Guy Barnard, Tim Gibson and Greg Kuhl from the Global Property Equities Team provide an update on real estate markets and the investment implications of the coronavirus as the pandemic spreads across the globe.
- While property has been included in the sell-off in global assets, we are seeing a distinction among different sectors, which are being impacted to differing degrees and at varying rates.
- Listed property valuations are close to Global Financial Crisis lows. While this time is different and future demand will likely be impacted, there looks to be greater resilience in cash flows and most balance sheets than the market is currently giving credit for.
- While investing in listed real estate may lead to greater volatility in the short term, we believe it may also create opportunities to access real estate for less than its intrinsic value.
We have seen a broad-based sell-off in global assets in recent weeks as investors (including ourselves) come to terms with the growing impact of the COVID-19 coronavirus and an effective shutdown of many economies. The latest phase of the sell-off and extreme volatility seem to be driven by a general unwinding of risk and a scramble for liquidity across all asset types. Correlations among asset classes, countries, sectors and individual securities have increased, leaving few places to hide.
Evidence that “A Rising Tide Does Not Lift All Boats”
This same trend is being felt across listed real estate markets, where property shares in most geographies and property types have been impacted. That said, we are seeing a distinction among different sectors, which are being impacted to differing degrees and at varying rates.
Retail-focused companies, as well as those with hotel exposure and weaker financial positions, are seeing the sharpest falls. In this space, we do expect downward earnings revisions and dividend cuts, and indeed this is already occurring for some retail and hotel landlords. The effects of virus containment efforts have only served to accelerate an ongoing negative structural trend for retail and hotel sectors, which we had previously identified as weak links based on their supply and demand characteristics. Already-stretched balance sheets, particularly among retail companies, may also lead to the need for additional funding if these challenging conditions persist.
While the de-rating in shares has been painful to watch, we continue to believe that some companies have relatively defensive income streams, robust balance sheets, lower leverage and more diverse sources of funding than current share prices give credit for. Hence, we do not yet see this as a credit crisis issue as it was in 2008-2009. In our view, the value of these robust income streams will come to the fore when market volatility subsides.
Those parts of the real estate market that are most stressed are areas we felt were already under structural pressure. Conversely, areas we have favored, such as logistics, manufactured housing, cell towers and affordable rental housing, have proved more resilient. In the logistics market, for instance, the current backdrop is supporting the acceleration of the structural shift toward online shopping and reinforcing demand from their tenant base, an example being Amazon’s recent comments around further expansion with the addition of 100,000 extra warehouse and delivery staff in the U.S. alone. How many people using online grocery shopping for the first time will continue to do so even when the coronavirus lockdowns are lifted?
Are Current Valuations Justified?
Clearly, the situation is incredibly fluid, and our conviction must be lower, but we continue to believe that those parts of the market offering more resilient cash flows can benefit from the resulting “zero-rate world” we may likely be in again. Indiscriminate selling creates opportunities, and the moves of the last few weeks have been extreme in a historical context. Listed property valuations are close to the low levels seen during the Global Financial Crisis (see charts below), and while this time is different and future demand will likely be impacted, there looks to be greater resilience in the financial health of many property companies than the market is currently giving credit for. Therefore, we think it is reasonable to expect some re-rating from current levels in the medium term.
Last week, global real estate stocks underperformed wider equity markets as fixed income, notably credit markets, became more disorderly. Central bank actions to give greater confidence here need to be watched closely.
In the short term, we expect markets to remain volatile. Investing against this backdrop can be inherently uncomfortable. Before the market begins showing signs of normalization, there are several criteria we think are needed:
- Peaking of coronavirus cases or signs that the pandemic is being contained (especially in Europe and the U.S.)
- A return to the smooth operating of capital markets (fixed income in particular)
- Adequate policy response (both monetary and fiscal)
While investing in listed real estate may lead to greater volatility in the short term, we believe it may also create opportunities to access real estate for less than its intrinsic value, which we feel is the case today.
At present, we see many compelling opportunities in the listed property sector at valuations not seen for more than a decade. With many property companies providing resilient cash flows, the good news is that we are still being paid by regular income as we wait for a re-rating.
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