2014AMP Capital Investors LimitedABN 59 001 777 591AFSL 232497

Understanding Real Estate

About real estate at AMP Capital

Delivering outstanding investment outcomes is our central focus and driving motivationAt AMP Capital, we are committed to delivering outstanding investment outcomes for our clients based on a long-term, trusted partnership. This means managing our clients’ real estate assets to ensure they remain relevant both now and in the future.

Experience has taught us what matters mostWith more than 50 years’ experience managing real estate investment, we’ve learnt what matters most - that is, to deliver outstanding investment outcomes and build long-term partnerships with our clients based on trust. With decades of experience sourcing and developing new investment opportunities, we are now one of the leading real estate fund managers in the Asia Pacific region. Our integrated and strategic approach to investment management spans the real estate risk and return spectrum, so we provide clients with access to global and regional, listed and unlisted real estate opportunities.

The whole is greater than the sumFor us, success is about expert teams coming together to discover the best possible insights and investment opportunities for our clients A key distinction for AMP Capital is our integrated approach to managing our clients’ assets. We aim to deliver outstanding investment outcomes by applying specialist expertise across funds management and analysis; asset, real estate and development management; and sustainable performance, operations, leasing and marketing. Our clients also benefit from the additional perspectives of the wider AMP Capital team, including our Investment Strategy and Economics team, as well as experts from our infrastructure, fixed income, equities and multi-asset investment teams.

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Please visit ampcapital.com

What is real estate? 3

Benefits of investing in real estate 4

Investing in real estate 4

> Ways to invest 4

> Risk-return characteristics 5

> Drivers of performance 6

> Risks specific to real estate investing 7

The importance of active management 7

Table of contents

Understanding Real Estate

1 AMP Capital is a proud participant in the Global Real Estate Sustainability Benchmark, (GRESB), an industry-led initiative committed to the rigorous and independent evaluation of the sustainability performance of real estate portfolios.

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Examples of real estate

What is real estate? Real estate is a physical ‘bricks and mortar’ investment where income and value are driven by rents that are paid by tenants under contractually binding leases.

Real estate can be appealing to pension funds, sovereign wealth funds, insurance and institutional investors because it provides a high income yield relative to other asset classes, and it is often less volatile in pricing. This volatility is lowest in direct real estate ownership and highest in listed real estate investments.

Direct real estate offers relatively stable returns due to the rental payments that tenants are required to pay under leases. Major tenants typically lease space for five to 10 years.

This provides investors with predictable cash-flows for an extended period of time. In addition, direct real estate typically does not trade as quickly as equities, so it prices are susceptible to investor speculation than listed real estate or equities generally.

Being a physical asset, direct real estate is more illiquid (takes longer to sell) than equities and bonds. Investors seeking greater liquidity have the option of buying listed real estate securities. However, the trade-off for higher liquidity can be greater volatility in prices compared to direct real estate ownership.

1 Office space at Collins Place, Melbourne, Victoria, Australia 2 Office space at Coronation Drive, Brisbane, Queensland, Australia 3 Mt Ommaney Shopping Centre, Brisbane, Queensland, Australia 4 Bay Fair Shopping Centre, Tauranga, New Zealand 5 Warehouse, Chullora, New South Wales, Australia

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1 2

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Benefits of investing in real estateStable, reliable income streamsReal estate can offer investors a stable source of income through regular distributions of underlying rental income. Over the long term, the majority of real estate returns come from rental income which is generally less volatile than capital returns, as rents are contracted under a lease agreement. In commercial real estate, this can be five to 10 years for major tenants.

Inflation hedgingSome real estate leases contain provisions for rental increases to be indexed to inflation, while in other cases there is an opportunity to increase rental rates whenever a lease term expires and the lease is renewed. Either way, real estate income should keep pace with inflation, helping to maintain real returns.

Low correlation to other asset classesDirect real estate has significantly lower correlation to other growth assets and it is not typically impacted by changes in market sentiment as quickly as equities. Its low correlation with other asset classes provides effective diversification benefits and can reduce the overall volatility of an investment portfolio.

The following chart maps out the efficient frontiers of a diversified portfolio (comprising shares, bonds and listed real estate), with and without exposure to direct real estate. An efficient frontier represents the best risk-reward ratio for an investment under the present circumstances.

The chart below shows that when direct real estate is included in a diversified portfolio, the efficient frontier shifts to the left, thereby signifying a reduction in volatility.

