Annual Report To Investors – July 2019

Dear Investors, Colleagues and Associates,

At the conclusion of another successful year for Peak Equities, we are pleased to provide you with our Annual Report, in which we reflect on prevailing economic conditions as well as providing an account of the activity and performance of our company.

A. Economic Observations

“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” (Laurence J Peter – ‘The Peter Principle’) In economics, each action gives rise to a counteraction, and each economic driver will have both positive and negative consequences. For example, the decline in the value of our currency increases the cost of consumer goods, and at the same time renders our exports more competitive, drives local tourism and increases the attraction of our capital assets to foreign investors.

Sound investment decisions, however, must take into account prevailing economic influences, as the medium to long-term performance of our investments will be influenced by the underlying strength of the economy in which we operate. In that context, we comment on a selection of factors that we consider to be directly relevant to the commercial property sector.

The unexpected month-on-month reduction in interest rates is likely to have a direct, positive effect on the value of commercial real estate. Whilst there exists some doubt as to whether the lower interest rates will effectively stimulate the broader economy, they are likely to have a direct bearing on the property market, increasing buyer interest and further contracting yields.

Our cost of debt has reduced by more than 0.5% and we are confident that rates will stay low for the foreseeable future – at this time we can borrow funds for a 5-year fixed term, at a rate only 0.25% above today’s variable interest rate. That is an extremely strong statement by the finance sector that no significant movement in rates is on the horizon.

Short-term fluctuations in interest rates do not bear directly on commercial property values. However, in a climate of sustained lower cash yields, one should expect property yields to continue to tighten. That reflects a generally positive outlook for our existing portfolio, however property yields will not contract across uniformly across the entire sector. The hunt for A-Grade investments will intensify, and the greatest yield compressions should be expected in the major capital cities.

It stands to reason that demand for commercial property increases in direct proportion to economic growth, particularly where the growth stems from population increase. This is clearly the case in Australia, however the sustained lack of real, or per-capita economic growth will weigh on the health of our economy over time. Property, like every economic sector, is subject to both domestic and global economic conditions.

Australia’s economic growth has been driven by public sector employment – between 70% and 80% of the new jobs created nationally in the year to May 2019, have been in the public sector. Whilst this will create increased demand in the commercial office sector, unlike private sector employment, it does little to enhance productivity and does not of itself lead to a strong economy.

Although commercial property as a broad asset class has enjoyed a sustained period of growth, conditions in the retail sector are more challenging. With real-wage stagnation, Australian consumers have adopted a cautious approach to discretionary spending. The impact of the weakening Aussie dollar on the cost of imported goods has added to the pressure on the sector, while the ever-growing market share of online retail compounds the pressure on bricks and mortar retailers.

From this tapestry of economic influences, we highlight two economic considerations that impact directly on our industry sector, both of which will affect the performance of our current portfolio and should inform our future investment decisions:

1. Sustained lower interest rates and population increase are both positive drivers – interest rates will impact directly on property yields and values. Demographic influences reflected by both overall growth and population movements will remain the ultimate driver of demand.

2. A climate of economic uncertainty has now operated for more than 10 years, since the leadup to the GFC, and continues to affect all capital markets. On the international front, major socio-economic volatility (Brexit, USA/China, energy prices) continues to fuel this uncertainty, creating a risk environment that we expect will continue into the foreseeable future.

B. The Year in Review

The past year has been one of consolidation and continuing growth for Peak Equities. Much of our attention was focused on two major activities.

In October 2018, we launched the Peak Diversified Property Trust No 1, adding 4 properties with an aggregate value of $85 million to our portfolio, which has increased in value to around $230 million. Investor numbers have increased markedly, with more than 160 active Investors in our various syndicates.

Our portfolio comprises Premium assets across the country – in Melbourne (2), Tasmania (1), Perth (1), Adelaide (2), Sunshine Coast (1), Gold Coast(2), North Queensland (3) and Darwin (2), and we continue to look for value propositions in NSW.

