First up, sorry about the title. Second up, as a commercial real estate investor we naturally have our own biases – hopefully we have enough balance in the way we are thinking about the current environment to be of some help to you but of course that’s up to you to decide. Third, while this is written from an investment perspective our thoughts and best wishes are with anyone who has been directly affected by the new disease – we are not ignoring the human side of what’s occurring.
As investors, a healthy degree of respect for the unavoidable uncertainty of where all of this lands is essential. As is a good dose of logical, clinical, unemotional thinking given how much noise there is out there at the current time. Some of the impacts are not yet known and are not immediately apparent. What’s that got to do with the price of fish? Not that we’re necessarily buying it one way or another but who would have thought the price of crayfish would have fallen from $150 to $70 per kilo? Or that you could get a flight from Australia to NZ for $9? Or that some property developments will be six months late as the pre-fabricated windows are stuck in China. Things are evolving and there’s plenty of changing views – you only need to take a look at the wild swings in the stock market over the past couple of weeks to see this in action.
Taking a good look through what we own and why we own it is a helpful exercise in testing our ‘property for income’ investment philosophy and our approach to risk. Or to look downwards, using Warren Buffett’s line ‘You only see who’s swimming naked when the tide goes out’.
To set the scene we manage about $1.4 billion of direct commercial property investments in office, industrial and convenience retail sectors – the portfolio is predominantly leased to national or international businesses as its tenants, occupancy sits around 98% and the average length of the lease is over seven years. Its annual cash rental yield is about 6.6% and debt levels are modest at approximately 31% (compared to the value of the portfolio).
We also manage more than $1.6 billion of real estate securities (managed portfolios of listed property trusts). These well diversified portfolios provide our investors with underlying exposure to thousands of high-quality properties across different sectors, that are well leased to quality tenants. The average debt level of the Australian Real Estate Investment Trust (AREIT) sector is at its lowest level since 1999 and is well below the long-term average of just under 30%.
We reckon there is upside and downside from what we can gather of the current situation – on balance we think the type of commercial property we own should be well placed, but here’s a snapshot of some of the things we are looking at.
- As investors become more risk averse and defensive, assets which have reliable income streams and real value (e.g. bricks and mortar) should be in more demand.
- As some businesses struggle with the impact of the crisis, leases provide a consistent earnings stream to property landlords.
- As interest rates are cut (the RBA last week cut the Australian cash rate by 0.25% to 0.50%), the yields on commercial property look relatively more attractive (obviously there are different risk profiles here but cash in the bank is approaching a zero real return at current levels).
- As interest rates fall, interest expense on any borrowings used to fund your investments reduce, increasing the cash available to the property’s owners.
- Generally speaking property is an illiquid asset class – while some of it sits in listed vehicles the properties themselves are not revalued as frequently as the hourly and even more frequent pricing on the stock market – the perceived stability of prices for commercial property also makes it relatively more attractive for some investors.
- If tenants are not sufficiently well capitalised or experience so much stress that they collapse, then that will hurt the landlord’s cash flow (usually there are bank or other guarantees in place for a period which may see through to re-leasing but a bankruptcy is usually pretty bad news).
- While interest rates may come down, for properties exposed to less robust tenants or with too much debt it may be difficult to refinance loans and may require the owners to put in more equity.
- Property developers may find it harder to ‘pre-sell’ development properties or find acceptable finance for their developments to proceed.
- Properties without long leases or exposed to operating risks (for example most hotels or student accommodation properties which don’t have leases) may well be directly affected by a reduction in occupancy (in some cases by more than 15%). It’s for this reason that we don’t have any exposure to hotels or student accommodation in our APN AREIT Fund.
- Properties in areas dependent on high amounts of foot traffic (for example in airports) and with rent tied to turnover (rather than fixed rents) also have earnings at risk.
Going through the above list you can see it really depends on what you own. While we are certainly not suggesting there aren’t risks within our portfolio, we have spent literally years trying to ensure we own well-located properties, leased to robust and well managed businesses, without paying too much and with financing them too aggressively. It’s quite possible commercial property will be the ‘new black’ in asset allocation for a period and we believe it’s very well positioned to weather the stress and uncertainty we are currently experiencing.
Agree? Disagree? We always appreciate your views, so please leave a comment below.
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