Commercial Property Cycle, Retail’s Comeback, Aged Care and Finding Value Where Nobody’s Looking: with Commercial Property Gun, Tim Slattery

0:00This episode is brought to you by ASA Real Estate Partners. A big thanks to them for keeping this content free. I'm Adam Schwab. I'm Adir Shiffman. And this is The Contrarians with Adam and Adir.

0:13And we are back, episode 244. We've got a very special guest with us in the studio, Adir. We've got Tim Slattery, a good friend of mine who is, in his daytime, is managing partner and co-founder of ASA Real Estate Partners. Tim, great to have you on the pod. Yeah, thanks for having me on, mate. You've had a great story from – we were obviously lawyers together at Freehills, but you became a CEO incredibly young. Can you tell us your first CEO? I think you were – were you even 30 when you were effectively – About 30. Chris was the chairman and I always joked. He was the – I was the CEO. He was the chairman.

0:45He did all the good parts of the CEO job. He did all the rubbish. It was about then. So you were a 30-year-old CEO of an ASX listed business, which is pretty rare. Which business was that? APN Property Group. The code was APD, so yeah, specialist real estate investment management firm. We sold it to Dexas in about 2021. What was the chairman and the founder? Chairman, he owned 26 % of it and he kind of stepped in. The previous MD had left and then he sort of stepped in. So he was executive chairman. I was executive director for a couple of years and then he was sort of chairman. As you got older, did you look back and think, I see what he saw in me to give me that role or are you perplexed about why he gave you the role?

1:31Probably a bit of both. I think sometimes I think, jeez, you know, to his credit, you know, Syrup backed a number of people, including me, from probably a relatively young age with not nearly as much experience as he would have had. And then, yeah, so like, jeez, you know, that was a pretty big call. And then on the other hand, I was thinking, oh, you know, it's worked out pretty well. He made pretty good money and we all do well for investors. So what was it like being CEO of a public company at specifically 30? Like people are having their first job at 30 and you're running a public company in the public eye doing shareholder stuff.

2:05What was it like 30? That is a lot of unemployment. As in some people start a job at 25 and are still doing their job at 30. Oh, I see. Yes, correct. I agree with you on that. So what was it like? Well, I mean, I suppose I did work pretty hard, I reckon. And you guys both know it pretty well, like early days. So, you know, I feel like I packed a fair bit in. I think, yeah, definitely bits of it were a bit like, all right, what am I doing here? But, you know, I guess because I'd worked a bit in listed marks of the M &A stuff and done it free and other stuff, I'd sort of been a little bit exposed to it.

2:38Well, but you're not dealing with investors as an M &A lawyer and I think that is a baptism of fire, investor meetings. What was the market cap of this thing when you went in there? Oh, it was small, like$26 million. Okay, so you're dealing with – It had been established, at least in 2005, grown aggressively and then basically GFC had caused a whole lot of challenges. And so it was being kind of reset post-day. But you were dealing with micro-cap investors basically? Yeah, sort of a range. Yeah, there was still some small institutions that were still invested in the, I guess, post-GFC. But yeah, micro-cap investors, you know, a threat of mums and dads.

3:20But our business was also managing money on behalf of investors. So even though, you know, I guess we had some experience in dealing with investors through, I guess, the rest of my role. But, yeah, it was a big step up. So it was$26 million when you started. $26 million was the market cap, yeah. Amazing story because I think you got it well into the hundreds when you eventually sold it, right? Yeah, it was sold for$320 million in 2021, but we – Unbelievable. That's a 10-bagger over what was not the best time necessarily for property investment. So you really dominated there. How did you guys do it?

3:51Yeah, I mean, it was probably cheap in terms of the$26 million starting point, to be fair. But it was what it was, the market. No, no, that's true. Yeah, that's true. I mean, it wasn't – I mean, we just tried to pick the sectors that were a bit unloved. But, you know, like industrial real estate in, like, 2013, it was like 8 % yields with good assets. And, you know, it was a bit unloved. So, you know, we launched a fund there and, I mean, I think we made a lot of the calls pretty well. But it was like, you know, you got a bit lucky as well. Like, you know, I think the two IPOs we did, you know, if they'd been six months on the side, it could have perhaps been a different story.