The inclusion of direct real estate improves the risk adjusted return

Investing in real estateIMPORTANT NOTE: In this section, we outline some of the benefits of investing in real estate, and on page 7, we describe some of the risks investors should be aware of when considering investing in this asset class. When assessing performance, we will draw on historical information. Investors should be aware that historical performance is not a reliable indicator of future performance.

Ways to invest

Direct real estateWhen investing in direct real estate, investors purchase the asset(s) themselves and gain access to the ‘pure’ risk of real estate. This means they can expect predictable secure long-term rental cash-flows, and exposure to the real estate market cycle, not the equity market.

The downside of owning a physical asset is that money has to be spent on maintaining the asset over time. However, historically direct real estate has produced relatively strong returns for investors – see table on page 5.

Direct real estate is usually valued once a year with the valuer aiming to capture a year’s worth of events at one point in time. Actual underlying market fundamentals and asset-specific risks are the principal drivers of direct real estate pricing.

Direct real estate investment by most private investors is in residential real estate, as it is beyond the reach of most individual investors to buy an office block or shopping centre, mainly because of the higher dollar amounts required.

These days, however, direct real estate is becoming more accessible to retail investors via fund products that offer access to these types of assets.

Pooled Funds

> Syndicates – Retail investors can buy partial shares of physical assets with other investors. This style of fund typically invests in one or two assets.

> Hybrid funds – These are funds that give investors exposure to partial ownership of direct real estate either via a syndicate or institutional fund, together with some holdings in real estate securities.

The inclusion of direct real estate improves the risk adjusted return

Volatility

Excluding direct real estate assets Including direct real estate assets

Retu

rn

Source: AMP Capital. For illustrative purposes only.

Listed real estateWhen investing in listed real estate, the investor does not hold the title to the property, but instead owns units in a fund or trust that pools money with the money of other investors to invest in a range of real estate assets. Popular listed real estate investments are Real Estate Investment Trusts (REITs), which make up a significant part of equity markets.

One of the advantages of REITs is that they allow investment in commercial and industrial assets, something that is harder to do directly. The pricing of listed securities is driven by market sentiment and prices are considered a reflection of future expectations. Unlike direct real estate, bad news or good news is usually reflected immediately and prices can ‘overshoot’ on the upside and the downside.

Risk-return characteristicsReal estate’s typical performance bridges the gap between fixed income and equities. Real estate can offer investors a stable bond-like payment structure with the potential for equity-like upswings in yield and capital.

Real estate ranks between fixed income and equities on the risk return scale

Factors influencing performance of direct real estate

When assessing the performance of real estate, consideration has to be given to the type of real estate asset (residential, commercial or industrial), where it is located, the quality of the tenants and how much of an investor’s money is in one asset. It is important to understand that all of the major real estate investment categories generate returns from both income and capital growth.

However, the proportion of that return varies when looking at each asset type. Over the long term, the highest returns have been produced by shopping centres, and prime residential real estate.

Performance of direct real estate

Total return (%) 10 year annualised

Australian retail

- Prime retail

- Secondary retail

10.8

11.2

10.5

Australian office

- Prime office

- Secondary office

9.9

9.8

9.6

Australian industrial

- Prime industrial

- Secondary industrial

9.5

9.4

9.8

Source: IPD Australia, quarter ending June 2013. Historical performance is not an indicator of future performance.

Residential

Definition: Real estate that derives its revenue from dwelling units.

Historically, residential real estate has been able to deliver high capital growth because of low vacancy rates and an undersupply of rental accommodation. For the past 10 years, housing demand has outstripped housing supply2. Some of this is due to town planning systems restricting the volume of new supply below demand. Low vacancy rates allow landlords to raise rents, and real estate values tend to increase when the potential rental earnings increase.

Demand for accommodation is also influenced by population growth and demographics, and less so by the economic or business cycle. Therefore, over the long term investing in residential real estate can be less volatile, reducing the risk of a sharp rise in vacancy rates when the economy slows.

Commercial

Definition: Real estate that is intended for use by commercial, retail or wholesale businesses.

Income yields in commercial real estate are generally supported by longer lease terms than residential real estate. Lease terms of up to 10 years or higher are common for major tenants in shopping centres and prime central business district office towers.

Shopping centres: Historically, shopping centres have had the lowest vacancy rates of all the commercial real estate sectors3. Retail spending is also more influenced by population growth and demographic shifts than office and industrial, which are more sensitive to the business cycle. Therefore, the retail sector has historically produced the most consistent growth in rents and the most attractive capital growth opportunities for investors4. The space for shopping centres in Australia is more regulated than for office buildings and factories because of town planning and this has helped to drive strong, stable returns for investors over the long term.

