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REITs revisited in 2020 – the listed real estate alternative
4th December 2020 / 6 mins read
Jennifer Cowan
Senior Consultant
William Hanna
Investment Analyst
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Real Estate Investment Trusts (REITs) are liquid equities which are listed on stock exchanges with underlying investments in real estate assets across most property types including apartment buildings, office buildings, mobile towers, data centres, hotels, medical facilities, retail centres, self-storage and industrial / logistics facilities. Typically, in a downturn, the contracted nature of the asset leases provides stable and predictable REIT cash flows for the investor. But COVID-19 was different -- it presented a “perfect storm” for real estate investors due to the government-imposed lockdowns designed to contain the virus. The global REIT index (hedged to AUD) fell by -29%  during the February / March 2020 period and has lagged global equities over the 12 months to 20 November 2020 by 20.1%. 

The investment rationale for REITs may vary depending upon the role REITs play within the context of the investment portfolio. JANA highlights three general functions REITs could perform:

  1. Completion portfolio. REITs could be complementary to a property portfolio which is mainly domestically focused and invested into traditional unlisted commercial /office, retail and industrial sectors. Global REIT exposure offers significant global diversification and access to “alternative” sectors more challenging to access in the unlisted sector. This is because the composition of the listed REIT sector has grown and changed considerably over recent years - “non-core” sectors such as data centres, single family housing  , hotels, self- storage, healthcare and student housing now comprise a larger portion of the benchmark index and the investible universe is more diverse than ever before.
  2. Income focus. Some REITs have had to cut distributions due to COVID-19 impacts, but we do not believe that lockdowns and distribution cuts will last indefinitely. We also note that the virus impact has been far from uniform across the property sector and in some instances, REITs’ operations and distributions have been unaffected by COVID-19.  REIT yields remain relatively attractive with the GREIT index yielding approximately 4%, supported by contracted cash flows. 
  3. Defensive equities. REITs present an opportunity for those preferring a more defensive equity exposure given the investment is underwritten by “bricks and mortar” real estate assets.  In other words, REITs are flow-through vehicles collecting rents from their role as a landlord and passing on the cash flow to investors, after allowances for maintenance capital and other expenses. Generally, stable rent collections translate to stable income for distributions and thus stable yields.  

COVID-19 impact

COVID-19 impacted many property owner’s ability to collect rent.  Furthermore rapidly accelerated market trends such as e-commerce, online retailing and work-from-home have implications for property demand. Over the recent past the retail sector has been facing the headwinds of rising online shopping. However, this same trend has been supporting the strong growth in logistics and industrial facilities. The work-from-home dynamic necessitated by COVID-19 has created a level of uncertainty regarding future corporate demand in CBD office locations. Lease structures and remaining lease terms vary significantly by asset and tenant type. 
Generally, REITs with longer and more robust contracted rental cash flows have been the better performers during the recent COVID-19 impacted period. 

REITs - not without risks

REITs are listed securities and as such pricing varies depending upon market depth or buying demand and selling supply, in exactly the same way as other listed equities. While this provides the benefit of investor liquidity, it also can result in pricing volatility and periods of significant performance decline. This occurred during March 2020 as the impact of COVID-19 became known and the market selloff occurred.  In most cases, the REIT fund manager’s benchmark is a listed index so managers are focused on relative returns and negative absolute returns can occur over some periods. In addition, the high short-term correlation with equity markets does not provide the diversification benefits sought by some property investors despite the underlying real estate assets. 

Market Dislocations Create Opportunity

COVID-19 has caused significant disruption across investment markets and particularly within the listed REIT market, albeit impacts have not been equal across all sectors, creating significant dispersion within the asset class. For example, REITs that trade at large discounts tend to be the most obviously COVID-19 impaired (hotels, malls, office); however, during the market’s sharp cyclical rotation in early to mid-November, these sectors have seen valuation discounts narrow as the clawed back some losses. Conversely, there are also significant portions of the asset class trading at large premiums (specialty, data centres and industrial property) as these have generally been beneficiaries of the virus impacted environment.
COVID-19 has not only accelerated existing structural changes but has presented additional rent collection challenges for many REITs. REIT landlords are working through the financial implications to navigate a path back to deliver the stable rental cash flows revered by investors in this asset class underwritten by real estate “bricks and mortar”. 

While JANA highlights that the sector is not without risks, REITs may present a solution to achieve property diversification, an income focus, or defensive equities positioning. This is on the proviso that your partner is a skilled REIT specialist fund manager who understands the nuance of the sector and is able to navigate through the investment landscape. 

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