage assets across a broad range of geographies and take a hands-on approach to asset management. This provides us with the ability to manage assets that may be too remote or challenging for some of our competitors.
Additionally, we’re willing to acquire assets that may be too small for some of our competitors. This competitive advantage often allows us to acquire assets at higher yields than many competitors.
As well as providing higher income for investors, higher-yielding properties can represent a shield from softening capitalisation (cap) rates. If cap rates compress, asset values rise. Conversely if cap rates soften, asset values fall.
To illustrate this with a simple example, consider an asset in a capital city with a 4% yield, and compare it to a similar regional asset with an 8% yield. If, as a result of market forces, cap rates soften equally by 1%, the value of the capital city property will fall by 1/4 = 25%, while the value of the regional asset will fall by 1/8 = 12.5%.
This is a simplistic, hypothetical example and these are crude numbers. However, the upshot is that higher-yielding properties have more capacity to weather softening cap rates than low-yielding properties, on a like-for-like basis.
Tenant-led expansion
Where possible, we look for the potential for tenant-led expansion in a potential acquisition. Tenants grow over time, and so do their needs. Tenant-led expansion and refurbishment foster strong relationships between us and our tenants, improve the prospects of retaining the tenant long term and increase the value of the asset.
If an asset and / or tenant shows this potential, it increases the property’s appeal as a potential acquisition. We make a concerted effort to investigate the potential for tenant-led expansion when assessing acquisition opportunities. This can include assessment of development potential, site coverage, and tenant interviews.
Connectivity and infrastructure
Trilogy Funds prefers assets that are located close to transport arteries and strong infrastructure. We also consider upcoming infrastructure plans for the regions where we invest.
Assets that are near rail, ports, airports and major roads connecting them to regional centres or cities present superior utility to current and future tenants, thereby supporting tenant retention and asset value.
Locations with significant positive infrastructure plans in place also have the potential for upside when the infrastructure is built.
Diversification
When selecting assets, a key consideration is how it would impact the diversification of the portfolio. For the Trilogy Industrial Property Trust, we seek to keep the portfolio highly diversified by geography, tenant industry and lease expiry.
Discover why we think an industrial property boom is coming
In our report, ‘The time for industrial property is NOW’, we explain the fundamentals driving the growth of industrial property and why Trilogy Funds sees great investment potential in the sector.
This article is issued by Trilogy Funds Management Limited ABN 59 080 383 679 AFSL 261425 (Trilogy Funds) as responsible entity for the Trilogy Industrial Property Trust ARSN 623 096 944. Application for investment can only be made on the application form accompanying the Product Disclosure Statement (PDS) dated 11 September 2023 and by considering the Target Market Determination (TMD) dated 11 September 2023 for the Trilogy Industrial Property Trust ARSN 623 096 944 available at www.trilogyfunds.com.au. The PDS and the TMD contain full details of the terms and conditions of investment and should be read in full, particularly the risk section, prior to lodging any application or making a further investment. All investments, including those with Trilogy Funds, involve risk which can lead to no or lower than expected returns, or a loss of part or all of your capital. Trilogy Funds is licensed to provide only general financial product advice about its products and therefore recommends you seek personal advice on the suitability of this investment to your objectives, financial situation and needs from a licensed financial adviser. Investments with Trilogy Funds are not bank deposits and are not government guaranteed. Past performance is not a reliable indicator of future performance.
