Taking an alternative look at property

After a year and a half into a pandemic, COVID-19 has accelerated the pre-existing trends across the real estate assets, delivering headwinds for some sectors and tailwinds for others, fund managers say.

With global on-and-off lockdowns and ongoing behavioural changes such as working from home and online shopping, the office and retail sectors seem to have absorbed the heaviest impact. However, the industrial, fuelled by e-commerce growth, and alternative real estate sector are definitely getting more investor attention.

According to Zenith’s ‘Sector Report – Property’, the news of a COVID-19 vaccine in November last year pushed equity markets higher and brought about a large rotation into value stocks. At the same time, the report found that despite the strong absolute performance of 25.2% and 30.7% for the 12 months to 31 May, 2021, both the S&P/ASX 300 AREIT index and the FTSE EPRA/NAREIT Developed Index $A Hedged index failed to recover from their 2020 drawdowns and lagged the fast-recovering equity markets.

The retail sector, which has already been problematic for several years, saw its performance punctuated by the market turmoil, however, there are definitely “nuances to the story”.

Chris Bedingfield, co-founder, principal and portfolio manager at Quay Global Investors, said that in those markets which had got past COVID-19 and were fully reopened, physical retail was actually doing better than it was in 2019, however, the large-format shopping centres needed to offer more than just shopping in order to survive.

“Retail is going to survive this as retail does not just offer you an opportunity to go shopping, it is going to offer you the opportunity to be entertained and this is where I think

Australian shopping centres are much better than their US or European counterparts because they do have a very heavy bias towards services” he said.

“I am more fearful about the smaller, mid-market shopping centres.”

Stuart Cartledge, managing director at Phoenix Portfolios, pointed out there were three main categories across the retail sector and their performance had been affected very differently throughout the pandemic. 

These three categories included large-cap mega shopping malls, such as the Scentre Group portfolio, mid-cap or the mid-size regional malls, a predominantly Stockland-type portfolio, and the convenience centres largely anchored by supermarkets such as Woolworths and Coles as well as some speciality shops.

“Retail has been hit hard by COVID-19 in the top-end of the spectrum, most hard. And the other thing that’s been bubbling in the background for several years has been the switch to online and COVID-19 came along and actually accelerated that process. It remains to be seen to what extent that change will last post-COVID,” he noted.

“If you’d asked me this kind of question pre COVID-19, I would have said that we have a preference for the bifurcated approach of large-cap, mid-cap regional malls at one end of the spectrum and the convenience retail at the other. 

“But what has happened through COVID-19 has been the mid-tier assets have done very well, because people have not been going to work and they’ve been shopping more in their local areas, but the super centres, particularly the CBD type, have really suffered.”

Shares in Scentre Group rose 23% over one year to 30 June, 2021, according to FE Analytics, while those in mid-size focused Stockland had risen near double that at 42%.

Cartledge said his fund had a small exposure to Scentre Group and overweight positioning in Vicinity Centres.

“Our positioning shifted out of Scentre Group and into the Vicinity to reflect the lower risk.”

He said his concern was that Scentre Group was taking the higher risk approach of having a far more geared balance sheet.

“That may turn into the right decision but we think it’s a risky position particularly for an asset class that is under pressure from online as well as COVID-19.”

INDUSTRIALS ON FIRE

Managers were in agreement that there was undoubtedly a growing demand for industrial space, as a combined result of COVID-19, which had provided some tailwinds for the sector, and an accelerated switch to online shopping and growth of e-commerce. 

According to them, there was still a huge amount of unmet demand for high quality, industrial assets and that was expected to continue to keep pressure on the pricing of these assets.

Steven Bennett, chief executive at Charter Hall Direct, commenting on the Australian real estate investment trust (AREIT) sector, said the demand for REITs was still very strong given the distribution yields from diversified AREITs were quite high, averaging about 4.6%, and the index was still below where it was pre-COVID-19. 

Having said that, Bennett pointed out that the standout sector within AREITs was fund managers such as Goodman Group, Charter Hall or Centuria.

