The future of property

From bricks and mortar retail to the future of office usage, the COVID-19 pandemic has been a disruptor to Australian real estate investment trusts (AREITS).

However, what is unknown is whether the pandemic will be a temporary disruption that will eventually lead back to normalcy or a catalyst for a transition into permanent change.

The COVID-19 pandemic has impacted every facet of our day-to-day lives: non-essential office workers have been working from home, and although essential retailers like grocers have continued, many other retailers and entertainment venues closed, leaving once densely-packed shopping centres as ghost towns.

However, not all property was created equal and different sectors have been impacted in different ways.

OFFICE SPACE

Will Gray, head of real estate at Real Asset Management, said that commercial offices had not seen any disruptive elements impacting it – apart from hot-desking and open-plan offices – for the last five to seven years. However, this had abruptly changed with the pandemic.

“COVID-19 has come along, it’s changing everything and we don’t know what the trends are going to be in the future,” Gray said.

“What I do know is that the downsizing that everyone has been talking about isn’t exactly the trend that we expect to happen.

“Offices are going to need more space and there’s going to be a greater emphasis on the ability to maintain social distancing.”

Janine Yoong, Principal Global Investors portfolio manager, said COVID-19 had created questions around the long-term sustainability of office demand.

“With so many companies working from home, as well as companies like Google who are extending that to the middle of 2021 for their employees, there’s a question about how much office space do corporations actually need,” Yoong said.

“But at the same time the flip side of the argument is that workspace density has increased tremendously in the last 10 years, so we’ve squeezed more and more workers into a small space.

“What’s happened is with COVID-19, you now need to have social distancing and increase the amount of space per worker so that’s going to offset some of the weaker demand from work from home.”

Paul Meierdierck, LaSalle Investment Management managing director and portfolio manager, said we were at the early stages of a transformation in which companies would reimagine how they used real estate.

“That starts with them harnessing the behaviours of working from home during this pandemic and that it will further ingrain remote working as a tool to attract and retain talent, reduce carbon footprint and control costs,” Meierdierck said.

“It doesn’t mean every single company is going to 100% work from home… some occupiers by nature of their business need to have people in the office more.”

Grant Berry, SG Hiscock director and portfolio manager, said offices were the core of business culture as they were the place where you need to go to mentor staff and connect with clients.

“The social distancing argument is positive in the short-term in that it stems the densification of offices,” Berry said.

“Offices have got more and more jammed so it’s a little bit of a pushback from that, however, I would challenge that argument a little as social distancing is very much a transitional phase.

“We’re unlikely to be living with COVID forever, you still have to get to work and people are probably going to have more challenges with public transport.”

Berry expected people would still want an element of working from home in the future and predicted an increase of 10% of people working from home going forward.

From a geographic perspective, there was significant pressure on effective central business district (CBD) office rents in Sydney and Melbourne where rents had effectively doubled over the last five years.

“Sub-lease vacancy is the key metric we are focusing on at the moment and we can see that starting to gather pace, which could lead to a meaningful correction,” said Steve Bulloch, PGIM Real Estate managing director and head of Australia.

“Some non-CBD markets in Sydney may hold up relatively well, particularly those where rents are at historically large spreads to the CBD. 

“Declining corporate profits and structural themes like employees wanting to work close to home also support this theme.”

WINNERS AND LOSERS

Yoong said it was difficult to look at AREITs as one broad group, as sectors perform differently based on environmental circumstances.

“There are certain stocks that are attractive, I wouldn’t say you can look at the entire sector and buy an index, because there are divergent stories within the space,” Yoong said.

“What COVID-19 has done is actually polarised a lot of sectors, so you’re going to have to drill down to a sector level.”

Retail was an example of this, although it was already struggling prior to the pandemic, it had now been put in an even worse position.

“Retail was already under pressure from online retail, so with COVID-19 and related lockdowns, it has accelerated the penetration for online retail, meanwhile physical shops haven’t been able to open,” Yoong said.

“That’s put added pressure onto retail AREITs and the tenants are either covered by the code of conduct, which requires the landlord to provide some rental relief or the tenants are just not in a position to pay rent.”

Since April, there had been tenants withholding rent which had created cashflow pressure within the retail space.

“There’s also questions about future leases – where rents are going to get set and how that relationship is going to go moving forward,” Yoong said.

“If you flip to the polar opposite, industrial is a beneficiary, from the growth in online retail you’re seeing more retailers increase their online offering, so industrial AREITs are a benefit of that trend.

Bulloch agreed that industrial property remained the favoured asset class. 

“The pandemic has accelerated several themes that were already playing out, including online shopping and we think strong e-commerce locations will continue to do well,” Bulloch said.

Gray said tourism-based assets had been impacted, because of a significant burden on income due to its inability to trade and operate.

