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Fear & Greed, Fear and Greed

Commercial property has had its share of headwinds. New data shows deal flow in the sector has dropped significantly – but much of the pressure is on office towers. Other parts of the sector are performing comparatively well.

And in the middle of it all are Real Estate Investment Trusts, or REITs. 

Matthew Strotton is the Executive Director, Head of Real Estate at RAM, which stands for Real Asset Management. He gives Sean Aylmer a 101 on REITs – what they are, how they work, and the outlook for the sector.

RAM is a supporter of Fear and Greed. This podcast contains general information only. You should seek professional advice before making investment decisions.

Find out more: https://fearandgreed.com.au

See omnystudio.com/listener for privacy information.

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Sean Aylmer: Welcome to the FEAR & GREED Business Interview. I’m Sean Aylmer. The

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Sean Aylmer: commercial property sector has had its share of headwinds lately.

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Sean Aylmer: New data from MSCI shows deal flow in the sector

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Sean Aylmer: fell by almost half to about $ 40 billion, dragged down

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Sean Aylmer: by office towers with so much uncertainty over the future

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Sean Aylmer: of the workplace. But commercial property investing in Australia is

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Sean Aylmer: much bigger than just office towers. In the middle of

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Sean Aylmer: it all are the real estate investment trusts or REITs, R-E- I- T-

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Sean Aylmer: S, REITs. I wanted to find out how they work,

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Sean Aylmer: how the team behind an ASX listed REIT goes about

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Sean Aylmer: choosing the property assets within the fund, and what sort

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Sean Aylmer: of assets are we talking about. Matthew Strotton is the

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Sean Aylmer: executive director, head of real estate at RAM, which stands

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Sean Aylmer: for Real Asset Management, a great supporter of this podcast.

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Sean Aylmer: RAM runs the ASX listed RAM Essential Services Property Fund.

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Sean Aylmer: Remember, this is general information only. You should definitely seek

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Sean Aylmer: professional advice specific to your circumstances before making investment decisions.

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Sean Aylmer: Matthew Strotton, welcome to FEAR & GREED

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Matthew Strotton: Thank you, Sean. Great to be here. Great to see

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Matthew Strotton: you again.

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Sean Aylmer: Can we start with a 101 on REITs, on real

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Sean Aylmer: estate investment trusts? Many out there know exactly what they

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Sean Aylmer: are, but many don’t. It is a massive part of

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Sean Aylmer: the market, but incredibly diverse as well. So what are

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Sean Aylmer: we talking about when we talk about REITs, and particularly

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Sean Aylmer: how diverse some of those assets are?

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Matthew Strotton: A great question, Sean. Real estate investment trust, it’s quite

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Matthew Strotton: a descriptive name, quite a descriptive acronym. It is typically

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Matthew Strotton: a collection or a portfolio of real estate assets and

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Matthew Strotton: oftentimes there is one distinction beyond that and that is

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Matthew Strotton: whether or not a manager is actually internalized or an externalized

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Matthew Strotton: manager. So at the core of a real estate investment

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Matthew Strotton: trust is a portfolio of pure commercial, typically commercial real

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Matthew Strotton: estate, and whether or not a manager is actually part

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Matthew Strotton: or embedded within that vehicle or it’s an external manager

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Matthew Strotton: is one of the main differences. As you pointed out,

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Matthew Strotton: the commercial office market is quite a significant part of

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Matthew Strotton: the real estate sector and therefore no surprise that the

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Matthew Strotton: majority or certainly a significant number of real estate investment

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Matthew Strotton: trusts are comprised of office assets in Australia.
All of

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Matthew Strotton: the other real estate sectors are reasonably well covered, including

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Matthew Strotton: retail assets or shopping center assets. These are shopping center assets

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Matthew Strotton: that can range from the assets that are some of

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Matthew Strotton: the largest in the southern hemisphere, like Chadstone, through to

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Matthew Strotton: smaller real estate assets like supermarket- anchored, Woolworths and Coles-

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Matthew Strotton: anchored assets, through to even smaller high street assets. And

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Matthew Strotton: then beyond that, we do have an array of residential

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Matthew Strotton: based real estate investment trust. These can include student housing,

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Matthew Strotton: they can include the growing build to rent asset types

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Matthew Strotton: that are emerging in Australia, and through to two of

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Matthew Strotton: the asset classes that I will call out, which is

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Matthew Strotton: two of RAM’s focus, which is the healthcare or medical

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Matthew Strotton: sector, which typically contain at the top end of the

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Matthew Strotton: spectrum private and public hospital. These are assets that can,

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Matthew Strotton: as you’d imagine, contain a longer term leasing commitment from

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Matthew Strotton: either public or private operations that provide services in the

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Matthew Strotton: hospital sector. These can be overnight hospitals, full service hospitals,

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Matthew Strotton: they can be day hospitals. Through to other aspects of

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Matthew Strotton: healthcare including IVF, mental health hospitals, and other allied healthcare.

