Why COVID is so bad for property investors

The A-REITs, which many hold for stability of value and income, have as a sector fallen further than broader equities this year, and further than global REITs. Many investors are soon to discover that their distributions will also be cut.

Among the hard-hit are those who follow Australia’s REIT index, which is heavily weighted to retail property. Since the February high, the S&P/ASX 200 Real Estate Index is down around 35 per cent compared with just over 20 per cent for the broader S&P/ASX 200 and about 25 per cent for global REITs.

Of course there are REITs, both in Australia and around the globe, that have outperformed and, in doing so, point the way to the fundamental changes under way in commercial property.

In an economy characterised by digitisation and economic disruption, the stronger real estate is in sectors such as logistics, data centres, government-funded offices, and, to a degree, healthcare.

Australia’s logistics leader, Goodman Group, closed on Wednesday at a price less than 20 per cent below its February high, a bounce that reflects the strength of e-commerce, low gearing and the fact that, unlike many REITs, Goodman has not withdrawn guidance.

Andrew Parsons, who as the chief investment officer of Resolution Capital manages an $8 billion listed global real estate portfolio, says other logistics leaders, such as Prologis and Segro in Europe, have also performed well.

“Globally you are not confined to office and retail,” he says. “There are some excellent vehicles in Australia but just not enough to provide real diversification and scale.”

Parsons highlights strongly performing global groups like Vonovia, which holds affordable residential in Germany and Sweden; Big Yellow, which is a leader in UK self-storage; Assura, which owns National Health Service doctors’ clinics in the UK; Healthcare Realty, which has US medical office buildings; Alexandria, which is a US leader in strongly leased life science/lab buildings; Cyrus One, with US data centres; Equinex, which is a global leader in data centres, and Equity Commonwealth, which is an office fund but which, led by the legendary Sam Zell, has “a tonne of cash waiting for opportunities”.

To be fair, most A-REITs did learn the lessons of the GFC. They cut gearing, diversified funding, and spread debt repayment schedules. This time they have been surprised by the erosion of rent.

Moreover, the listed REITs are not the only class of real estate to be affected by the fall in income and values due to the pandemic. Unlisted real estate will follow.

Dugald Higgins, the head of real assets and listed strategies at Zenith Investment Partners, has already noted some unlisted funds withholding part or all of their distributions. Others are tightening their redemption facilities to account for falling valuations. “This will become more widespread,” he says.

Few property leaders expect a V-shaped recovery, even as Australia starts to normalise.

Vicinity Centres announced on Wednesday that 530 stores had reopened in the past seven days, increasing the occupancy to 65 per cent of the gross lettable area.

Nevertheless chief executive Grant Kelley expects “challenging conditions to persist for at least the next 12 months”.

Resolution Capital’s Parsons warns that the economic consequences of the pandemic are “yet to be fully appreciated”.

First earnings fall, then values
Tim Church, the head of real estate Australasia for UBS, says this crisis is “far, far worse than the GFC”.

“The likely significant impact on unemployment, the housing market, consumer confidence, retail sales – particularly discretionary sales – and now the rapidly increasing online penetration will mean this is a long, hard and slow road to recovery for the overall economy and the property markets, particularly discretionary retail,” he says.

Unlike the GFC, the current problem is not the balance sheet but earnings.

Analysts at Jefferies estimate the average cut to distribution at around 9 per cent this financial year and 10 per cent in 2020-21. JPMorgan estimates an average 12 per cent fall this year, 11 per cent in 2020-21 and 8 per cent in 2021-22.

The big shopping centres will make larger cuts. Unibail-Rodamco-Westfield, with shopping centres in Europe and the US, and an uncomfortable level of gearing, has already cancelled its final dividend for the year.

As income falls, so will values. Kiwi Property last month announced a 20 per cent reduction in the value of its New Zealand retail assets.

Many also believe office values will weaken as bad debts and vacancies emerge. Kiwi reported a 1 per cent rise in office values but the increase was largely due to positive revaluations for towers underpinned by long-term leases to government.

Late last month Zenith’s Higgins wrote to investors about the “unhappy” performance of Australia’s REITs and asked “why maintain an exposure to listed property, given the outlook?”

His answer included a table detailing the widely varied annual performance of the GICS (Global Industry Classification Standard) sectors in the S&P/ASX 300, with the A-REITs ranging from worst in the year to March 2009 to some of the best in the years to March 2015, 2016, and 2019. He concluded that investors should continue to hold REITs as part of a diversified portfolio with “an array of risk drivers”.

“While a reduction in income for REITs is likely, the outlook for general equities is even more uncertain,” he wrote.

“Given the REITs have a strong income focus, in a world where the ‘lower for longer’ interest rates scenario has extended out to hitherto unforeseen levels, the merit of real estate remains intact.”

Resolution Capital’s Parsons, with his global view, is less focused on income and more on total return.

“Great real estate will continue to produce competitive returns, provided you are selective,” he says. “Don’t buy an index, and don’t limit yourself geographically; buy select real estate from a global opportunity set.”