If cash is king, then rent is an ambitious prince for listed property investors. It’s all (mostly) about rental income for those sifting real estate investment trusts and the offices, warehouses and shopping malls in which they invest.
In the prior two articles in this collection, we’ve looked at the most important ways Freehold’s Grant Mackenzie gauges the quality of assets, including tenants’ capacity to keep the rent paid and debt collectors at bay. Alongside free cash flow and yield, structural aspects (long-term themes that determine the likelihood of success or otherwise) are high on the list. Accelerating online adoption is one that stood out for me as surprising in such a bricks-and-mortar context. But it’s largely why both retail and offices will struggle (think e-commerce and work-from-home) in the medium-term.
In the final part of the series below, Grant Mackenzie discusses relative value in the Office and Retail sectors.
What's priced-in, and what's outpriced
Grant Mackenzie, Senior Portfolio Manager, Freehold Investment Management
This is about the relative value, that is, what’s priced in and what’s not. Look at the Office sector, which is currently trading at 20-25% discount to NTA – is that warranted or overshot? In our view the latter.
While we acknowledge that effective rents will come back and vacancies will lift, exacerbated in second-tier assets as tenants move into higher-quality assets, we still think firms want their staff back in the office for productivity, collaboration and cultural reasons. Office is not dead!
Similarly, Retail malls are also trading at a big discount to net tangible assets but in contrast to the Office sector, the NTAs are not validated by transactional evidence. Malls still have increasing vacancies and they are struggling to backfill the spaces available. To overcome these vacancies, malls have had to diversify into different asset classes – more service-related, such as gyms and childcare. This is new, and being done to solve the vacancy issue but the rents are lower. Overall, the sector stills need to adapt to the structural challenges present - that shopping habits have changed – something that was accelerated due to Covid-19.
We don’t believe the market is fully appreciating the challenges, nor the fact that malls will not revert to ‘normal’ due to the substantial changes in shopping habits. For these reasons, Freehold is still cautious towards the sector and remains underweight in large malls.
A key to the cure
As the vaccine-led recovery continues to roll out, the raw materials needed to keep kickstarted manufacturing companies supplied will be crucial, and these logistics and warehousing requirements are reflected in the industrial property theme emphasised throughout this three-part series. Another industrial segment briefly touched on was data centres, a theme that’s quickly catching on for investors as the digital revolution got its own shot in the arm throughout COVID and beyond.
What becomes of the office and shopping mall remains an open question, but the near-universal view is one of transformation and adaptation rather than extinction.
Source: Originally published by Glenn Freeman on Livewire Markets on 6 April, 2021.