Investors selling what they can, not what they want
I would like to say upfront that on behalf of everyone at APN Property Group, that our thoughts go out to those directly impacted by the COVID-19 virus. We regard the situation as very serious and encourage people follow the advice and precautions to try and stop the spread. We do think it will take some time to resolve and expect there will be a high degree of uncertainty across financial markets.
The local AREIT sector has been extremely volatile. Since the peak in the market around 20th February 2020, equities markets have dropped by ~30% with the AREIT sector dropping by ~38%. Obviously panic selling is occurring across all sectors and AREITs certainly haven’t been immune. A key driver of this, we believe, has been the higher exposure to retail that the Australian sector has. This indiscriminate sell down that we’ve seen of what is, traditionally, a very defensive asset class, is proof of this panic selling that we’re seeing across the globe.
Despite the market volatility, the alarming headlines and the pressure on valuations around the world, we believe that the fundamentals of investing in commercial property remains very strong.
Businesses will obviously struggle to varying degrees with the impact, but the leases which are in place provide a level of consistency of earning streams to property landlords, this is an obligation on the tenant to pay the rent which is very important. The tenants within these buildings, are being very well supported by governments and the federal banks which are pulling as many levers as possible to provide support. The quality of these larger businesses, many of which are key tenants in the retail, industrial and office assets mean they have the balance sheet to trade through this current situation.
With interest rates now at near zero, the yields on commercial property look increasingly attractive. There are certainly different risk profiles out there but cash in the bank is a difficult investment to have for people when it’s effectively providing no return, especially over the medium to long term. We feel the cashflows which come through while there may be implications short term there’s also opportunities for investors looking to the medium to long term to secure income levels to support their investment portfolios.
The Asian market REITs that the Fund is invested in (namely Singapore, Japan and Hong Kong) have experienced significant volatility. Some of these reasons can be explained by concerns with respect to the fundamentals – for example the impact of a sharp decline in tourism due to border closures/travel restrictions thereby impacting visitor numbers at certain retail centres. However, we think that’s to a limited extent and in our assessment, there is actually a significant amount of panicked or forced selling occurring.
We have spoken with several REIT management teams who have said they believe that margin calls have been a major source of their stock price instability – a major share price fall begets margin calls, which causes forced selling and hence further price falls - and so on.
It seems investors are selling what they can sell, not what they want to sell.
We have also heard that the negativity of this current crisis far exceeds the GFC of 2008/09, and, approximates that of the Asian Financial Crisis of 1997.
Focus on the long-term
Firstly, let me take a step back and recap some performance numbers so far. These numbers are up until the 31st of March. We saw a peak in the Asian REIT market around 20th Feb and since then – the Asian REIT Index has fallen about 19.9% in AUD dollars.
For a bit of context, if you look at the preceding 12 months to that peak (20th of Feb), the Asian REIT index returned nearly 29%. In the preceding 24 months to that peak, the return was nearly 61%.
While a near 20% price decline is not easy to stomach, I think it is important to remember (other than “this too shall pass”) that we are investing for the long term. If we look at performance on a rolling 1-year and 2-year basis, the numbers are certainly much less daunting.
On a rolling 1-year basis, the Asian REIT Index is down circa 1.6%. On a rolling 2-year basis, the returns are 23.8% of the Index. So, these are decent numbers and important to keep in mind when we are seeing red in the screens.
We are by no means calling a bottom - things can get worse before they get better, but pandemics come and go – we have seen it happen before.
Markets eventually move past them and carry on. And, as historical precedence shows, the rebound can be strong.
There are reasons to remain positive
The income delivered by the Asian REITs remained intact through the global financial crisis in 2008-2009 and we have every reason to believe that it will be the same this time around.
Through all this market noise and barrage of information (and misinformation), investors in commercial real estate should remember that the lease contract is a legal obligation on the tenant to pay the rent ahead of any obligation to shareholders. This ‘cash flow priority’ is a key consideration when assessing risk to the income stream or dividend. If you believe that well managed and capitalised companies will survive this turmoil (and we do), it is fair to conclude that their landlords are in a more secure position.
When I look at the fundamentals of the Asian REIT sector, I see that they remain healthy – supply and demand dynamics are mostly favourable across most markets and property types. Businesses will obviously struggle to varying degrees with the impact of the current situation, but the leases which are in place provide a level of consistency of earning streams to property landlords - this legal obligation on the tenant to pay the rent is an important one.
Now there are going to be outliers for sure – you will no doubt read headlines about many retail tenants who have shut its stores and retail tenants who will be asking for rent relief and so on. Yes, that is certainly happening, but we are also seeing central banks and governments stepping up to provide their support in an unprecedented way.
Better Balance Sheets than the GFC
Last but not least, I’d like to address the issue of balance sheet and leverage because those issues were the undoing of many companies back in the GFC. One of the key reasons the Asian REIT sector appeals to us is because of strong governance measures enforced by various governing bodies when REIT legislation was introduced in the early 2000s. One of these measures relates to gearing restrictions, which ensures the REITs do not overextend themselves. In the last financial crisis, we saw the equity value of highly levered companies reduce swiftly. This time around I suspect it will be no different. Fortunately, balance sheet prudence has always been a part of REITs in Asia - leverage across the sector was around 35% in the GFC days, very similar to the levels today. Furthermore, from the learnings of the GFC, funding sources for the REITs are much more diversified today thereby further lessening the refinancing risk.
We’re certainly not suggesting there aren’t risks in the portfolio and things can certainly get worse before they get better, especially the longer this situation persists.
The key thing for us is to keep our focus. We believe that best decisions are made when there is little emotion and made on the facts available. We appreciate this can be very difficult when markets are imploding, headlines are so alarming, and the unit price value of your investments has declined. But eventually, we believe assets which have reliable income streams and real value will continue to be in demand over the medium to long term. We believe that the search for yield will return especially in what will now undoubtedly remain an exceptionally low interest-rate environment globally for quite some time.
This is an extract from the APN Asian REIT Fund Investor update and conference call. To listen to the full update, including a Q&A, please click here
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Corrine joined APN Property Group as a Portfolio Manager for the Asian REIT Fund in February 2015. Corrine has over 15 years of experience in property and REIT investment in Australia, Asia and the North American markets.