4:31But we, yeah, we just sort of found sectors we thought were being loved off and good returns. And it was pretty incremental. Like, you know, Chris, we always talked about, you know, long-term compound growth sort of trajectory, don't do anything that could cause us a big step. But we did have to make some calculated bets. Most of the growth was all just organic incremental stuff. We didn't do any kind of M &A or didn't use a lot of debt, anything like that. It was more just keep delivering returns and people will word of mouth and other things. So yeah, there wasn't anything amazing. It was basically just simple business relatively.

5:05If it was that easy to 10X your money, everybody would do it, especially with what you guys took. Nothing's risk-free, but you guys avoided big risks. and obviously people blew themselves up in the GFC, you completely avoided that. So you were able to maintain an incredible return with a low risk profile, which is the holy grail of investing really. People want alpha without the huge risk. Like you can make lots of money investing in crypto and going to the casino, but to make money without taking big risks with capital is sort of what every investor really wants, right? Yeah. Oh no, I think that's right.

5:34I mean, and APN had had, you know, had had its, you know, its challenges through the GFC. So that was kind of the rebuild. But yeah, I think that's a big thing. People always look at the returns, but the path that you take to get there is often one. You don't really see it unless it goes wrong. Like a lot of returns and probably the last few years for property has been tough but before then it was the game settings were on easy. You could just, yeah, everyone could make money. Everything was up and to the right. Everything, cap rate compression was just happening so it was easy but yeah, I think that's a lot of it is the risk management and we had a lot of our own money as the manager invested into the funds and I think that counts for a lot.

6:13I mean, we're massive believers in sort of skin in the game and there was many governance and risk management policies and all that stuff but, you know, having your own money invested and being very conscious about – like whenever we look at investing, we're always trying to think, okay, if we're going to lose our money, where are we going to lose it and can we understand those things and what can we do to manage it? If we can't, fine, we'll just pass, move on to the next thing. But, you know, if you take a calculated risk and the upside is there, then that's, you know, stood us in relatively good stead with the benefit of hindsight.

6:40You had this amazing exit to Dexus for more than 300 million bucks. Can you talk us through that process? Obviously, Dexus is a massive ASX listed, one of the biggest property businesses in the country. How did that process come about? Did you run an auction process? How hard was it for you to - Such a boring name, Dexus. No one ever talks about that. Deutsche XUS. Is that what it is? Deutsche XUS Real Estate. That's a great acronym. That was the old Deutsche Property Trust, and then they split it off and it was all the stuff that wasn't in the US. The Germans that named that, presumably, had not done a marketing degree at any point in time.

7:16Look, that is a boring name of a company and if I didn't know about that business, I wouldn't even bother wanting to know more about it. No one ever thinks about the names of businesses. Property companies are awesome at having super boring names. At least you've got the word real estate in the name of your company. It's somewhat of a giveaway. Dexas could be anything. It could be nail polish. a spaceship company or something like that. Yeah, once you get big enough I think they assume everyone knows their property and they kind of take it out there. So smaller companies have still got real estate but yeah, 100 % agree.

7:46So when you sold something, how did that process come about? Was it a, they approached you guys or you sort of auctioned the business? So APN had bought the management rights to the ING Real Estate Healthcare Fund when ING left Australia post-GFC and that was a phenomenal deal. I think we bought the management rights for about$3 million. We had, management team there had about a 30 % stake and then we sold it to North West in 2015, about five years later for just$58.5 million. I remember the numbers very well. So that was an amazing transaction. That's like 20 times. Dexas had been there under – you know, they'd approached us but they couldn't get to the price that the North West guys – and to be fair, they still made good money after we sold it.

8:27So we'd met Darren and those guys after then. And then I think for Dexas strategically, office markets have been challenged. they needed to figure out where the growth, you know, the next growth and so on was them. So they went into sort of a diversified funds management model. I'm just going to pause you because you know everyone, but the listeners might not know who Darren is. Oh, Darren Steinberg, who's the CEO of Dexas. Is he still the CEO? No, no, he left a couple of years ago. Had a few issues since he left, unfortunately, with Melbourne Airport and a few things. Yeah, they've had a few challenges.

8:58But the business that they bought from us, I mean, they had two ASX listed REITs, which had good assets, good performance, had a whole retail distribution network, which took us 20 years to build. So they bought a really good business and I think those businesses continue to perform well by and large. But Darren, the CEO of Dexas, just called up and said, if we make you guys an offer at a big premium, would you stick around? And I'm like, well, Darren, I'm also going to take that to shareholders, but probably need to tell us what you mean by a big premium and then also what you mean by sticking around.

