Insights and Research Investment Highlight | March 2017

Multifamily Residential in

SYNOPSIS Overview The following research paper has been With Australian continuing to attract significant Disclaimer prepared by Emerge Capital Partners, and offshore investment, increased competition for prime represents our views. commercial assets is leading institutional investors to seek out Given the current conditions of the alternative asset classes with attractive characteristics. Situation to Australian residential market, is there an be Assessed opportunity for Multifamily Residential is often mentioned as a potentially (“MFR”) as an asset class? attractive sector, due to its success in a number of offshore markets including North America, Japan and mainland  Origins in affordable housing; Europe. However, to date institutional investment in  Focussed on gateway cities; Observations Australian residential has been fairly limited, prompting from Mature  Driven by demographics & supply debate about the factors that are holding investment back in Markets constraints; the local market. (USA, Japan,  Policy environment important; Europe)  Attractive investment characterised by This research paper seeks to examine the typical stable income profile. characteristics and drivers of Multifamily Residential in offshore markets, and to understand its applicability to the  Strong demand for rental housing; Australian market.  Supply constraints in inner city areas; Drivers in  Strong rental growth & low vacancy; What is Multifamily Residential? Australia  Growing acceptance of Multifamily Residential refers to a multi-unit residential living; (e.g. an apartment building) owned by a single entity.  Investor appetite for new assets. Individual dwellings are rented to residents, typically on the  Higher development returns to strata open market, but in some instances to special market sectors product crowd out development; (e.g. social and affordable housing, military housing).  Investors and occupants need to In mature markets, product varies widely in terms of location Challenges in understand new asset class; Australia (inner urban to suburban), density (low rise to high rise) and  Policy environment biased to positioning (affordable housing to premium product). In the ownership & strata buyers; world’s largest securitised market, the US, the market is fairly  No experienced operators. distinctly separated into affordable housing, known as Low Short Term: Ad-hoc growth in sector Income Tax Credit Housing, and premium product, which has mainly driven by strategic development grown recently due the higher proportion of households plays and/or distressed projects. for longer. Outlook Long Term: Strong growth expected over the longer term, supported by changes to the policy environment at a Federal and State level. The market environment appears ripe for Multifamily Residential to begin emerging Key as an asset class in Australia. The growth in Takeaway this asset class would be greatly aided by policy changes, which can be promoted through industry advocacy.

Insights and Research Multifamily Residential in Australia

Investment Characteristics Multifamily Residential in the UK Globally, multifamily residential real estate funds have experienced a period of expansion in recent years. Multifamily Although the market is far from mature, Multifamily is usually viewed as attractive to institutional investors due to: Residential is beginning to emerge as an asset class in the  Stable Income Profile: Rental income is typically stable , driven by regulatory and economic due to the relatively inelastic demand for housing; changes.  Attractive Risk Adjusted Returns: Total returns Parallels may be drawn between the historical limitations of typically have lower standard deviations than other Multifamily in the United Kingdom, and those in Australia. property classes; In particular, government policies that favour home ownership / strata investment have crowded out  Portfolio Diversification: Allows diversification across institutional investors in both markets. sectors and geographies to spread risk; and However, recent changes to tax treatment of strata investors  Inflation Hedging: Residential often viewed as an in the United Kingdom are expected to significantly cool effective inflation hedge. demand from smaller investors. To maintain investment in From a development perspective, multifamily is also attractive new housing, the Government is implementing a suite of as it: recommendations from the Montague Report (2012) aimed  Increases Speed of Development: Removes the at increasing institutional investment in the sector. requirement to meet pre-sales hurdles; These policies are beginning to take effect, with a number  Mitigates Settlement Risk: Forward sale to an of projects now coming to market, including the institutional buyer mitigates settlement risk; and of several council housing estates. This shift  Retains Control: Development above an existing asset policy stance may be indicative of the change required in (e.g. shopping centre) allows an owner to retain control, Australia for multifamily to become attractive asset class. mitigating risks associated with operational requirements or expansion potential of the underlying asset.

Observations from Mature Markets

Key observations from mature multifamily markets including the US, Germany, and Japan, include:  Origins in Affordable Housing: Mature multifamily markets tend to have their origins in affordable housing due to government policies aimed at promoting supply.  Focused on Gateway Cities: Multifamily tends to be concentrated in gateway cities, where housing affordability is low, and population growth and limits on new supply underpin strong rental growth and low vacancies.  Driven by Demographics & Supply Constraints: Key success drivers appear to be demographic demand drivers Factors Supporting Multifamily in Australia (e.g. high formation of rental households), restrictions on new supply, and a supportive policy environment. When considering the Australian market, there are a number  Policy Environment is Important: A policy of factors that suggest Multifamily Residential may be environment that supports and incentivises institutional attractive: investment in residential is a common driver across mature  Demand for Rental Housing: Australia is experiencing a markets. structural shift toward lower home ownership, with  Product Varies to Meet Market Demand: MFR product increased demand for rental housing driven by varies widely in terms of form (low to high density) and affordability issues. This demand is further compounded market positioning (affordable to premium). Developers by the increasing population of Australia’s key capital will typically design for local market conditions, with rents cities. / leases designed to meet the market.