Sound management of our assets is of equal importance to our business as our acquisitions. Each investment property is serviced by a local estate agent acting as Property Manager. From our office, we take on the role of “Asset Management,” which involves managing the direction and performance of each of our assets and high-level tenant relationships.

Throughout the year, we have held our focus on the strategic management of all assets within our portfolio. We maintain close communications with each of our managing agents, and have visited every property on a regular basis, fostering stronger relationships with our major tenants.

During the past year, we encountered serious challenges at our retail investment property in Townsville, North Queensland (the Precinct Shopping Centre), where we experienced a significant fall-off in foot traffic and retail spending. Several tenants were lost to closures and we were obliged to reduce rents and offer substantial incentives to attract and retain others.

To avert the prospect of a continuing decline in the performance of the Centre, we put a recovery plan to our syndicate members, who supported our efforts with an additional capital contribution. We are immensely grateful for that support, as a result of which have been able to attract a substantial anchor tenant to the Centre with a strong 12-year lease and are now firmly set on a course to restore unitholder value.

Associated with the revitalisation of the Precinct, we recently acquired a smaller retail centre in suburban Townsville, which is the operating and production base for our new anchor tenant, Otto’s Fresh Food Market. Otto’s is an iconic business with an enormous local following, which now operates from both our Precinct and Warrina Centres in Townsville.

The re-election of the Federal Coalition Government and the approval for the Adani mine have been very positive factors which will benefit the region over coming years. There is no mistaking the improved air of confidence in the Townsville ‘street’.

Our own confidence in the North Queensland region has grown significantly. Asset values are ready to improve from a sustained low base. Again, population increases will be required to underpin that growth into the future.

C. Our Strategic Direction

Sourcing and securing assets in the current market that satisfy our stringent investment criteria is our major challenge and our principal daily occupation. Premium, fully developed assets are selling at yields that make it difficult for us to offer attractive income distributions to our Investors, particularly in the Melbourne and Sydney markets.

Some more speculative opportunities do present from time to time. For example, the opportunity to acquire an asset with significant vacancies whose value can be improved by increasing occupancy, or assets with a short remaining lease term, whose value would increase if a new long-term tenant were secured. However, these opportunities do not suit the risk profile of the majority of our investors.

In October 2018, we successfully launched our Diversified Property Trust No 1, comprising 4 properties with an average Lease Expiry of almost 13 years. In a short space of time, we succeeded in raising more than $40 million in investor capital, offering monthly income distributions at 8% per annum. This affirms our Investors’ appetite for an attractive, yet secure income stream, which we can achieve by acquiring high-yielding assets with strong lease covenants. We propose to continue along the same path in the current year.

In launching the Diversified Property Trust, we tested the market for the first time in offering a monthly income yield at 8% per annum – all previous syndications offered higher income yields. The strong support we received is evidence that investors are wellattuned to changing market conditions. In our opinion, the recent successive reductions in official interest rates may require us to put forward opportunities offering monthly distributions below the 8% per annum benchmark.

D. Conclusion

Despite the steady increase in commercial property prices since 2016, attractive opportunities will arise from time to time. They just require a little more patience and perseverance. We prefer not to pursue opportunities for break-out capital gains, which can only be achieved by adopting a high-risk investment approach.

Our investors have clearly communicated their preference for a secure and attractive income stream, which provides a great degree of comfort and certainty in contrast to the volatile equities markets and the unacceptably low returns from fixed interest investments.

Nonetheless, as our investor base has grown and diversified, we recognise that there is an appetite amongst several of our investors for higher returns. This year we propose to introduce one or more opportunities for investors to participate in commercial property developments, where we will partner with proven, reputable developers. We hope to present the first of these opportunities in coming weeks.

The Peak Equities Pty Ltd business is conducted by a small and highly focused team. Maintaining a low-overhead environment is essential if we are to avoid the need to make frequent acquisitions simply to defray our operating costs. As such, whilst we continue to investigate opportunities on a daily basis, our acquisition decisions will always be made with a sole focus on the interests of our investors and in conformity with the investment standards that we have applied since the commencement of our business.

May the new financial year bring you success, satisfaction and good health.

Sincerely
Tom Borsky
Managing Director