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Matthew Strotton: And beyond that, there are other smaller sub- sectors like

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Matthew Strotton: we call essential services retail, which is your daily or

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Matthew Strotton: weekly needs visitation for the type of retail assets including supermarket-

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Matthew Strotton: anchored and other localized retail offerings. And then you have

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Matthew Strotton: other REITs that do cover everything from service stations and

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Matthew Strotton: so on. But the broad intention of REITs is to house

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Matthew Strotton: a collection of real estate assets and derive what is

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Matthew Strotton: typically a sustainable rental income from those portfolios.

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Sean Aylmer: That is a great explanation. And the bottom line is

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Sean Aylmer: real estate investment trusts are trusted invest in real estate,

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Sean Aylmer: which is stating the obvious, but real estate is such

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Sean Aylmer: a broad… So it really is across the spectrum. They

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Sean Aylmer: haven’t done so well in more recent times. Tell me

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Sean Aylmer: how interest rates affect REITs and then going forward, if

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Sean Aylmer: REITs start to fall, what that means.

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Matthew Strotton: That is a very good question, Sean. The one central

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Matthew Strotton: feature of REITs is the level of transparency. Naturally in

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Matthew Strotton: a listed environment, and including myself as well as all

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Matthew Strotton: of our peers, are subject to the regime that exists under

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Matthew Strotton: the ASX, which means regular reporting, which means regular updates

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Matthew Strotton: of our valuations of our assets, which are conducted by

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Matthew Strotton: third parties. And on that particular point, Sean, I’ll call

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Matthew Strotton: out that most of your viewers would no doubt be

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Matthew Strotton: aware that the valuation of real estate, longer term commercial

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Matthew Strotton: real estate is linked to a cap rate, and a

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Matthew Strotton: cap rate is typically linked to what or what is

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Matthew Strotton: representative of the sustainable income that can be attributed to

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Matthew Strotton: a piece of real estate.
In the stronger points of

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Matthew Strotton: the real estate cycle there have been examples where high

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Matthew Strotton: grade commercial office, even supra- regional real estate, can be

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Matthew Strotton: used priced as low as a 4% cap rate, and

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Matthew Strotton: cap rates can vary beyond that depending on the asset

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Matthew Strotton: quality, the asset location, the sustainability of that income in

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Matthew Strotton: terms of how long a lease duration remains on that

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Matthew Strotton: particular asset, so on and so forth. There is an

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Matthew Strotton: inextricable link between cap rates and lending rates. And in

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Matthew Strotton: this particular example, when we witnessed, or as we all

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Matthew Strotton: witnessed inflation start to move upwards, our reserve banker and

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Matthew Strotton: therefore lending rates by our financiers within Australia started to

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Matthew Strotton: increase interest rates. And because that has a natural burden

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Matthew Strotton: on investment, particularly if I’m holding any sort of longer

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Matthew Strotton: term debt instruments, I am then going to naturally compare

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Matthew Strotton: to what is a competitive holding in equity real estate,

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Matthew Strotton: and that lends itself to increasing the required levels of

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Matthew Strotton: return in equity returns and thus points to, in this

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Matthew Strotton: example, a higher expected rate of return on real estate.

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Matthew Strotton: Therefore cap rates rise and prices start to reduce.
What

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Matthew Strotton: it does do in an environment where inflation and interest

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Matthew Strotton: rates did rise quite quickly, it tends to shine quite

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Matthew Strotton: a light on the particular underlying fundamentals of real estate.

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Matthew Strotton: I think in periods of the economic cycle where real

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Matthew Strotton: estate is moving, and as it did coming into the

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Matthew Strotton: end of this real estate cycle or this interest rate

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Matthew Strotton: cycle, real estate wasn’t necessarily priced perhaps as individually, shall

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Matthew Strotton: I call it, as it should have been. I think

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Matthew Strotton: there were sectors and assets being traded that probably maybe

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Matthew Strotton: moved a little bit too rapidly up the pricing curve.

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Matthew Strotton: And in this environment at the moment where pricing has

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Matthew Strotton: become, as you alluded to in your opening comments, has

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Matthew Strotton: been a little bit less frequently traded, capital is being

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Matthew Strotton: a little bit more cautious when it undertakes an analysis

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Matthew Strotton: of any sort of new acquisition or new disposal. It

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Matthew Strotton: means the individual fundamentals of assets tend to become far

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Matthew Strotton: more important in their analysis, and that lends itself to

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Matthew Strotton: even an even wider curve in cap rates. So cap

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Matthew Strotton: rates, yes, are inextricably linked to interest rates, but importantly

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Matthew Strotton: you tend to see a wider spectrum of cap rate

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Matthew Strotton: across different sectors.

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Sean Aylmer: Stay with me, Matthew, we’ll be back in a minute.