Insights and Research Multifamily Residential in Australia

 Supply Constraints: There is a general undersupply of  Investor Acceptance of Asset Class: Early investors are rental housing, particularly in the inner areas of the likely to require higher returns for an asset class with no gateway cities Sydney and Melbourne, and new supply is local track record, making development even more restricted due to site availability and planning controls. challenging. In this environment, Multifamily assets are  Market Metrics: As a result of the supply and demand also illiquid in nature and appreciation is notional unless metrics, Australian cities have demonstrated strong rental the sales are realised. growth and low vacancy rates, which compare favorably to  Limited Policy Support: State and federal policy is mature Multifamily markets. currently heavily biased towards home ownership and  Growing Acceptance of Apartment Living: The recent strata investors (e.g. beneficial tax treatment for retail apartment boom, driven by a long-term trend towards investors including negative gearing and capital gains tax), inner urban living, indicates a growing acceptance of distorting the market in favour of strata investment. There apartment product in Australia, which is more amenable to is limited support for institutional investment in residential Multifamily product. outside of social and affordable housing.  Investor Appetite for New Assets: A shortage of  No Experienced Operators: Multifamily Residential is traditional asset classes is pushing up prices, stimulating challenging to manage due to the number of tenants, but increased investor interest in alternative assets effective management is crucial for successful funds. There are currently no experienced operators with a track Challenges for Multifamily in Australia record in Australia. Establishing a credible and effective platform will require investment and a minimum scale. Despite the supporting factors, a number of challenges exist:  Higher Returns from Strata Development: Given the strong demand for residential product from strata buyers, the yields in the strata market are significantly lower than would be accepted by multifamily investors (Figure 1). All other things being equal, this means that development returns to strata development will be higher, which suggests that strata development may be crowding out multifamily product.

Figure 1: Strata Yields (Aus & UK) vs. Multifamily Yields (%, Y/E Dec 2015)

6% Lower strata yields may crowd out MFR 5.1% 5% 4.6% 4.5% development 4% 3.6% Conclusions 3% 2.6% 2% Multifamily Residential as an asset class is typically viewed as attractive to institutional investors due to its ability to generate 1% high quality risk adjusted returns over a long term, and add 0% diversity to existing real estate portfolios of scale. Australia UK USA Germany Japan Strata MFR Given the current investor demand for new product, combined 10 Year Bond Rate Yield Spread with recent challenges and frictions in the strata apartment development market, Multifamily is becoming an attractive Source: IPD, REIA, Bloomberg, 2016 proposition. We therefore expect that Multifamily  Limited Understanding of Product: Given the lack of developments will start coming to market in the near term. mature assets in Australia, there is limited understanding Growth in the sector will be greatly aided by changes to the of Multifamily product (and its differentiation from strata policy environment. Given the current focus on housing product) from both investors and occupants. Early projects affordability at both a Federal and State level, we see this as will need to clearly articulate this difference to establish likely, and expect this will drive strong growth in the asset the value proposition of their product to prospective class over the medium to long term. investors tenants.

Insights and Research Multifamily Residential in Australia

Case : Equity Residential (USA)

Investor Equity Residential

Location United States

Investor Type Publicly traded REIT

Market Cap US$41,748 million

109,540 units Portfolio (Of which 76,116 units are in high density, coastal gateway cities)

Portfolio Rental Income US$2.74 billion in FY 2015

Portfolio Gross Rental n.a. Yield  Equity Residential is an S&P 500 company, the largest multifamily REIT in the U.S.  Active in acquisition, development and management of high-quality apartment properties in Description the U.S., with a focus on high barrier to entry / core markets.  Key business segments include garden, high-rise, and military housing.  Vertically integrated acquisition, development and management of apartment properties in Property Management targets markets that are favourable to multifamily property operations and appreciation. Strategy  Develops new urban-core properties when acquisition opportunities are not viable.  Keeps assets competitive via unit renovations and rehabilitations.  Listed on the New York Stock Exchange.  Obligation to pay 90% of taxable income as dividends requires high leverage. Financing Strategy  Possesses a debt-to-equity ratio of 0.96 as of June 2015 (Industry average of 1.06)  January 2016, retired $1.7 billion of unsecured and secured debt using disposition proceeds.  In Q1 2016, Equity Residential acquired a total of c.500 units across the U.S., equating to c.US$150 million. Recent Deals &  In Q1 2016, Equity Residential completed a $5.365 billion sale (averaging US$230,634 per Acquisitions unit, generating an Unlevered IRR of 11.3%) to Starwood.  Additionally, the Company sold eight other consolidated apartment properties (2,900 apartment units) for an aggregate sale price of c.US$950.0 million.

