Julian Campbell-Wood from Resolution Capital, Portfolio Managers for Nedgroup Investments Global Property Fund, reflects on how the various property sectors have fared during the crisis.
This quarter was one of the most challenging and extreme we’ve seen. The real estate sector was not immune and underperformed global equities, which reflects the unique impact that the pandemic has had on global real estate. Many real estate sectors rely on social mobility and visitation to function and the uncertain duration of the event, has led investors to re-price the sector.
The sectors facing the most acute pressure, which have endured the most significant re-pricing and valuation declines, are hotels, retail and seniors housing where visitation is critical to their operations.
One of the key drivers for the sector over Q1 and especially in March, where we saw extreme volatility, was the dysfunction in credit markets. The fiscal and central bank policy to stabilise those markets has been critical to underpin the sector and business more broadly, enabling REITs to roll their debt at reasonable pricing. In that sense we haven’t seen material distress, such as equity raisings yet.
In terms of leverage and assessing leverage, the sector entered this crisis in a better position than for the GFC. Generally, the global REIT sector has reduced gearing, which provides more flexibility in a challenging operating environment. Debt maturities have been extended and there is access to capital. What will be tested in this crisis is Interest Cover (ICR), which is already playing out in terms of rent collection. At the low end, retail malls have collected 15%-20% of April rent with the more resilient property types, such as industrial, logistics and office at 90% - 95%, residential is in the 85%-90% range and shopping centres are in the 45%-60% range with hotels materially below that. Lack of rent collection will put pressure on cash coverage, particularly in those sectors facing this challenge.
Portfolio components and how they’ve fared
Retail is about 6% of the portfolio, compared to our almost 50% holding during Athe GFC, reflecting the big shift in the retail environment, profitability and the challenges facing some malls around the world. We entered this crisis with a sizeable underweight exposure to retail property and this has been a big contributor of relative returns for the portfolio. We expect the footfall decline and shift to online shopping to continue after this event and put pressure on retail property globally. We expect to maintain minimal exposure to retail, with the ones that we do have more focused on the non-discretionary property segment.
Healthcare: Our exposure in the portfolio is split between medical offices, life science and lab space with very small exposure to hospitals and seniors housing. Medical offices and life science have been extremely resilient with a burst in funding for life sciences given this event. We have just over 10% of the portfolio in healthcare and about 4% in life science, one of the largest overweight positions in the portfolio.
Office is around 18% of the portfolio, which includes 4% of life science. We did reduce exposure to this sector during the period as some of our positions did have development exposure, something we are less comfortable with right now. There are medium-term questions around demand and the requirements for office space after this event.
Logistics is 17% of the portfolio and is the second largest overweight position. There are very strong demand dynamics in logistics, which have been accentuated by the current event. The increasing critical nature of supply chains as mobility is restricted has seen increased demand as more and more retail shifts online and this delivery infrastructure becomes even more critical.
Residential is currently 22% of the portfolio and the largest absolute position in the portfolio with several different residential exposures. The current event compounds the need and the value of one’s home. This exposure should perform relatively better but will have some headwinds given the job losses and unemployment we’re seeing in certain markets.
Data centres and towers is our largest sector overweight at about 10% of the portfolio. Again, very powerful and structural demand drivers for this property type with everybody working from home and increased internet traffic volumes boosting demand for this type of property. It performed very well for us over the period so we have increased our exposure to this segment.
Valuations and the outlook
It’s a very challenging period to have confidence in your outlook when you’re due a recovery. We need to focus the portfolio on those segments and property types where we have greater cash flow visibility, maintaining our strong bias towards those companies with lower leverage, which has been an important contributor of our long-term returns and will be now too. We will also be increasing our focus on liquidity, particularly for those property types, which are experiencing lower cash rent collections. The portfolio is still conservatively positioned with minimal exposure to retail, hotel and senior housing where we’re seeing the most acute risk.
In terms of the portfolio’s performance of -19.7% for Q1, the period was disappointing from an absolute perspective, reflecting the drawdown. From a relative standpoint, our focus on high quality real estate and positioning the portfolio away from high-risk sectors has stood us in good stead over the quarter if we look at the Index* return of -28.5% for the period.
* FTSE EPRA/NAREIT Developed Index (USD) Net TRI.