Key offshore opportunities in senior housing and self-storage as sectors regain health

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COVID might have tragically disrupted business as usual in the aged care sector but there are opportunities for investors as the sector regains its health.

In this episode of Expert Insights, Quay Global Investors principal and portfolio manager Chris Bedingfield discusses the damage done to the industry and the way forward.

Demand might have dropped during the pandemic but supply has followed suit. And it's not as if the population is going to stop ageing overnight.

"We're seeing these opportunities where we can buy assets below replacement cost," Bedingfield says. "When you're buying below replacement cost, the supply stops. And if you have a good demand story that backs you up, like the senior-housing demand story is, and if you're patient, you can do quite well."

Quay is finding value in Canada in the form of Chartwell Retirement Residences. "We think we're owning these particular residences that are around $200,000 a door," he says. "They cost $300,000 a door to build. So we're buying deep value."

Bedingfield also explains why his team likes self-storage assets — it's to do with an inefficiency of real estate markets and the value created for those in the know.


Investing in global listed real estate

Quay, a Bennelong Funds Management boutique, focuses on the preservation and creation of wealth through innovative strategies in real estate securities. For more insights on global property, visit Quay’s website.

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Edited transcript

You have identified the ageing population as a mega theme. What are some of the opportunities and challenges in senior housing?

The short-term challenges really are that COVID was devastating for the industry on a number of levels.

First of all, there was a number of mistakes that were made by officials using skilled nursing and senior housing as a place of refuge for people who were sick, which unfortunately made the virus much worse. And people of that age were very susceptible to COVID. And so you had a lot of fatalities and a lot of sickness in those facilities. And so that was the first problem.

The second problem was that once those facilities shut down, you couldn't have tours for new residents to come in. So occupancies have collapsed. Occupancies that were once 89, 90% are now in the 70s. And so earnings have collapsed as a result. And part of that risk, I guess, is that the product is theoretically tainted to some extent.

If you've heard of a story where someone's grandma died in one of these facilities during COVID, you're probably less likely to want your parents to go into these facilities as well.

So that is the big challenge right now. But in many respects, that's also the opportunity because the penetration rates for senior housing are already pretty low.

Only 10% of people eligible end up going into these particular facilities. So it's not as if there's a lot of market to lose. There's probably more market to gain.

I think the other opportunity is that supply has collapsed. Developers aren't building anywhere near as much supply as they were three, four, five years ago, because the maths just doesn't work.

Again, we're seeing these opportunities where we can buy assets below replacement cost. When you're buying below replacement cost, the supply stops. And if you have a good demand story that backs you up, like the senior-housing demand story is, and if you're patient, you can do quite well.

The industry definitely has challenges and we're keeping an eye on that. And that's why we run a fairly diverse portfolio.

We're not always in one sector at a time, but we see more upside than downside and we're prepared to be patient. And we think we're going to do quite well out of it.

Which stocks have you been buying in the senior-housing sector?

In senior housing, I think one of the more interesting ones is a company called Chartwell, which is the leading senior housing operator in Canada.

Chartwell has a market capitalisation of around $2.5 billion, give or take on the day, a total enterprise value of roughly $3.5 billion. It's the leading owner and manager of senior housing facilities in Canada. It's quite diverse across most of Canada.

Just like what I explained with the United States, it has the same issues. Its occupancies were around 90%. They're fallen to around 70%.

The demographics are just as good in Canada as they are in the United States. Supply is a little bit harder to come by in Canada than in the US. So they tend to have higher barriers to entry — a bit like Australia in some respects.

But where the real opportunity is is that not only are we buying deep, deep value, we think we're owning these particular residences that are around $200,000 a door. They cost $300,000 a door to build. So we're buying deep value.

If you normalise earnings to pre-COVID, we're buying it around 12 times earnings. Pretty attractive from an earnings point of view.

But the real opportunity is their two cousins in the United States that are in the senior housing space, Ventas and Welltower, are on a huge buying spree. These companies are seven, eight times the size of Chartwell.

So we've seen a lot of mergers and acquisitions in senior housing. And Chartwell, we think, has a lot of corporate appeal. And so if the price doesn't recover through a natural sort of organic recovery, we feel like we've got a bit of an underwrite from the big guys as well.

So there's corporate appeal. It's deep value. It's a great secular tailwind. We buy it below replacement cost. It's pretty good management. It's the leading operator in Canada. Yeah. We like it.

You are also drawn to self-storage. What attracts you to this sector?

I don't think there's anything that really attracts us necessarily to any particular sector apart from the returns. I think that's the starting point and we just see a lot of good returns in self-storage.

One of the reasons that self-storage always pops up for us as something that is relatively attractive is one of the great inefficiencies in real estate.

One of them is what we call stay-in-business capex, or stay-in-business maintenance. The funny thing about real estate is, it all seems to report in a pre-depreciation way.

So earnings in listed real estate is always you add back depreciation for your FFO, for what we call funds from operation. When a valuer values a building, it takes the net income of the building and puts a cap rate on it. That's a pre-depreciation, net-income number.

So the big inefficiency in real estate, anyone that owns a department or a house knows that eventually the floors need to be done again or the curtains need to be replaced, walls have to be painted.

That's real cost. And in commercial real estate, some asset classes have very, very high levels of maintenance capex.

Hotels are a great example — 30 cents in every dollar you make in a hotel goes back into maintaining the hotel. Five cents in every dollar in self-storage is all that you need to keep the self-storage facility competitive. So that's a huge difference.

Self-storage facilities generally generate buckets of free cash, much higher than what people think, because everyone's sort of looking at these pre-depreciation numbers.

So they tend to be consistently underpriced in the way we think about it, because we're very cash-flow driven. And that usually points us to a lot of self-storage when we look at the universe.

Do you expect Australian real estate to outperform global markets?

It's really hard for us to see how the domestic market can outperform global markets on a five-year view. Very hard to take a position on a 12-month view or a two-year view.

We always find it much easier to look out five years and see where the big trends are. When you look at the Australia market, it is dominated by developers or funds management businesses or industrial property, all of which have had a terrific run, particularly industrial property.

The largest real estate investment trust in Australia is Goodman Group, which is a developer, fund manager and industrial property.

It ticks all the boxes when it comes to some of the favourable themes that have occurred over the last few years. But when you look at pricing for industrial and when you look at pricing for funds management business or real estate funds management business, it's hard to see where you're going to get the returns going forward.

So when you're looking forward for the next five years where we see the returns really tend to be more offshore. There are certainly opportunities in Australia. Scentre Group I mentioned earlier.

But by and large, when you look at the composition of the Australian real estate market, it's a very heavy weighting towards developers. It's a very heavy weighting towards industrial. Those sectors have done brilliantly well, but looking forward, we can't see those returns being sustained. We certainly see better returns offshore.



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