Sizing up shares versus commercial property in the post Covid era

March 2021

Written by Per Amundsen, Head of Research, Thinktank

Rather like those old bar room debates between Holden and Ford enthusiasts, strongly held opinions prevail on either side of the equities versus commercial property investment debate.

Although advocates of equities enjoy bragging rights with recent relative performance, commercial property has proved extremely resilient over time often delivering returns that are equal to or better than blue-chip shares.

Just as two souped-up vintage Holdens are not alike, commercial property straddles the diverse sectors of retail, office and industrial (such as warehouses, cold stores and logistics facilities).

Performance has not been uniform. But as a rule of thumb industrial assets have benefited from the ecommerce boom that requires larger automated facilities closer to the end customer.

So-called ‘alternative’ real estate has also done well: assets such as self-storage facilities, child-care centres, car parking and medical centres underpinned by long lease terms and quality tenants.

Unsurprisingly, retail assets – notably shopping centres – struggled during the Covid lockdown, as did the office sector.

But there’s no ‘one size fits’ all measure of retail performance. For example, the non-discretionary retailers (supermarkets) outperformed the bricks-and-mortar specialty stores, as did ‘big box’ retailers such as Bunnings and Harvey Norman.

As for the ‘Holden’ versus ‘Ford’ comparison, over the past year the real estate income trust (REIT) sector has notably underperformed the ASX200 index. The latter is a measure of the top 200 stocks that encompasses ‘blue chips’ such as the banks, Telstra and the supermarkets.

Over this period the ASX200 index has gained around 13%, which reflects the market’s spectacular recovery from the short and sharp Covid sell down in late February and March 2020.

The REITs have lost around 7% of their value. On a five-year measure, the ASX200 has gained 30% while the REITs have edged up 1.7%. On a 10- year graph the tables are turned: the REITs have gained 59% while the top stocks averaged a 45% return.

Although the office and retail REIT sectors have been unsettled by the spectre of rising vacancies and rent defaults, the strongest headwind has been the ongoing but sporadic sell off in global bond markets, which points to bets on higher interest rates and inflation re-emerging over time.

Lower bond prices mean higher bond yields, which reduce the relative appeal of rental returns on property. Higher interest rates also increase the cost of borrowing to buy assets, although the same applies to the corporate world across the board.

According to Macquarie Group’s property research, “the key impediment to the sector has been a steepening yield curve which has seen the 10-year government bond rise from around 1% to as high as 1.9%.”

The firm believes the 10-year bond yield is likely to creep up to 2% in the current year. But with spot bond yields at 1.8%, much of the impact on property values arguably has been felt already.

As a result, the REIT sector is trading at a 5% discount to the ASX200 sector, as measured by price to earnings multiples. Both sectors were at parity at the start of 2019.

The REITs recent profit reporting season highlighted the strength of owners of industrial assets such as warehouse and logistics facilities – and a less dire than expected showing from the office and retail sectors.

With REIT distributions gradually being restored, broker Credit Suisse forecasts an average current-year yield of close to 4% for the REITs, compared with 3.5% for the ASX 200 stocks. The firm’s expected yield estimates for 2021-22 year are 4.1% and 3.6%, respectively.

Morgan Stanley’s property analysts contend the retail conditions were “clearly not as bad as the markets and landlords anticipated.”

While shopping centre rent collections tumbled to 40% in the Covid-ravaged April to May period of last year, by December much of the losses provisioned in the June half had been unwound.

“We continue to believe the retail malls are a great way for investors to gain exposure to any snapback in the domestic economy,” the firm says.

A bellwether of consumer sentiment, the country’s biggest shopping centre owner Scentre Group flagged December half rent collections of $1.18 billion, much improved on the June (first) half tally of $875 million.

Scentre (formerly Westfield) restored a dividend payout for the period, as did Vicinity Centres, half owner of Chadstone (Australia’s biggest shopping complex).

The country’s biggest pure-play industrial property fund, Centuria Industrial REIT reported a 42% leap in funds from operation to $42.8 million, with almost full occupancy across its $2.8 billion portfolio.

“The industrial sector has continued to strengthen, with sector tailwinds from ecommerce and tenant demand supporting investor appetite and driving asset values,” Centuria’s Jesse Curtis says.

A potential wildcard card for property performance is what happens when the JobKeeper subsidy ends in March.

Some specialist property sectors also look to be off-limits, notably student accommodation and shared workspaces. Not only had these facilities rapidly expanded at the onset of Covid, but the pandemic quelled demand for their product.

Any properties linked to the international travel sector (such as hotels) are also risky propositions, although they arguably offer more valuation upside in the event of the sector returning to somewhere near normal in a post-vaccine world.

Overall, commercial property investors look well placed given the ongoing availability of cheap funding and ongoing public measures to kick-start the economy.

“Although the current situation remains highly fluid, Covid is unlikely to radically transform demand for quality real estate in the long term,’ says Zenith Investment Partners’ head of real assets Dugald Higgins.

“However, landlords need to move rapidly to accommodate both short-term necessities and longer-term trends to ensure assets remain resilient against economic fallout from the pandemic.”

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This article is for informational purposes only and does not constitute a product recommendation, taxation or financial advice and should not be relied upon as such.