9:30One thing went to another and it was like a – The conversation with the board was like it was very hard to find value. I mean, the industrial cap rates were sub 4%. Can you explain, Frely, what's an industrial cap rate? Yeah, so an industrial real estate asset. So think about like a shed that Amazon might have all of its – A warehouse. Shipping in a warehouse, yeah. And a cap rate basically is like a yield. So instead of a price to earnings multiple that people would value a company on or some other multiple, the cap rate is basically similar to the yield. So rental yield on the property. Yeah, exactly.

10:05So if the property's worth$100 million and it gives you$7 million of rent each year, it's a 7 % yield. So the cap rates have come a long way. Values have gone up a lot. We should say, so people work out the value of a property in kind of a bit of a counter intuitive way, which is they work out what yield it should be and they work out the valuation based on that. And so if you're saying it was a 4 % yield, you say, well, then effectively you should just multiply that by 25 and you can get the valuation. 100%. I don't know why that did my head in when I started. It's a bit of a weird way to work it out.

10:37I'm like, why don't you just call it a 25-month multiple and use your income instead of your income? I know. 100 % agree. It's just one of those quirks of the industry. It's not the weirdest. I think it's different because most assets aren't valued simply on times in the yield by 25. Like, you look at shares, there's P multiples all over the place, whereas property tends to be much more homogenous, right, in yields generally. Yeah, and I think the cash flow, it's like if everyone paid out 100 % of their earnings as a dividend, then everyone would value itself on a dividend yield. It kind of makes sense.

11:05But, yeah, I get it. It's kind of weird. But at that time, you know, valuations had gone up a huge amount. It was really hard to find anything that we would put our own money into or our investors in. So it was like, well, at that price that they were offering us, the conversation at the board was really straightforward. that's six or seven years growth. We've got a good business. And then if rates go back the other way, because interest rates were really low, then that could be like 15 years. So it's a pretty easy decision. And is that why yields were so low? Yields were low because effectively interest rates were so low and the risk-free return was so low.

11:36And so everything is just price relative to that. Basically comparing to interest rates. That's definitely one valuation comparison. Always look at the current interest rate and the 10-year bond yield. A lot of people would look at that as how much of a spread is there. So, you know, yields go down a long way, then, you know, the cap rate, you know, should naturally go down a bit and also the cost of borrowing. So most, you know, people typically year, you know, borrow against commercial real estate at anywhere between maybe 30 and 60%. So the cheaper the debt is, the more, you know, the more money you get out.

12:09So, yeah. Yeah. And also and presumably in times where, like there are times when people love getting into industrial property. There are times when they think there are much better things to be buying than industrial property, so probably there's some demand side component to it as well. Definitely. And the demand side is kind of twofold. One on the tenant side, like just how much vacancy is there? You know, we have this whole growth of online retailing. There's a huge demand for warehousing space, and that's a big sort of growth driver. And then the other thing is exactly you talk about how much capital and how much investment demand is there for those assets.

12:43And, yeah, I mean, it's nearly happened in – I mean, the big three sectors, retail, office, industrial, at different points in time over the last 20 years, they've all been absolutely golden child, flavour of the month, people just piling in. And then at other times they've been completely out of favour, like, you know, office, like, you know, most Melbourne office buildings at the moment, you kind of can't. So is the office building still depressed? I think so. Like, I mean, there's a Victorian Melbourne thing in that example. And that's where you probably got to, you know, We think there's good money to be made if you're happy to...

13:16Presumably now's the time. You want to invest when there's blood on the streets, right? Not when everybody's flying. Yeah, when everyone's leaving. Well, Adam always... Adam's catchphrase is it all returns... Congrats to the main. ...inverts to the main. There is nothing more cyclical in real estate, in my view. Like, ultimately, the reason businesses are not valued on yield is not just because they don't all pay out 100 % of their dividends. It's because they grow their earnings at different rates, basically. but real estate is something that is much more cyclical than most industries in my experience.

13:46Yeah, I'd say that's true, and particularly the development side of that. Say if you own an income producing out on a 20-year lease to the government, that's going to be a bit less volatile than a bit of land where in a great market you can sell apartments or residential is going really well, the land goes up a lot more or down a lot more. It's a lot more volatile. But yeah, I think that's certainly right, which is kind of funny because people, people would look and real estate when it's done well it can be a fantastic asset class to generate good income you've got inflation protection because it's you know got a real physical assets that amount it can be fantastic but then often it hasn't delivered on that promise it's been volatile people have you know paid a lot and it's gone the other way so yeah it's kind of if you look at it now you talked about three different asset three different main real estate classes how do you rate them at the moment where are we currently seeing in the cycle Yeah, I mean, industrial is fantastic.