Risk

Retu

rn

Real estate ranks between fixed income and equities on the risk return scale

Direct Real Estate

Private equity and hedge funds

Equities

Infrastructure

Listed Real Estate

Fixed income

Cash

Real estate and infrastructure are often classed as ‘real assets’ because theyare tangible

Source: AMP Capital. For illustrative purposes only.

2 National Housing Supply Council, Housing Supply and Affordability Report, 2012

3 JLL Research, Real Estate Investment Service, June 2013

4 IPD Australian Quarterly Digest, June 2013

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Offices: Office markets have historically been a more volatile direct real estate investment for investors, mainly because multi-storey office buildings take three to four years to build and the market has historically mis-matched the timing of construction with the shifts in demand because of the length of time it takes to build a skyscraper. Office real estate is also more susceptible to economic and business cycles than other real estate sectors.

Industrial

Definition: Real estate that is intended for industrial purposes.

The industrial sector holds over 100 million square metres of industrial space3. As a consequence, the industrial market has historically had higher vacancy rates than other property sectors. Because of higher vacancy rates, the industrial market has struggled to increase rents faster than inflation due to an abundance of land to build new warehouses. Consequently, the majority of the return from industrial assets tends to be derived from income yield rather than capital growth.

Drivers of performance

The performance of the real estate market is affected by changes in physical and financial cycles. Real estate cycles typically last over a decade, and reflect a process of events such as fluctuating prices, vacancies, and rental demand.

> The physical cycle represents vacancy rates which, in turn, influence changes in rental levels.

> The financial cycle represents the capital flows that go towards funding real estate developments; new construction affects the price of real estate.

The real estate market is affected by changes in physical and financial cycles

Source: AMP Capital, adapted from Barras, R. (1994) Property and the economic cycle: Building cycles revisited. Journal of Property Research, 11(3), 183-197. Past performance is not a reliable indicator of future performance.

2 National Housing Supply Council, Housing Supply and Affordability Report, 2012

Economic upturn Credit expansion

Increased property demand Supply shortage

Rising rents / falling yields Economic boom Building boom Credit boom

Increased supply & Slackening demand Rising interest rates Falling rents / rising yields Recession Property slump Credit squeeze

Physical cycle Real estate cycle Financial cycle

Economic downturn

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Risks specific to real estate investingReal estate returns may be affected by factors such as investor demand for assets, demand by tenants for commercial space, rental income levels and the supply of new commercial space. The cost of real estate debt, or costs and losses associated with natural disasters or other events which prevent the normal operation of real estate investments also have an impact on the performance of real estate returns. The following risks are among those investors should consider when investing in real estate:

Sector riskThere are a number of factors which may affect the real estate sector, including the cyclical nature of real estate values, over-development and increased competition, increases in real estate taxes and operating expenses, demographic trends and variations in rental income. Changes in the appeal of properties to tenants, increases in interest rates, the level of gearing in the real estate market and other real estate capital market influences can also affect the performance of the sector.

Vacancy riskThe risk of a tenant vacating a property, failing to meet their rental obligations or failing to renew a lease can have a detrimental impact on rental returns.

Value riskAsset values are influenced by location, supply and demand, rental agreements, occupancy levels, obsolescence, tenant covenants, environmental issues and government or planning regulations. Changes to these drivers may affect the end value of the asset.

A good approach for those wishing to minimise risk is to invest in real estate which is leased to good quality corporate type tenants. In selecting assets, we believe the higher the quality of the asset, the higher the quality of the tenant. Therefore, it is advisable to look for well-located properties, in locations such as central business districts or central shopping malls, with lengthy and secure income streams.

The importance of active managementActive management adds value for an investor if it earns back its costs – investment management and transaction fees – and achieves a return greater than that available through passive management.

In our view, real estate securities have a number of unique features which present opportunities for active managers. There are significant differences between real estate markets around the world which require local knowledge. At a basic level, distinctions exist between real estate investors, fund managers and developers. There are also material differences in corporate structures and regulatory frameworks – for instance, there is an obvious difference between REIT and non-REIT structures.

Within the real estate sector, there are many important regulatory considerations which allow active managers to add value through research, local knowledge and prudent asset allocation. However, not all active managers are the same and it is important to select an active manager that has the ability to generate consistent strong performance.

Important notice to all investors:

While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing

general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

Contact usIf you would like to know more about how AMP Capital can help you, please visit ampcapital.com

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