The greatest opportunities in a beaten up sector

Amy Pham

Pengana Capital Group

Looking forward, Covid-19 has created earnings uncertainty for certain sectors such as those exposed to discretionary retail whilst creating opportunities through an acceleration of structural shifts such as ecommerce. The main casualty is the passive investments that did not take into account earnings risk. In the short term, due to earnings uncertainty, the majority of AREITS (in particular retail REITS), have withdrawn their earnings and distribution guidance, and for the first time under the code of conduct, landlords are now being asked to share the pain with their tenants by providing rent relief.

As restrictions ease and more businesses reopen, collections should improve. However based on the REITs quarterly updates, April’s rent collections are as follows:

  • retail landlords were able to collect only 30 to 40% of last year's rent,
  • for offices, they’re collecting about 70 to 80% and
  • for industrial, about 90 to 95%.

There's been an increase in capital raisings as companies look to strengthen their balance sheet and provide flexibility for growth opportunities. In the long term there's been cyclical headwinds which includes higher unemployment rates and lower GDP growth, which impacts tenant demand, vacancy rates and market rents. Importantly, Covid-19 has accelerated some of the inevitable structural changes such as the adoption of online retailing and more flexible working options. We summarise some of the affected areas below:


This is the sector we think will most benefit from this new normal. Logistic assets which form part of the supply chain for food and delivery of parcels have shown to be quite resilient. In actual fact, there's been an increase in demand from online retailing which has benefitted that subsector. We’ve factored in a 5% fall in valuations mainly towards the smaller logistic centres which are more exposed to the SMEs.


Most of the large retail landlords which are exposed to discretionary retailing have been impacted and are trading at a large discount to NTA of about 40 to 50%.

We see this sector as having the most downside risk to earnings going forward as it suffers from both cyclical and structural headwinds.

In Australia, the penetration rate of online retailing has been relatively slow at around 11%. With Covid-19, this is expected to increase to 19% over the next two years. With the increase in retail consolidation and online presence, we expect that the shift of power will move from the landlord towards the tenant. With this, we expect that there will be a rebasing of rents and shorter lease terms going forward. As a result, we're factoring in a 20-30% fall in valuation for regional malls and 5-10% for convenience centres as they're more defensive and exposed to supermarkets, and essential services.


With the unemployment rate at an all-time high of 10%, tenant demand will be impacted, as will vacancy rates and market rent. What we've learned from past downturns is that when vacancy rates increase from 4% to levels of about 10 to 15% net effective rents decrease from about 20 to 25%. In terms of structural shifts, it is too early to determine how successful the adoption of working from home has been. However, companies now know that with the existing technologies available, certain functions can be done from the home. Offsetting this is the space required for physical distancing and the elimination of hot desking. So net net, we're expecting a 25% fall in valuation for CBD offices and a 15% fall for metro offices.


The increase in the unemployment rate and moderation in migration will have a negative impact on demand however this is partially offset by a reduction in interest rates and expected reduction in supply in both existing stock and new. So we're factoring a fall in sales of about 20 to 30% and a 5% decline in price. However, in the long term we believe there'll be more of an upside risk than downside risk as we know that during downturns the government is supportive of this sector, especially in the first home buyer market segment.


I think the greatest opportunities will exist around the industrial sector, especially the ones that form a supply chain for ecommerce. Over the next couple of years this will be the only sector whereby we have cap rate compression instead of expansion, which is what we would have expected from the retail and office space.


The REIT space is in a far better position than it was during the GFC. Gearing is much lower at 27% compared to 45% then. Liquidity is also better as more diversified sources of funding and longer durations helps REITs in terms of not having to raise capital and dilute earnings. However, Covid-19 has created both cyclical and structural headwinds to the ability to deliver on capital security and income yield. We remain focused on investing in REITS with sustainable earnings growth, strong balance sheets and favourable thematic drivers.

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Amy Pham
Fund Manager - Pengana High Conviction Property Securities Fund
Pengana Capital Group

Amy is portfolio manager of the Pengana High Conviction Property Securities Fund, and has over 20 years of property funds management experience. Previously, Amy has worked at Charter Hall/Folkestone for 6 years, managing a high conviction...

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