After a strong 2019, Global Listed Property looked set to continue its strong performance into 2020. However, the COVID-19 pandemic in March and associated economic and social restrictions sparked the worst market fall in years, at one point down ~30%. As a result, the one-year returns have been dominated by this event.
From a longer-term perspective, over the 10 year-period to May 2020, Global Listed Property has posted respectable returns (A$ Hedged +8.0%; Unhedged +8.3%) which had outpaced both Global Bonds (A$ Hedged 6.1%) and Australian Equities (7.3%) at that point. In broad terms, Property has performed strongly for the last decade on the tailwind of declining interest rates.
Traditionally a defensive asset class with yield, backed by leases delivering reliable income streams; global listed property appears to be better positioned than most asset classes for a post COVID-19 world.
As at 31 May 2020, G-REITs appear to be attractively priced relative to other asset classes, trading at a -13% discount to Net Asset Values (-4% in May 2019) and at a discount to Global Equities. However, valuations of sub-sectors and regions vary and most Managers are positioning their portfolios according to their assessment of relative value of stocks within their sector and region. While earnings growth expectations for CY2020 have slipped from +4.8% to -3.7%, they are expected to recover in CY2021 as COVID-19 restrictions ease and the situation normalises. G-REITs still offer dividend yields of 3.3% to 5.8% p.a. which are attractive and offer an above-average premium relative to bonds (+3% to +5%) across all markets.
There has been a close correlation between bond rates and the global property securities sector in recent years, with upticks in the outlook for interest rates coinciding with pull-backs in the value of property securities. Despite the deterioration in operating conditions due to the COVID-19 pandemic, the commitment of central banks to maintaining interest rates ‘lower for much longer’ through expansionary monetary policy and yield curve control is expected to provide support to the asset class. For rental focussed REITs the outlook is underpinned by existing tenants on long leases with in-built rental growth. REITs with large funds management exposure may hold up well (based on ongoing fees), but those with high development exposure are more susceptible in weaker market conditions.
Unlike during the Global Financial Crisis (GFC) of 2008, G-REIT balance sheets are in better shape although many REITs have raised equity capital in order to ensure they can withstand potential reductions in valuations impacting on debt covenants. Gearing is manageable (LVR ~30%), interest rates are low (2-3%), and REITs have a more conservative payout ratio on their corporate earnings component.
The COVID-19 pandemic has in many ways exacerbated and accelerated secular trends and bifurcation between sector ‘winners and losers’. Sectors expected to benefit from the ‘new normal’ include Data Centres, Storage and Manufactured Housing, which have grown materially over the last 10 years, and are expected to continue to outperform based on the rise of the ‘digital economy’ and demographic changes. Another potential beneficiary is the Industrial/Logistics sector, which outperformed during the COVID-19 downturn, and is expected to continue to grow off the back of e-commerce tailwinds. However, access to these sectors comes at a premium.
Residential rental (apartments, multi & single family housing, student housing) is also favoured given the consistency of income and demographic trends, however higher unemployment poses a risk.
On the flip-side, traditional ‘bricks and mortar’ Retail property, the tenants of which were already under pressure pre-pandemic, are expected to face increased weakness particularly from ‘middle’ placed assets (between fortress malls and food-based neighbourhood centres). While earnings will recover once restrictions are lifted, long-term structural issues mean asset values may come under pressure as rents adjust downwards. Hotels/Lodging are expected to recover more slowly and will be heavily reliant on vaccines which remain some time away.
While the ‘working from home’ phenomenon poses a risk to Office demand, astute landlords may look to offer tenants a more flexible model to encourage continuity at the next lease expiry. Expectations are for a rise in vacancy levels and lower net effective rents, although whether this is a cyclical or structural change is still up for debate.
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