While the primary effects of coronavirus are currently being felt by individuals and communities around the world, the duration and severity of its effect on real estate are still largely unknown.
Here’s what we have seen to date.
A first order impact that relates to our health and the ability to continue with our daily lives. Then, the secondary impact – the global reaction to the COVID-19 pandemic, which is a combination of a flight to safety in the investment markets and a restriction on global trade both within and between countries. This restriction has an impact on the movement of goods, currency, people and ultimately gross domestic product.
Listed versus unlisted property securities – different impacts
Depending on the duration of the coronavirus pandemic, the experience of investors in listed and unlisted property securities may be quite different.
Listed property securities, or Australian real estate investment trusts (AREIT), are exchange traded and are valued second to second by the market. This results in an immediate valuation adjustment for any news or investor sentiment. We have seen the impact of this over the past few weeks with high levels of daily and intraday volatility.
On the other hand, unlisted property securities are unit priced periodically (monthly, quarterly or annually) on an appraised valuation basis. The trustees of unlisted property securities have a set valuation policy that determines when each asset in the portfolio is valued. Often 25 per cent of the portfolio is valued each quarter, resulting in 100 per cent being valued over the full year. This generally prevents an over or underreaction from any individual news event and delivers a less volatile experience for investors.
Although AREITs are subject to daily market valuations, the assets held within each listed security are still valued on the same principle noted above for unlisted securities. Because of this, we can see large gaps between the implied value, based on the price of the listed security, and the net tangible assets (NTA), which lag.
Over the past six weeks, for example, the AREIT sector has gone from trading at a premium to NTA to a significant discount, demonstrating this effect. Examples include Dexus Property Group (ASX:DXS), which has gone from a 15 per cent premium to a 5 per cent discount, and GPT Group (ASX:GPT), which has gone from a 3 per cent premium to a 19 per cent discount. On the flip side, AREITs will be the first to respond on any positive news with respect to coronavirus.
Not all AREITs are the same
It is important to assess the different risk profiles within the AREIT sector. At the lower end of the risk spectrum are the passive rent collectors. These AREITs have a portfolio of existing core assets that are generally high quality, with strong tenant covenants and balance sheets that are conservatively geared. These securities represent a purer exposure to property assets.
Further up the risk curve are the listed property securities that introduce equity-like risk from more active revenue streams, such as funds management, development projects or operational risk. During periods of strong growth, these types of AREITs tend to outperform because of the higher level of risk. However, when the market moves to ‘risk off’, the defensive characteristics of the pure property securities provide some downside protection and a more sustainable level of income for investors. Despite this, with the extreme reaction to the coronavirus from the market, AREITs are withdrawing their guidance provided during the reporting season less than two months ago and we expect to see some cut their dividends.
Different sectors, different effects
In addition to listed property securities being embroiled in the stock market downturn, the most immediate impact of coronavirus within the real estate sector has been connected to assets that host a large floating population, such as shopping centres and hotels. Foot traffic at major shopping centres is well down and in hotels, occupancy is low and cancellations are up.
The second body of assets, also hosting large groups of people, albeit with a more permanent population, includes office buildings and social infrastructure, such as aged care, childcare, schools and even prisons. The ability to compartmentalise and control these types of assets is far greater than for the first group. Only now are we starting to see a reaction to coronavirus, with companies that occupy these properties implementing business continuity plans with flexible working policies and quarantining taking place.
The final group of assets is more affected from the supply side. In this group are tenants of industrial buildings with logistics operations that are being affected by the restrictions on the movement of goods. Equally, in the residential property sector, the construction industry requires materials to complete properties and then purchasers to acquire completed stock – many, particularly offshore buyers, have left.
What are we doing during this period?
In times like this, it is important to be clear on your long-term investment thesis and interrogate your assumptions as to what, if anything, has changed.
At Freehold, we generally employ a defensive strategy in our core funds through the inclusion of unlisted assets and from our strategy for the listed allocation, where we screen out equity-like risk from the universe of potential securities. This provides some downside protection and a more secure income stream.
Grant Atchison is managing director at Freehold Investment Management.