14:36I think, you know, and it is – these are all general comments. Like, you know, you've got to look super specifically at different markets. Like even the Melbourne office market, you know, if you've got an office building in the Docklands that's, you know, 10 years old, you know, you probably work cut out. If you own, you know, 101 Collins straight at the top few floors, you'd probably be – Or an office building in wealthy suburbia. I mean, work from home. like people working from them but also working from wealthy suburbs more than they were like five or six years ago. Yeah, Cremorne's going pretty well.

15:08Yeah, Cremorne and there's different and smaller tenancies and some of these co-working offices. I mean, so there's definitely – it's hard to generalise completely but I'd say very big picture. Industrial, I mean, it was – the vacancy rates got super low and it was very much undersupplied and so you saw good rental growth. So even though the cap rates and the valuations were high, you did have rental growth. Because of e-commerce, was that driving? Yeah, yeah. And basically, and just people hadn't built enough of it. It's amazing how developers, anytime there's money being made, just more supply comes through.

15:41It happens with the office, happens with – resale's probably a bit harder, but yeah, definitely industrial. So industrial, let's be a bit more industrial. So you've got warehouses. Yeah. The art of centres falls on industrial, I guess. Probably in its other category. I mean, we're a big one and only invest in what we understand. I can't understand – like I just struggle. I'm interested in your guys' perspective. you know you've got even you know use ai one of those models you know there's a whole range of different prices that generates different revenues or different earnings stream but the business has to make enough money on a long-term sustainable way to enable it to pay the rent so and some of those things are still moving around a lot so it's hard to get a good rate on you can work on the value you can work out the valuation of a data center you make an excel and you say the value is x and then every month just run a command that says x times 1.05 and that's the value of a data center it just rises five percent every month i mean that's basically how it suits the increment that's probably our yeah that's what we scratch your head around i think you're probably right and it's just like well there's money there and we can we can just get people to buy into that but um i mean a lot of these things work until they they don't but you know like you say it comes back everything comes back to the mean it comes back to cash flow like if you can't generate the cash flow sustainably.

16:54It's not going to be worth it. So let's put data things to the side. Yeah. So industrial, yeah. So warehouses, factories. Warehouses like cold store. Yeah, there's sort of warehouse and then there's sort of other, you know, other use like factories and those sort of things. But warehouses are nearly different. And there's very large ones, you know, in the sort of logistics. Yeah. Yeah, from areas like Derrimad or, you know, Melbourne's West and around Downing in the North. So they're doing those sorts of areas. Do you still like industrial now or what's your where it's at the cycle? There's definitely opportunities.

17:24Like, for example, there's a lot of foreign capital that came in to invest into data centres at quite full valuations. Some of them got the rental value, some of them didn't. But the foreign owner land tax surcharge in Victoria, which I know is going to be a topic close to your heart, that has made it quite – I mean, sometimes up to a third of people's net income is going in the foreign owner land tax surcharge. So for those foreign owners, there's definitely going to be some opportunities for them to exit and maybe you can pick up assets. But big picture, we don't see the same rental growth coming through most of those markets as there has been for the last three or four years because suppliers respond to this and there's more vacancy, there's more stock.

18:05You know, incentives, you know, some incentives are like 30%, which, you know, that's basically you do a leasing deal for 10 years and you get three years' worth of rent back as an incentive. Like that, and that's sort of bizarre. that change could be largely characterised as capitalism works. Like there was a huge amount of demand and not enough supply so price was high and then people said that's okay, we'll create supply because that's a great price and eventually it overshoots and then it comes back and that's a cycle basically. 100 % agree and it just overshoots I think typically these things overcorrect my mind out of it like office, all this office but it's probably compounded by COVID work from home and all that stuff but you know, too much office it didn't really happen in Australia but in the US they built so many more shopping malls all these ghost malls because people were making great returns actually it feels like the reverse situation here we have two retail stores in Chaston and Westfield Bondi and I think the head of Westfield recently said there's 40 vacancies across the entire portfolio in all of Australia so it feels like certainly commercial space for retailers is crazy tight because dumb people like me you thought shopping malls were in trouble.