“That’s an area that will bounce back strongly post-COVID-19 but it might take some time once international travel and mobility comes back up,” Gray said.

Supermarket-based retail had also performed strong during the pandemic, showing resiliency when previously it was facing significant disruptive elements.

“Supermarket-based retail is not your large Westfield-type enclosed shopping malls where you dwell on a weekend,” Gray said.

“It’s more your local neighbourhood Coles, Woolworths or IGA that typically also has a pharmacy, medical centre, bakery and butcher. Those smaller supermarket-based shopping centres are located in every one of our suburbs around the country.”

DIRECT V LISTED AREITS

Investing in property through AREITs was not the only option investors had and Bulloch said direct property offered a purer exposure to real estate.

“It also typically provides the ability to have a longer-term focus, as REITS tend to be more focused on short-term results,” Bulloch said.

“The other major advantage is that REITs are usually active buyers only when acquisitions are accretive – that is, when they have a low cost of capital and/or are trading at a premium.

“With asset prices likely to correct further in the next year, it will be difficult for the REITs to take advantage of the better opportunities, particularly given the significant dry powder available in the unlisted market.

“Having said that, with valuations yet to change significantly for many forms of physical real estate, the significant discounts to net tangible assets that some of the REITs are trading at, suggests they may be relatively attractive.”

GLOBAL OPTIONS

Global REITs also provided an alternative to AREITS, providing an advantage by gaining access to sectors that were either unavailable or in limited supply in the Australian market.

Chris Bedingfield, Quay Global Investors portfolio manager, said the Australian market was dominated by office, retail, industrial and some residential development.

The Quay Global Real Estate fund had won Money Management’s Fund Manager of the Year 2020 Award for global property securities.

“When you think about the current environment, two of those asset classes – office and retail – are very challenged right now,” Bedingfield said.
Although there were smaller sectors like storage and healthcare, the choices outside the major asset classes were stark.

“If you stick to the current market, you’d have to pay through the teeth to buy industrial, which by every metric is so expensive, notwithstanding the positive themes,” Bedingfield said.

“The beauty about being offshore is that you can fish around asset classes that aren’t as readily available here in Australia.”
That included sectors like senior living, hospitals, nursing facilities, self-storage, data-storage – all of which could be available in Australia but on a smaller scale.

OUTLOOK

Bulloch said Australia was currently facing significant headwinds as many of our key economic and real estate drivers were under pressure, which included factors such as population growth, employment, housing, education and tourism.

“Some of this is yet to fully hit property prices due to the stimulus measures and supportive banks, therefore we see more downside to valuations,” Bulloch said.

“However, we expect Australia will bounce back reasonably strongly when the health crisis is under control because we think it will still look relatively attractive to foreign capital and many of the key drivers will return.”

Bedingfield said it was important to stay focused on buying value and keep a long-term vision to the portfolio.

“It’s pretty easy to pile all your money into those sectors doing well and feel like you’re going to be safe for a while, but you have to pay up big-time to get into those sectors,” Bedingfield said.

“There are other sectors that have interesting longer-term opportunities and you just have to grit your teeth and accept real estate is set up to be a long-term investment – you’re not supposed to be trading all the time.

“We’re just trying to find opportunities that we think in five years’ time, we are going to look back on as great buying opportunities during the pandemic.”
Yoong said valuation dispersion had increased since COVID-19 started and defensive sectors like industrial and long-leased assets were trading at a premium.

“We went into COVID-19 being positioned to the defensive with a structural growth story, so industrials had a structural growth story there that was being supported by online penetration,” Yoong said.

“Retail and office are more of a challenge and we’ve been underweight in those sectors, but we continue to assess it because everything has an appropriate price.”

Berry said there’s “certainly uncertainty” out there in the current economic environment but it was still a good opportunity to invest in REITS at this time.

“We have seen quite a sell-off in March because of the uncertainty with what’s happening with tenants and things of that nature,” Berry said.

“But having said when you look at the implied fall on some of the assets, it’s actually thrown up some interesting opportunities.”

Although the situation was fluid and continuously evolving, Berry said there was past pandemics, particularly in Asia, that showed a roadmap to a functional recovery.

“We have seen a snapshot of that already in retail, for example Melbourne is going through a second wave at the moment, but when things opened up, we saw foot traffic return to retail assets in a meaningful way,” Berry said.

“With over 90% of their stores back open, foot traffic was back up to 86%, while companies saw foot traffic back up 110% on the same month as prior year.”
Gray said investors would want to put their money into real estate because bonds are so low, debt is obviously cheap, and the cash rate was at a historical low.

“Where else can you get a stabilised yield outcome where it’s perceived to be relatively safe and managed by specialists?” Gray said.