When Freehold Investment Management was established in 2010, we set out to offer investors an opportunity to invest in a portfolio delivering sustainable income and long-term capital growth. By investing in real estate and infrastructure, the portfolio was designed to deliver exposure to real assets and perform ‘through the cycle’.
In reflecting on the 10 years, where investment strategies were designed in a post GFC world, we addressed many of the lessons learnt by the industry during that period. The most notable were managing risk and liquidity. Assessing and managing these fundamental elements mean our portfolios remove equity-like risk and deliver a pure property and infrastructure return to investors.
Today, we of course find ourselves in the middle of a global pandemic that has seen the ASX A-REIT 300 fall -34.4% in the first quarter of 2020 and unlisted managers start to announce asset write downs. Challenging times, yet pleasingly, the A-REIT sector looks very different now. Balance sheets are in much better shape with average gearing standing at circa 30% versus circa 45% when the GFC hit.
From the perspective of Freehold’s 10-year history, there have been some notable market and industry changes or trends. The most significant he notes are:
1. In 2010, Retail was the largest sector weight in the A-REIT Index and Westfield Corporation the largest individual security. In fact, the Retail sector was the cornerstone of property portfolios - listed or unlisted - with premium grade centres highly sought after and application queues to get into the best unlisted funds. It was also a time when online retail sales were about 3% of total sales. Today, Retail remains the largest sector in the A-REIT Index. However, Westfield as we knew it, no longer exists having been broken up over an extended period of time and the Lowy family’s exit completed with impeccable timing. Growth in total retail or selling space in Australia continued until recently, although from our perspective, is unlikely to continue and in fact, change of use is likely. The significant growth in online ‘shop at home’, now closer to 10% of retail sales, has led to the balance of power shifting from landlords to tenants and resulted in substantial pressure on retail centre earnings. Similarly, whereas once there were queues for applications into unlisted funds, today, and for some time, there have been queues for redemptions. In summary, as a result of the combined effects of change of use, online sales growth and the Coronavirus pandemic, we are witnessing an accelerated and permanent structural change in retail.
2. The shift in industry perceptions about how A-REITs should behave relative to how they are actually behaving. Before the GFC, A-REIT managers were criticised by industry analysts for having ‘lazy’ balance sheets. Their suggestion was that this resulted in lower growth. In response, A-REITs were geared up, investments were made offshore and distributions greater than free cash flow were paid out. When the GFC hit, the sector lost in excess of 60% of its value and highly dilutive capital raisings were needed to repair balance sheets. REITs have learnt from those experiences and since then, as a general rule, managed their balance sheets better. The challenges more recently relate to income rather than distressed balance sheets. We have already seen some capital raising activity and there will be more. All are driven by a desire to bullet proof their balance sheets in a period of income uncertainty and for some, to position themselves for the opportunities that may arise.
3. Infrastructure emerged as a separate investment sector under the general alternatives asset class. Freehold led the industry by including infrastructure in its real estate portfolios effectively driving the evolution of real estate into real assets. The investment characteristics of infrastructure have similarities with property, particularly as the income is sourced from long-term contracts for the exclusive use of tangible assets. There has been substantial growth in the size of the listed infrastructure sector over the past 10 years driven by a growing population, economy and the demand for yield from investors. Investments such as Sydney Airport, Spark Infrastructure and APA Group have been beneficiaries of this growth. By blending property with infrastructure, we have been able to broaden the investable universe and as a result provide investors an increase in sustainable returns and diversification.
When considering future opportunities and risks in the industry, there are a few key themes Freehold is watching. COVID-19 has, in our view, ‘fast tracked’ a number of themes. The first is the impact on the demand for offices over the medium term as employers embrace a more flexible work environment. This change has been coming for a number of years but with some resistance. Equally, while already a significant asset class, data centres and related IT infrastructure is likely to become more mainstream, faster. This comes as businesses fully transition to the cloud. Then finally, the transition to renewable sources of power and the growth in distributed energy generation will present both opportunities and risks for the infrastructure sector.