Since publishing our climate change approach for our direct real estate portfolio in 2020, we have focused on mitigating climate risks and decarbonising our real estate portfolios. But our real estate environmental, social and governance strategy also considers wider environmental and social topics, including those associated with nature and in particular biodiversity . How can real estate reduce its negative impact on nature? And how can it have a positive impact and contribute to climate solutions? 

A focus on nature

We are experiencing a nature and climate crisis. While the spotlight has previously been on climate change, nature is now sharing centre stage. The two issues are interdependent.

Some key initiatives have caused real estate investors to sit up and pay attention to the relationship between buildings and nature. 

• The final framework of the United Nations' Taskforce for Nature Related Financial Disclosure (TNFD) was released last autumn, which sets out a framework for companies to report their impact on nature. 

• The introduction of the Biodiversity Net Gain legislation in England in February requires at least a 10% biodiversity net gain for new developments. 

How does real estate affect nature? 

Real estate contributes directly to four of the five main drivers of nature loss. Therefore, action to reduce the impact in these areas can also reduce risks for real estate assets.

Five drivers of nature loss

• Climate change 

  Buildings contribute to almost 40%[1] of global greenhouse gas emissions because of their heating, lighting and cooling requirements. It is imperative that buildings are decarbonised to reduce greenhouse gas emissions and to mitigate climate change. 

• Resource exploitation

  Buildings require raw materials such as cement, steel and sand. The challenge for real estate developers is to understand where and how these are sourced in the supply chain and how to change practices to be more sustainable. For example, developers can use recycled steel and concrete or responsibly sourced timber. This can help reduce the impact on nature and provide a more dependable supply. 

• Land- and sea-use change

  Real estate has changed land use. Legislation, such as the Biodiversity for Net Gain for development in England and Wales, can help to ensure that biodiversity is maintained and improved on-site. This can be achieved by introducing green walls or roofs, and by maintaining existing shrubs and trees. But real estate investors and local authorities should prioritise building on brownfield sites (previously developed land) to avoid expanding into greenbelt areas. 

• Pollution 

  Contaminated land risks from fuel or toxic-waste leakages are a concern if waste is stored inappropriately at real estate assets. Prevention and remediation of contamination is essential. 

• Invasive alien species

  While real estate doesn't affect invasive species, certain plants can present risks to real estate investments. For example, Japanese knotweed can de-value an asset and affect the stability of a building. 

Green infrastructure creates a positive impact

Real estate provides the unique opportunity to have a positive impact at the construction phase of a building, particularly in terms of design. This may involve maintaining existing green areas or improving habitats that are in poor condition. But it can also have a positive impact in the post-construction phase, by implementing green infrastructure (see examples below). This can promote local biodiversity and contribute to climate change mitigation and adaptation. Real estate can also have a positive social impact and provide operational efficiencies.

Types of green infrastructure [2]

• Sustainable drainage system

  Using green infrastructure as a sustainable drainage system can:

  - retain 60-72% rainwater run-off, which helps flood mitigation.
  - provide 60-80% species richness, which is similar to that of a natural pond.

• Street trees

  Having trees next to and around buildings can:

  - reduce the air temperature by up to three degrees.
  - provide carbon sequestration (absorbing carbon dioxide) from the atmosphere.

• Green roof

  Vegetation growing horizontally on a roof of a building can:

  - provide a 6.7% energy saving for the space directly underneath the roof by providing insulation.
  - reduce noise by 11 decibels.

• Green wall

  Vegetation growing vertically on a wall can:

  - provide an energy saving of up to 8% for the adjacent space.
  - reduce the indoor temperature by 2.7 degrees.
  - improve local exterior air quality by removing nitrous oxides.

   

How does nature benefit real estate investment performance? 

Green infrastructure can have a positive impact on people, by improving the aesthetics of a building, reducing energy costs, minimising flood remediation costs and improving local air quality. Studies show that there can be a 10% increase in willingness to pay for assets that offer green cover. Green infrastructure can increase property values by around 9.5%. And buildings in close proximity to parks or green spaces also benefit from higher values. Real estate assets with green infrastructure are more attractive to tenants, which can help to reduce void periods and increase rental values. 

Real estate has a key role to play in the nature crisis. It can reduce its negative impact on nature, and it can have a positive impact and contribute to climate solutions. Nature also has the potential to enhance investment returns and to make buildings more attractive to owners, tenants and communities. 

Author: Georgie Nelson, Head of ESG, Real Estate

The first weekend of March saw 2,019 auctions take place across the combined capital cities, down slightly on the previous year's 2,054, however clearance rates were up, 71.8% in comparison to 66.3% in 2023. Melbourne once again led the way, with 1,038 auctions taking place, followed by Sydney with 721, well above that of the other capitals, with Brisbane, Adelaide, Canberra and Perth recording 103, 85, 69 and 3 auctions respectively. 

The preliminary clearance rate of 71.8% for the weekend indicates that buyers and sellers are on the same page for the most part, particularly in Sydney where a clearance rate of 76.8% was achieved, well above the 68.7% of the same weekend last year.

