Vaccines, Recovery And Value
While global real estate investment trusts (REITs) have participated in the ‘vaccine rally’, on a real estate sector basis the rebound has been uneven and overall performance of the sector globally has lagged the broader equities markets.
The REIT ‘dawdle’ is likely a consequence of investors questioning the relevance of some types of real estate and its ability to recover when COVID-19 has forced changes to the way occupiers use land and buildings.
An analysis of over 4,700 corporate earnings transcripts between July and December 2020 by Bloomberg found that about one-in-eight firms globally were re-assessing their real estate needs in an effort to cut costs. Headlines like these can cast a shadow over the entire sector, however amongst the clouds lie value opportunities.
AN EARNINGS DISTORTION
In Chart 1 we have charted the performance of global REITs, global equities and fixed income during the 12 months to 31 December, 2020.
The chart provides a clear illustration of the aforementioned relatively lacklustre market sentiment towards the REIT sector.
However, when considering earnings stability through the course of the pandemic, one must ask if this sentiment and corresponding underperformance is justified?
The fact is global REIT earnings have proven to be less volatile than the broader market through the pandemic and over time.
Whilst the COVID-19 economic fall-out has been materially detrimental to certain areas of the REIT market which have stolen the headlines, many property types have been hugely resilient.
THE REIT SECTORS TO WATCH
The strongest indication of overall REIT resilience is the fact that 94% of our own portfolio as at the end of the fourth quarter of 2020 has maintained or increased dividends through the pandemic.
Trends toward digitisation and e-commerce have seen a material acceleration as a result of the pandemic. This has strengthened the case for logistics, data centres and cell tower REITs. We believe the trend acceleration further enhances the long-term investment case for high-quality REITs in these sectors.
Take NASDAQ-listed REIT Equinix as an example. We view Equinix as a world leader in network-dense data centres – think of these as modern-day telephone exchanges that are critical for the effective functioning of the internet. Not surprisingly, Equinix has benefitted from the acceleration in data usage caused by COVID.
Demand for data centre capacity continues to grow with the current pandemic conditions only serving to reinforce entrenched structural trends.
When it comes to logistics, the e-commerce driven demand for logistics properties has continued unabated since COVID-19 began spreading across the globe. The pandemic has pulled forward an estimated five years of expected online sales growth in the US and UK. In the US this is evidenced by the scale of Amazon’s roll out where they’ve increased fulfilment capacity by around 50% through 2020. To put that in perspective that equates to over half of Walmart’s (the largest US retailer by sales behind Amazon) distribution network which was developed over 50 years.
Similar trends are evident in other markets. In the UK, the third quarter had the greatest take-up of logistics space on record driven predominantly by pure-play online retailers, food retailers and third-party logistics.
Another sector we have long been attracted to is the life-science office segment. Strong demand conditions existed even before COVID-19, driven by an ageing population, increased healthcare spending and enthusiastic venture capital funding. The task of tackling unsolved complex human diseases has a long runway in our view – and is increasingly being addressed using talent from both technology and medical science often found clustered in knowledge-based markets such as Boston, San Francisco, San Diego and Seattle.
The rapid development of several effective COVID-19 vaccines is no doubt in part due to the enormous funding and effort put towards the same cause. Perhaps unsurprisingly, there has been a significant increase in capital focusing on the life science office sector.
One of our top portfolio holdings has been US-listed Alexandria – a leading owner and developer and the only pure-play listed REIT focused on this sector.
WHAT ABOUT TRADITIONAL PROPERTY SECTORS?
Rising office market vacancy rates and conjecture around the structural impact of working from home (WFH) on office buildings continue to make headlines.
We believe the office will continue to play a critical role in employee collaboration, mentorship and business development activities. However, the pandemic has proven the effectiveness of technology in enabling many office workers to WFH at least part of each week. Therefore, net office utilisation will likely be lower than the pre-pandemic baseline, reducing landlord pricing power.
In response, office landlords will be encouraged to offer tenants more lease flexibility and amenities – as such the asset class becomes even more capital intensive and operationally complex. Larger landlords with advantages of scale and access to capital will be better placed to take market share.
Locations which offer better quality of life, more affordable living options and business-friendly regulatory and tax environments should also benefit.
For example, in the US there has been a spate of corporates weighing plans to establish a presence or relocate to the Sunbelt including Oracle, Hewlett Packard and Tesla from San Francisco to Texas, and Goldman Sachs and Blackstone from New York to Florida.
When it comes to the retail sector, fiscal and monetary stimulus has put many consumers in a relatively strong position with government stimulus cheques boosting incomes while lower spending on many services (such as travel and entertainment) has boosted household savings rates.
Together with the positive net wealth effect of rising asset prices (stocks and houses), conditions are ripe for strong consumer spending in many markets. Investors have an opportunity to take advantage of attractive valuations of select retail formats that stand to capture a disproportionate share of this spend.
We believe non-discretionary, service oriented or value retail formats in markets with moderate supply of retail space per capita are more resilient to e-commerce substitution.
Retail landlords will also need more capital to manage occupancy and/or re-develop their assets, therefore we also favour better capitalised retail landlords.
GLOBAL REITS WITHIN A PORTFOLIO
The above touches on just a handful of sectors within the global REIT universe. It is a hugely diverse universe which can provide investors exposure to some of the best real estate in the world – real estate that very few individuals are able to access directly.
While we hear much about the doom and gloom in office and retail it would be naïve to be hasty about investment decisions even as many economies across the world continue to grapple with COVID-19. We recall the dramatic predictions of workplace changes following September 11 and SARS which ultimately proved to be over-stated.
However, rather than attempting to speculate, investors are best served analysing existing trends that are changing course or accelerating. Whatever your view is on office or retail, exceptional long-term investment opportunities lie in property outside of these sectors – properties which have proven to be some of the most stable assets during the most significant health crisis of our time.
An allocation to a diverse portfolio of global REITs could prove to be a resilient pillar in your investment portfolio. Resilience that would seem to be underappreciated by the market today, given the valuations afforded.
Marco Colantonio is global property portfolio manager at Resolution Capital.
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