COVID-19 has caused havoc in the REIT sector with economic shutdowns, rent relief and concerns about behavioural changes (structural shifts) weighing heavily on the performance of the sector. As we look forward into 2021, the focus turns to how the rollout of various effective vaccines and reopening of economies will impact specific REITs within the sector.
The question is – will the market recover back to pre-COVID normal and what will this normal look like? At the peak of the pandemic, rent collection for large retail malls was as low as 30%. As economies are reopening, rent collections for large retail malls are now tracking at 70%-90% with foot traffic close to pre-pandemic levels. However, as the retail REIT sector is continuing to lose market share to e-commerce (11% of sales in Australia we made online vs 7.2% in the prior year, per the ABS at November 2020; and expected to reach 20% by 2025), we see stabilisation in earnings for large retail malls to fall by 20%-30%, allowing for a higher level of structural vacancies, rent deferrals and reversion of rents. Anecdotal evidence suggests that with a shift to e-commerce, shopping centre landlords are facing increasing pressure from tenants to adopt turnover-style rent agreements. If this eventuates it would result in an elevated risk to the sector compared to the current 4-5% p.a. rent reviews for a typical 5+ year deal.
We do not have exposures to large retail malls. Our exposure in retail is in bulky goods such as Bunnings Warehouse Trust (BWP) which has benefited from working from home (WFH) and expect to continue to benefit from a recovery in the residential sector.
Turning to office REITs, even though physical occupancy is low at 30% and 7% for Sydney and Melbourne respectively, the rental collection remained fairly solid at 90%. Throughout 2020, our holding in office has been defensive. We prefer metro offices with large exposure to government tenants and long weighted average lease expiry (WALE) such as Centuria Office REIT (COF) and Irongate Group (IAP). As we navigate through the pandemic and assess the impact of WFH, we believe businesses will likely adopt a more flexible working arrangement with staff working 2-3 days in the office and the remainder from home. This will likely reduce office space requirement as companies look to reduce overheads. However, there remains the question of decentralization – CBD versus metro offices.
When we look at what staff and businesses want – quality retail amenity and good public transport – the CBD and selected metro markets such as Parramatta and North Sydney in Sydney offers this.
Going forward whether it’s in the CBD or metro, office space will be more about collaboration and empowerment. A well-designed productive space which can accommodate tenants’ changing needs will be in demand.
We believe tenants who are already in the CBD pre-COVID is unlikely to move out to suburban areas. They would likely consolidate their office requirement but aim to upgrade to higher quality space. With this in mind, we have added Dexus Group (DXS) to the portfolio. DXS is well placed in terms of balance sheet capacity (has been selling $1bn of assets in 2020 to redeploy into developments and funds management, further diversify earnings) and their variety of products (ranging from traditional workspaces (typically 7 years lease terms) to meeting spaces (1-hour bookings)) is best positioned to accommodate for flexible working requirement going forward.
As a high conviction and benchmark unaware manager, we are able to invest outside the index. As it stands, the portfolio has close to 40% exposed to alternative real estate sector such as logistics, data centres, storage, childcare, seniors living and manufactured home estates. We believe these sectors provide both sustainable earnings growth driven by secular trends and diversification from the traditional core sectors of retail, office and industrial.