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Sean Aylmer: I’m talking to Matthew Strotton, executive director, head of real

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Sean Aylmer: estate at RAM. So cap rates/ interest rates, we’re talking

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Sean Aylmer: about quality of buildings. On top of that, you’ve got

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Sean Aylmer: things for office, for example, work from home trends, all

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Sean Aylmer: the post- COVID stuff that’s going on, it makes it

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Sean Aylmer: a challenging sector just to get your head around, really,

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Sean Aylmer: maybe not to invest in. What about RAM Essential Services

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Sean Aylmer: Property Fund? Where do you play? Where do you think

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Sean Aylmer: the sweet spot is?

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Matthew Strotton: I like our outlook in that we are… Two of

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Matthew Strotton: our central areas we focus on is in healthcare in

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Matthew Strotton: the medical sector, and we’ve had some very strong areas

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Matthew Strotton: of momentum over the last 12 or 18 months in that space,

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Matthew Strotton: as well as essential services retail, which is those shopping

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Matthew Strotton: centers that we all visit once a week, twice a

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Matthew Strotton: week, that either house a Coles or a Woolworths.

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Sean Aylmer: I’m a daily shopper, Matthew. I’d love to be twice

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Sean Aylmer: a week. Really essential services. Go on.

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Matthew Strotton: There you go. So in quite a short summary form,

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Matthew Strotton: those particular sectors have remained quite defensive. And when I

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Matthew Strotton: say defensive, that means our tenants that are housed in

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Matthew Strotton: our real estate properties, be they private hospitals, day hospitals,

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Matthew Strotton: supermarkets, the local butcher, the local grocer, or some of

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Matthew Strotton: those other local services that we visit on a regular

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Matthew Strotton: basis, have withstood an array of different economic scenarios. And

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Matthew Strotton: we’ve all experienced that over the last four or five

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Matthew Strotton: years. So today, looking forward, not only can I speak

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Matthew Strotton: with such confidence that we’ve endured an array of stress

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Matthew Strotton: tests economically, and we’ve remained very defensive in terms of

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Matthew Strotton: our income levels, looking ahead in an environment where we

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Matthew Strotton: may… Our Australian economy either as a whole or certainly

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Matthew Strotton: parts of the economy are going to experience more duress,

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Matthew Strotton: we might start to experience a little bit more weakness

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Matthew Strotton: in our household incomes or whatever it might be up to

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Matthew Strotton: this discussion.
It’s going to mean it’s going to put

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Matthew Strotton: further pressure on the tenants that exist in certain real

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Matthew Strotton: estate holdings, and I would rather in this environment have

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Matthew Strotton: a more substantive exposure to healthcare, which is… I think that

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Matthew Strotton: the fundamentals of healthcare, why it’s remained resilient, I think

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Matthew Strotton: is self- evident, but also in that essential services retail

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Matthew Strotton: class. You talked about office and it being subject to

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Matthew Strotton: disruption, like retail has been subject to disruption over the

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Matthew Strotton: last 10 or 15 years as we’ve absorbed and seen the flow-

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Matthew Strotton: on effect of a change in behavior in the manner

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Matthew Strotton: in which we shop. But there’s one thing about real

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Matthew Strotton: estate, there is always going to be an underlying level

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Matthew Strotton: of demand that is always pinned to both population growth,

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Matthew Strotton: income growth, and other demand drivers that is always going

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Matthew Strotton: to underpin the longer term fundamentals of a particular sector.

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Matthew Strotton: When we talk about disruption, like you hinted at with

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Matthew Strotton: office, those impacts tend to be absorbed within a period

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Matthew Strotton: of time. I think office has… Yes, it’s gone through

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Matthew Strotton: an interesting cycle, but I might suggest, like a lot

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Matthew Strotton: of our peers are describing at the moment, that office

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Matthew Strotton: has absorbed that impact. The underlying demand for space is

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Matthew Strotton: certainly reemerging and you’re starting to see quite a level

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Matthew Strotton: of interest back in that particular sector. But not withstanding

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Matthew Strotton: all of that, when you add all of those features

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Matthew Strotton: up, it’s easy to describe real estate perhaps in a

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Matthew Strotton: cap rate on one hand, but on the other end

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Matthew Strotton: of the spectrum, yeah, there are a lot of factors

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Matthew Strotton: that can impact the volatility of real estate.

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Sean Aylmer: Matthew, I learned a lot today about real estate. Thank

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Sean Aylmer: you very much for talking to FEAR & GREED.

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Matthew Strotton: Oh, my pleasure, Sean. Good to see you again.

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Sean Aylmer: That was Matthew Strotton, executive director, head of real estate

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Sean Aylmer: at RAM, which is a great supporter of this podcast

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Sean Aylmer: and runs the RAM Essential Services Property Fund. This is

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Sean Aylmer: the FEAR & GREED Daily Interview. Remember, this is general information

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Sean Aylmer: only and you should get professional advice before making investment

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Sean Aylmer: decisions. Join us every morning for the full episode of

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Sean Aylmer: FEAR & GREED, Australia’s best business podcast. I’m Sean Aylmer. Have

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Sean Aylmer: a great day.