19:16And it turns out they're not. So that's 70 % of our portfolio is in retail. And it's been a very good place to be. Exactly because of that. Everyone thought Amazon was going to kill the bricks and mortar shops. So you had that. And then in Victoria in particular you had COVID came through. All the rents got smashed and the cap rates were out. But then you look at it and – And there's no consumer confidence and yet – Yeah, but there's still – for the type of retail which is essential daily needs, It's like you've got to go to the supermarket, you've got to go to the pharmacy, you've got to go – these things, they're not really – like fashion and other stuff is a bit different.

19:48Even the Chadston's unbelievable. And Chadston, yeah, that's an amazing – You don't have to go to Footlocker and you don't have to go to like Adairs, but they're still taking up slots in the mall. And Footlocking and trying the shoes and I don't know, there's a whole thing. But anyway, they've stayed full and it's also hard to build them. It feels like you can't build them. When was the last time a shopping centre was built? Well, particularly in a suburban area, like when Blackburn Square, it's like 15km east of Melbourne, you know, it's got thousands of homes around it. You can't just go and, you know, whack up a giant – you'd never get the land and you'd never get the planning approval to do it.

20:24Because the land doesn't even exist, like as in there's houses there. So you can't. Yeah, so in the growth areas you can – they have these town centres and things. But you're right, like those areas – There's no more chance in spending. Like that's a corner resource. No, no, I think that's very, very hard. Which geographically, where are your retail? So we've got Victoria, WA and New South Wales. So we own Blackburn Square, which is just 15 k's east of Melbourne CBD. Dog Swamp, amazing name. Four k's north of Perth CBD, a little neighbourhood shopping centre. We own the two big Ampol service stations north on the M1, headed out of Sydney towards Newcastle.

20:59They're the three main retail assets. You tell us more about ASR. The assets you're talking about now are in your current fund. So you left APN and a couple of years later you and Alex and Chris came and said, we've got another go in this, let's go again. Basically, yeah. Yeah, APN Mark II sort of the idea. And we set the business up. We didn't necessarily have a product. We just knew that given where values had fallen to, we knew that timing is a massive thing. I mean, I think you guys were saying it's right. Like it's very cyclical. Things do really depend on your timing. So we knew that it was a good time and we thought, oh, APM Mark II, we can put our money together and we'll be able to find good opportunities.

21:42And then an opportunity came along to take over the existing fund. Australian Unity wanted to find a new manager for the fund. So we basically acquired that whole platform and that's where those assets came. So we've got that fund and then it basically aims to generate very consistent long-term income with some capital. So it should be our long-term sort of compound growth project. Can you give us a bit of data on so far how have you gone? So how much have you – how much fun have you got and what's the performance been in the last three years? Yeah, so the fund's about$600 million of assets. So the 10-year performance to June was 9.3 % per annum.

22:23Pays about a 7 % distribution yield. And that – I mean it's also – it's been fully tax-deferred in the last year which is – for people – I don't know if everyone understands this. How do you get a tax deferral? It's basically how property trusts work. You basically calculate your taxable income versus the distribution yield, and it basically means that it's treated as a reduction in your cost base. So it's treated as capital. So if you're a long-term investor, most of our investors are, they'd invest for five plus years, so it actually works out quite tax effectively. This is like a 9 % return after tax in a way.

22:54Is that what you're saying? 9.3, yeah. That's the return, yeah. So last year it did 10.3. 15 % before tax. Yeah, if you gross it up and assume that you would otherwise have to pay tax, What happens at the end? So you get all this tax deferral, then you've got no cost base left for your asset. That is the issue. That's why it's tax deferral. It's not you never pay the tax, but if you have a view that you hold it for the long term, then you're deferring the point at which tax. And that is something where the tax, you know, that CGT changes is relevant. But if you take the view that, oh, the capital for real estate will go up more or less in line with inflation, then you previously had the 50 % CGT discount.

23:32You might pay no tax. You might, yeah, and you defer it. So obviously the time value of money maximum. I mean, that is a very interesting point. So you might be the singular beneficiary of these CGT changes. It doesn't feel like that, but maybe. Not in your personal life, maybe, but because now that only the real gain is taxed, and hopefully you'll be above the real gain, but property is not, unless you're kind of just at the right time of the cycle, inflation is a pretty good marker for a kind of gain. Yeah, it should be long, long chase. Plus you get your yields as a reduction along the way.