Melbourne, Adelaide, Brisbane and Canberra all managed to achieve clearance rates of above 60% for the weekend, with 70.1%, 69.4%, 65.0% and 63.8% respectively. It is interesting to note that all capital cities achieved a greater clearance rate than the same weekend in 2023, other than Adelaide, where a 72.9% clearance rate was achieved on the same weekend last year.

February brought yet another strong month for property prices, with CoreLogic's Home Value Index showing a 0.6% increase across the combined capitals and combined regionals, with all capital cities experiencing growth except for Hobart, where prices fell by 0.3% for the month.

Once again, Perth experienced the greatest level of growth, increasing by a mammoth 1.8% for the month, contributing to a 5.2% quarterly growth and an increase of 18.3% annually. Adelaide also experienced strong monthly growth of 1.1%, followed by Brisbane with a further 0.9% increase, bringing the median property value of Brisbane above $800,000 for the first time, with a median value of $805,593, the second highest median value nationally, behind only Sydney with $1,128,155. Canberra, Sydney and Melbourne also experienced growth for the month of 0.7%, 0.5% and 0.1% respectively, with all cities except for Hobart (-0.6%) and Darwin (-0.1%) experiencing an annual increase.

Whilst there was no RBA meeting this month, economists continue to believe we are at the end of the rate hike cycle, with many expecting interest rate reductions before the end of 2024. Should interest rates ease, we expect that there will be a bump in property prices.

Clearance Rates & Auctions week of 4^th of March 2024

Property Values as at 1^st of March 2024

Median Dwelling Values as at 1^st of March 2024

Quick Insights

Values to Outperform

Two-fifths of valuers surveyed by CBRE have predicted house prices to outperform by up to 10% in Adelaide, Perth, and Sydney. Valuers were also relatively bullish on the apartment sector with 44 per cent predicting prices to increase over the next 12 months. The survey also highlighted a high level of demand from upgraders and downsizers, buyer segments who were less sensitive to interest rate movements.

Source: Australian Financial Review

Build-to-Rent Builds Steam

Salta Properties, is now surging into the build-to-rent sector, with ambitions to create a $3 billion platform and with its first project in inner-city Melbourne close to completion. 

"We could see that we were heading into a fairly significant housing shortage in Melbourne, and more broadly across Australia," said Sam Tarascio, manager of the firm. The first block is a 94-unit project in trendy Fitzroy North at 249 Queens Parade.

To be known as Fitzroy & Co, the building has topped out and is on track to welcome first residents from July into their one, two and three-bedroom apartments. Those tenants can expect a range of resident services, access to shared spaces and a variety of amenities.

Source: Australian Financial Review

Author: Filippo Sciacca, Director - Investor Relations, Asset Management and Compliance

As investment managers, one of the most important - but also one of the hardest - things to do is knowing when to admit you've made a mistake. And errors of judgment can happen frequently in investment - in-depth research, strictly applied investment philosophies and disciplined portfolio execution are all critical tools that can help minimise risk and create robust investment portfolios capable of generating strong long-term returns, but they can't predict the future.

So, recognising the need to revisit an investment thesis, or when to reverse a trade entirely, is a lesson all investment managers need to learn. For us, that time came midway through last year.

AI: a technology game changer

We started 2023 being wary of the technology sector. Many firms within the sector had benefited from the prior cycle of cheap money, leading us to have concerns that such firms would suffer in a tighter spending environment compounded by higher capital costs.

What we hadn't anticipated was the rapid emergence of a new form of technology that would structurally change the prospects not only for the tech sector itself, but could also have much wider economic and social implications.

AI is not new a technology. In fact, its history can be traced back to the 1950s. But what changed on 30 November 2022, with the launch of ChatGPT, was the emergence of usable generative AI and machine-learning tools that have the potential to completely transform the business world in the decades ahead.

Suddenly, the future pathway for the technology sector shifted dramatically. AI will likely define a new era of technology adoption, making it a secular driver of growth that is independent of broader economic trends. Businesses and governments will need to invest in AI or risk being left behind. AI has become the new arms race.

Applying a Future Quality lens to AI

Having discerned that there's more to AI than hype, we conducted rational and focused research to ascertain the extent to which AI overlaps with the principles of our Future Quality philosophy. Not only did we conclude that AI is a tangible, long-term trend, but we were also able to identify a host of reasons for why capital expenditure on AI should grow rapidly.

The cost of undertaking machine learning and AI is massive; leading-edge computers are required to handle these models and datacentres will need to be scaled up. The tech titans are leading this AI spending, dipping into their deep pockets as they perceive AI as a way to deepen the moats around their franchises. Similarly, governments are also allocating funds to capture the military capabilities of AI and its utilisation in modern warfare.

This deep dive into AI clearly established that the sector would benefit from a very real and tangible tailwind that would likely endure for the next decade or longer. While our bottom-up, stock-picking investment approach centres around finding Future Quality companies - those which are able to grow, attain and sustain superior returns on invested capital and have key quality pillars in place (Franchise, Management, Balance Sheet and Valuation) - we are not averse to harnessing long-term structural themes that will help drive that growth.

