A-REITs (Australian Real Estate Investment Trusts) staged a remarkable comeback with the best monthly performance over the last 10 years recorded in April (14 per cent), after the worst month on record back in March (negative 35 per cent). A phoenix-like ascent from the depths of the March lows continued into May.
Listed markets in general tend to overreact and overshoot to the upside when markets are buoyant, and subsequently fall excessively as sentiment turns. In the short term, investor sentiment can deviate from excessive levels of confidence to overtly pessimistic, influencing share prices. In the current environment, uncertainty created by the COVID-19 pandemic and its potential cash flow impact on landlords resulted in A-REITs share prices plummeting in March.
The banning of social gatherings emptied shopping centres, last drinks were called at pubs across the nation, while white-collar employees were ordered to work from home. Unfortunately, this scenario had never been envisioned by financial markets, there was no prior rule book for listed markets to follow, a truly one in 100-year event. An unprecedented and coordinated rapid response by Governments and Central Bankers globally was unleashed, dwarfing the stimulus that blanketed the global financial crisis. The fear of the unknown came home to roost.
We’ve witnessed some extraordinary A-REIT price movements in a short period of time. Listed retail landlords Scentre Group (SCG), manager of the Westfield Shopping Centres, and Vicinity (VCX) owner of Australia’s largest mall, Chadstone, rebounded by 50 to 66 per cent respectively since their March lows after having collapsed ~50 per cent during March. Pub landlord, Hotel Property Investments (HPI) also saw its share price fall around 50 per cent during March, while it launched a staggering comeback, up 80 per cent from those depths.
So how does one reconcile these moves when the news headlines point to Armageddon? What’s happened? For a start, social distancing restrictions have eased. As of 28th May, SCG is reporting 80 per cent of its retail stores are open in Australia and 93 per cent are open in New Zealand1. This has led to rising patronage and the cash registers (credit cards tapped) filling up.
In addition, clarity is emerging as the Government sets in place the rules of engagement, thus removing the blanket of uncertainty that swept the sector. In April, the Federal Government announced a set of good faith Mandatory Code of Leasing Principles for commercial landlords and tenants in relation to COVID-19. The principles predominantly apply where the Landlord or Tenant has turnover of less than $50 million and is designed to assist small and medium enterprises (SMEs) that can prove loss of income of over 30 per cent as a result of the pandemic, with those businesses eligible for JobKeeper also qualifying. In short, the Code provides a framework where:
- the Landlord cannot terminate a lease or draw on tenant security during times of hardship caused by COVID-19.
- any rent relief provided will be proportional to the tenant's trading/turnover decline.
- the rent reduction will be implemented via a combination of (i) rent waivers, and (ii) rent deferrals; the rent waiver component to be a minimum 50 per cent of the relief, whilst the rent deferral will be spread over the lease term, meaning this portion of rent is still payable; and
- where agreement between landlord and tenant cannot be reached, binding mediation will be sought.2
For larger tenants, the status quo remains in place, meaning rent is required to be paid, there is no policy intervention, leaving it up to the landlord and tenant to negotiate suitable outcomes if and/or when they arise.
To put this in context, many A-REITs have provided some insight into their exposure to SME’s. For GPT, SME’s account for 26 per cent of income and 21 per cent for Mirvac (MGR). Growthpoint (GOZ) noted SME tenants account for four per cent of income, while Stockland’s (SGP) comprise 30 per cent of rental income within its commercial portfolio.3
The point that must be highlighted is, A-REITs are still in the early stages of rent relief discussions with tenants and not all tenants classified as SME’s will be eligible for relief. As a result, the actual impact to landlord incomes has not yet been quantified.
Several A-REITs provided quarterly updates in May, with office and industrial portfolios holding up. From a property valuation perspective, GPT’s unlisted office fund recorded a minor decline in value after revaluing all of its assets, a two per cent reduction to book value. GPT’s unlisted retail fund, faired a tad worse, reporting an 11 per cent asset devaluation. Importantly, GPTs retail devaluation potentially highlights the listed markets overaction to listed retail stocks, where at one point, pricing for many listed retail landlords implied asset value devaluations of 30-40 per cent4.
Prior to the virus outbreak, office property vacancy rates in Melbourne and Sydney were low at around four per cent. In the short term, the pandemic induced slowdown is likely to see a pause on any new developments across Australia. At the margin it is possible that the large portion of the white-collar workforce working from home will spur the rise of remote working. However, commercial office will remain a hub to collaborate and build rapport with colleagues, customers and suppliers. Offices in locations with higher car parking allowances, to allow employees to drive to work because of constraints on numbers allowed to use public transport may lead to increased de-centralisation and increase the attraction of fringe and metropolitan office locations.
Demand for industrial properties is likely to continue to persist due to the positive trend in e-commerce. COVID-19 may additionally spur demand for industrial space in the medium term as businesses are likely to seek to adjust their supply chains in light of the disruption caused by the pandemic globally. Notably, many industrial businesses operated throughout the period of social restriction as deemed essential.
Retail has faced major headwinds, exacerbated by the pandemic. Neighbourhood shopping centres should however remain resilient as 50 to 60 per cent of the rent roll is generally related to essential spend retailing i.e. supermarkets. Over time, quality shopping centres will retain their dominance due to the irreplaceable nature of these assets, with larger listed mall landlords provided an opportunity to rebase rents from where rents can begin to grow.
Despite the battering, A-REITs are currently offering investors income yields ranging from 5 to 8.5 per cent, which compares favourably to the Australian 10-year Government bond yield of 0.87 per cent and Reserve Bank of Australia cash rate of 0.25 per cent. The question the listed market has been grappling with is whether their distribution yields are to be believed going forward and whether the risk is already priced into A-REIT stocks. The impact to landlord incomes will come to light over coming months, pleasingly though, A-REIT capital structures in general are much better positioned to withstand the current stresses, with the A-REIT sector weighted average gearing at around 23 per cent when compared to over 40 per cent in the pre-GFC halcyon period.
Some listed landlords will fare better than others depending on the industry exposure of their tenant base. Of all the equity sectors that have been worst hit from COVID-19, i.e. energy, banks and A-REITs, it appears A-REIT downside risks are better understood by the market at this point. In addition, uncertainty over dividends in sectors such as the banks makes A-REIT distributions screen much more favourably from this grouping.
We are not of the view at this juncture, that A-REIT sector solvency is at risk akin to the GFC period. There is greater clarity on landlord and tenant playing field, childcare subsidies, and various other significant stimulus packages, and a health system ready to cope with what the pandemic has to offer.