Insights and Research Multifamily Residential in Australia

Case Study: Vonovia SE (Germany)

Investor Vonovia SE

Location Largest listed real estate company in Germany

Investor Type Real Estate Company (Multifamily)

€16.13 billion Market Cap Listed on Frankfurt Stock Exchange 340,000 units Portfolio (All located within Germany)

Portfolio Rental Income €1.420 billion in FY 2015

Portfolio Gross Rental 6.5% as at Q4 2015 Yield

 Vonovia has been formed from the merger of Deutsche Annington and the GAGFAH, both Description the companies have been in German real estate for more than 100 years.  Vonovia was established in 2015.

 The company does not develop new assets rather makes long-term investments in the Property Management maintenance, modernization and senior-friendly conversion of its properties. Strategy  The properties are split into three portfolios: Strategic, Non-strategic, Privatize & Non-Core portfolio.  The company finances its acquisitions with a mix of both debt & equity. Financing Strategy  The company has been awarded BBB+ long term corporate credit rating by S&P.  The company has announced a takeover of Conwert. The deal is valued at €2.9 billion euros Recent Deals & and will add 27,000 to their current portfolio. Acquisitions  Most of these apartments are located in prime eastern German locations of Berlin & Leipzig. This deal has helped Vonovia establish itself as the largest listed landlord in Germany.

Insights and Research Multifamily Residential in Australia

Global Multifamily Residential Real Estate REITS (US)*

Bloomberg Dividend Gearing Name Country Currency Market Cap Price YTD Occupancy Ticker Yield Ratio

AvalonBay USA USD AVB 23.24 billion 169.26 -8.08% 3.19% 0.66 96.5% Communities

Camden USA USD CPT 7.03 billion 80.5 10.21% 3.73% 0.97 95.2% Property Trust

Essex Property USA USD ESS 13.97 billion 213.29 -10.91% 3% 0.86 96.4% Trust

Investors Real USA USD IRET 715.31 million 5.88 -15.40% 8.84% 1.91 94.9% Estate Trust

Mid America Apartment USA USD MAA 6.96 billion 92.22 1.55% 3.56% 1.15 96.2% Communities

Sun Communities USA USD SUI 5.57 billion 76.34 11.04% 3.41% 1.58 96.2%

United Dominion USA USD UDR 9.28 billion 34.74 -7.53% 3.4% 1.25 94.4% Realty Trust

Apartment USA USD AIV 6.8 billion 43.63 8.9% 3.03% 2.65 94.4% Investment

Equity USA USD EQR 22.2 billion 60.82 -12.48% 3.31% 1.05 94.0% Residential

Bluerock Residential USA USD BRG 240.8 million 12.09 2.03% 9.59% 2.78 95.0% Growth

United Mobile USA USD UMH 325.6 million 11.76 16.21% 6.12% 3.14 92.9%

-7.06% 0.70* Independence USA USD IRT 554.7 million 8.04 8.96% 93.3% Realty Trust (April 16)

Monogram Residential USA USD MORE 1.7 billion 10.50 7.58% 2.86% 1.3 95.4% Trust

Next Point Residential USA USD NXRT 299.6 million 18.07 38.04% 4.56% 3.21 98.7% Trust

*(Table Updated as at 30 April 2016)

Insights and Research Multifamily Residential in Australia

Global Multifamily Residential Real Estate REITS (Non-US)*

Bloomberg Dividend Gearing Name Country Currency Market Cap Price YTD Occupancy Ticker Yield Ratio

North View Canada CAD NVU-U 829.8 million 19.70 12.19% 8.27% 1.09 90.3% Apartment

Canadian Apartment Canada CAD CAR-U 3.6 billion 28.99 8.01% 4.31% 0.94 97.9% Properties

Ascott 0.39* Residence Singapore SGD ART-SP 1.88 billion 1.14 -3.8% 7.41% - Trust of (April 16) Singapore

Irish Residential Ireland EUR IRES 458.9 million 1.17 -0.09% 2.71% - 99.7% Properties

United 0.51* Empiric GBP ESP 556.4 million 111.25 -1.62% 5.41% - Student Pro Kingdom (April 16)

Starts 0.48* Proceed Japan JPY SPI 8979 27 billion 156,100 -8.93% 5.28% 95.9% Investment (April 16) Corporation

Advance 0.52* Residence Japan JPY ADR 3269 398.11 billion 294,900 10.99% 3.38% 96.6% Investment (April 16) Management

*(Table Updated as at 02 Nov 2016)

Insights and Research Multifamily Residential in Australia

About Us

Emerge Capital Partners is an independent international real estate investment and advisory firm that was established in 2008. The firm specialises in the Real Estate and Infrastructure asset classes with coverage in the Middle East, Europe and Asia-Pacific.

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