When talking about investment-grade property and nest eggs, there’s one bit of jargon that I firmly believe IS worth recognising and understanding.
I’m talking about the acronym WALE.
It’s a relatively simple concept, it’s increasingly visible, and potentially an extremely useful tool in helping frame financial decisions regarding investing in professionally managed property funds, be they ASX-listed property funds or unlisted property funds, also known as direct property funds.
WALE stands for Weighted Average Lease Expiry.
The Property Council of Australia describes WALE as ‘the weighted average lease term remaining to expire across a portfolio’.
So, imagine for a moment there is a property fund you are considering investing in that has one asset only, namely a CBD office building, which is leased to three separate tenants.Each tenant leases the same amount of space, at the same rental rate, with leases expiring in three-year’s time, four-year’s time and five-year’s time respectively. The WALE for the building in this case would be (3+4+5) / 3 which equals a 4 year WALE.
WALEs can either be measured in terms of rental income or by square metres.
In determining the WALE for a portfolio of properties in a fund the calculation is simply extended to give the average length of tenancies over all properties in the fund.
As a general rule the longer the WALE, the more secure the income stream of the property investment and ultimately the distributions to the property investors.
So, a fund with a WALE of, say, 7.5 years, on the face of it, is likely to provide a more secure income stream than a fund with a WALE of, say, 3.5 years, all else being equal.
Basic principles being a longer WALE means less tenancy turnover, less cost associated with leasing and tenancy upgrades, and most important of all, less likelihood of vacancies in the building, or buildings in the fund and the resultant lost income.
Charter Hall in the majority of cases seeks to have properties and funds with long WALEs. For instance, the division I manage, Charter Hall Direct, has some of the longest WALEs in the sector and this characteristic is a significant attraction for investors.
A further notable point about property funds with long WALEs: it offers the opportunity for the fund manager to hold the property for a prolonged length of time, earn strong income,achieve capital growth AND then sell it with an attractive lease duration still remaining, thus maximising potential gains for investors.
A potential downside of having a long WALE property is that you may miss out on rental increases that might have been achieved in a property market that is experiencing strong rental growth. That is, short WALEs can be considered attractive when properties have leases that are below market rental rates and the manager believes that the property can be easily re-let and at significantly higher rental rates.
At Charter Hall we never purchase a building without having an exit strategy, that is, a plan to sell the property, and a long WALE is a positive factor in being able to achieve an attractive exit, and optimum result for investors.
The WALEs of the four Charter Hall Direct property funds currently open to investors are:
(As at November 2018)
This commentary focuses on WALEs, but a quick mention of the other key characteristics to look for when considering an investment in a property fund.
First is quality of tenants: Businesses (tenants) with a strong brand name, national profile and history of performance combined with a strong balance sheets and cashflows are desirable.
Second is occupancy: as close to 100% as possible is best!
Location of properties is another: investing in a prime grade property that is well located and likely to attract or retain tenants is a key goal.
The gearing or borrowing level of a fund is another key attribute. Generally, it is wise to only invest in funds with gearing ratios below 50%. Funds with higher gearing may be able to offer high headline rates of income but they are more susceptible to economic and interest rate cycles.
Finally, the reputation of the manager is also a key variable. Investing in a fund with a manager that does not have strong tenant relationships,a track record of success and property professionals located near the assets that are being managed is also exposing oneself to unnecessary risk.
Most of these characteristics are self-explanatory and not subject to acronymism. I trust I have provided some insight into how WALE watching can be a profitable exercise for self-directed investors and SMSF trustees.