“A part of the reason why they have performed so well and why most people, including ourselves, think that they will continue to perform, is because the way the co-investments take in third party capital has really leveraged them to the growth side. And you can grow the fund management business, and the profitability, a lot quicker than you can if you are a pure rent collecting REIT,” he explained.

“That is also part of the reason why Goodman is often quite favoured because it combines the fund manager with the tailwinds of that industrial logistics sector,” Bennett said.

On top of that, Australia’s penetration rates and e-commerce was still well behind countries like China and the UK and US and approximately lagged about five years, compared to the US, which also provided some room for growth.

“The second key trend is around onshoring. The Government realised throughout the pandemic that they needed to have national resilience across things such as pharmaceuticals, vaccines and food logistics so we are going to see a continued push for certain things to be onshore. It is the exact opposite trend to what has been happening for multiple decades of offshoring.”

Commenting on Goodman, Cartledge added: “When we model something like Goodman Group, which has an industrial portfolio around the world, we certainly are willing to buy the argument that they are going to have very strong earnings growth for a number of years because the market they are operating in is very strong, making big development profits, generating performance fees. 

“So, we believe that this will translate into good things in terms of earnings growth for that stock but then we have to marry that up against what are we paying for that.”

However, Bedingfield said, at the same time, the industrial or logistics assets were currently quite expensive which made the sector probably one of the most challenging to find value.

“This area as challenging to find good opportunities, we are finding some opportunities but this is probably the most challenging part of the market, to be honest,” he said.

“It’s not just a question of demand, it’s a question of supply, and how easy it is to deliver that supply. It [industrial assets] feels good at the moment, but at some stage supply will catch up and the overall returns will be pretty average.

“Industrial is on fire and there’s no question about that. But I guess my concern would be over the more medium-term, as supply catches up with demand that you’ll get a normalisation effect,” Cartledge added.

“I would definitely argue that what we are seeing at the moment are certainly heated conditions, whether it’s peak, who knows, but it’s certainly not the trough.”

ALTERNATIVES

As the traditional sectors are still struggling to determine what the post-COVID reality would look like for them, investors are beginning to shift their focus away from those assets and towards the alternative real estate. While there are varying definitions of what classed as ‘alternatives’, the most common examples would be childcare, residential and data centres and it had profoundly grown in the US-listed market over the last couple of years. 

Following this, there is a strong conviction that Australia would follow this trend, with the alternative sector described as a ‘dormant giant’ and expected to attract more institutional capital in the coming years. 

Patrick Barrett, Charter Hall’s portfolio manager, listed securities, confirmed that the alternative asset class is now becoming in Australia what a “more institutionalised asset class” as opposed to being held by more individual operators in the past.

“There’s institutional capital behind it and sophisticated investors behind it now. And there is a changing acceptance of those asset classes in Australia which has changed dramatically in the past five to 10 years,” he said.

According to Bedingfield, the residential sector was currently overall one of the most exciting sectors across alternatives to watch.

“We tend to have a lot of residential across our portfolio, particularly in the US, and within residential we really like coastal apartments and we also like single-family housing as housing everywhere is going crazy.

“We think post-COVID-19 everyone will sort of reassess their lives’ priorities a little bit and part of that has been to invest more in their home. 

He said that another area which would be interesting to watch is also manufactured housing, where Stockland is currently getting into, as it offers a much more investor-friendly model and is expected to have more of a future than apartments or multi-family properties.

SG Hiscock director and portfolio manager, Grant Berry, said that the lifestyle and holiday communities sector was particularly attractive for REITs investors as the investments were being made in land, with the opportunity to expand through development. This sub-sector is becoming more mainstream as larger players move into this space.  

Additionally, rent in the lifestyle sector were relatively secure because the residents were often supported through the Government pension system and rental assistance supplement.

“Having said that, some of the stocks in this space have had a tremendous run and they are looking relatively expensive so we have reduced our exposure. But it is regarded as a good sector and pricing recognises that.”