AI undoubtedly represents one such driver, but we also track several other so-called 'mega themes' in order to identify other investment prospects and ensure our portfolio benefits from a diversified set of independent growth drivers. At present, we see long-term alpha opportunities from enablers of the energy transition; the normalisation and structural growth in global travel following pandemic-imposed restrictions; and among the providers of more efficient healthcare at a time when the world's population is ageing rapidly and there is a great need to reduce the cost of health services worldwide.

A Future Quality case study: Nvidia

Once a trend has been robustly ascertained, the next step is to look at the set of players to identify who will be the likely winners and losers. To do this, we looked back at previous waves of technology adoption - there have already been several over the last few decades - and found that leading hardware providers have dominated. They have had first mover advantage and have taken the lion's share of profitability. In the mainframe era, the winner was IBM. In terms of PC adoption it was Intel, and for smartphones it has undoubtedly been Apple.

So, when we looked at hardware spend on AI, we found that one name currently leads the pack: Nvidia.

Nvidia ticks all the boxes of our Future Quality thesis. It has long-term leadership in the provision of the GPU/DPU technology needed for leading-edge AI, making it the partner of choice for many key technology customers (Franchise). It has stable management and scores highly in terms of both corporate governance and human capital development (Management). Its balance sheet is strong, with net cash, high free cash flow returns and further share buybacks are expected (Balance Sheet). As one of the magnificent seven stocks that led the stock market advance last year, its share price may have already appreciated significantly, but we forecast an enduring period of high growth (Valuation).

Chart 1: Nvidia cash return on equity (%), 2023 - 2027

Source: Nikko AM forecast, as of August 2023.

Having affirmed Nvidia's Future Quality credentials, we purchased the stock in August 2023. As the dominant semiconductor provider, we believe Nvidia will maintain its growth trajectory amid an acceleration in the market for AI-compatible chips, as well as its additional software services. In short, we see this as a US$1trillion opportunity.

Chart 2: The opportunity for Nvidia 

Source: Nvidia, August, 2023.

How AI helped re-focus a business: Meta

We also considered how AI is being applied by other technology businesses.

While Meta - the owner of Facebook and Instagram - was always on our watchlist, we no longer held the stock within our portfolio as we felt its heavy investment in developing the metaverse represented a poor return on capital and perceived that the business had taken its eye off the real revenue driver of its business model of selling advertising to large and small businesses around the world.

Fortunately, Meta's management recognised the error of its ways, redeploying capital into AI and using AI to reinforce its core franchise. This is already delivering a notable impact; people are spending more time on its platforms and Meta has already seen its share of global advertising revenue go up - a particularly notable feat during a time when the advertising cycle is under strain from a more depressed economic environment.

This change in business strategy has resulted in a notable improvement in Meta's returns on capital and better growth prospects. We now believe that Meta once again meets our Future Quality criteria, as its outlook now aligns with our expectations of sustained and superior returns, and as a result we have reintroduced the stock back into our portfolio.

Identifying the leaders of the AI revolution

Investing isn't an exact science. Trying to pick winning businesses over a 5-10 year horizon is not an easy task and errors will inevitably be made, especially when new trends emerge. However, for seasoned investors, the ability to acknowledge such mistakes and take appropriate action is the key to long-term, successful investing. For us, that means re-evaluating an investment thesis based on our Future Quality criteria. Our research shows that AI is a new paradigm that will have significant investment implications for the future and shouldn't be ignored or avoided. However, as with every nascent development, the successful adopters of AI and the ultimate winners are not yet evident, so we will proceed with caution rather than run with the herd. Our focus remains on finding Future Quality businesses with a visible pathway to future growth, regardless of whether they are AI-aligned, affiliated with another megatrend or have their own robust idiosyncratic business case, but all are connected by our Future Quality investment philosophy.

Globally equity markets performed strongly in February. In the US, the S&P 500 was up +5.2%, the Nasdaq increased +6.1%, whilst in the UK, the FTSE 100 was flat. The driver of the US markets was continued strong performance of the technology sector, as well as a decline in inflation (+3.1% rolling 12 months), which bodes well for future monetary policy. The ASX All Ordinaries rose +1.2%, with technology and consumer discretionary sectors being the top performers. Gold was the worst performer, impacted by rising bond yields and a poor reporting season, where cost increases were a factor. Rising costs against a backdrop of weaker commodity prices were a headwind for the resources sector, though we would note investor sentiment is already quite bearish.

Regarding the ASX reporting season, we viewed it as better than had been expected. Of note, a reasonably large number of small/mid caps stocks beat analyst expectations, both on profit margins and revenue growth. The overall theme was that despite the large number of interest rate hikes in the last 18 months, the Australian economy and consumer spending has been resilient. Whilst unemployment has risen in recent months (currently 4.1%), it is still very low by historical standards. In terms of monetary policy in Australia, the RBA remains "on pause" whilst it monitors inflation data. We do not assume any interest rate cuts for the next 6-9 months but believe we have seen the worst of the interest rate rises. In bond markets, the US 10-year bond rate increased +26 basis points (bp) to close at 4.28%, whilst its Australian counterpart rose +12 bp to finish at 4.14%. The Australian dollar was flat, ending at US$0.65.