COVID-19 is reshaping offices and the way we work, which means investors need to be asking questions about whether returns from high-yield real estate investment trusts can be sustained.
Hopes of a COVID-19 vaccine have been the right medicine for flagging office real estate investment trust share prices but the path to future gains is far from clear as uncertainty lingers over the lasting impact of the pandemic.
Roslyn Newbound, managing director of business consultancy Accuratus, has permanently closed her office and is reinvesting rental savings back into the company and staff whom she says work just as productively from home.
Newbound, whose company provides administrative and governance support to small businesses, says her team of 10, which has doubled this year, prefer the lifestyle. The technology for staying in touch with clients has also improved.
“There has been no need for any trade-offs in work quality or employee and client contact,” says Newbound, who estimates saving about $40,000 in rental costs since closing her office in March.
"What we know is that businesses and office owners must consider how the crisis will reshape the relationship between people and place".
— Selina Short, EY managing partner for real estate and construction
But Dugald Higgins, head of real assets and listed strategies at Zenith Investment Partners, who has also been working from home, says that while it must be done during a health emergency, the long-term “outcome is sub-optimal and not a conducive environment” for collaboration and culture, particularly for mentoring and training younger staff.
Debate about the future of offices also poses some tough questions for investors about the growth prospects for real estate investment trusts investing in office property, particularly high-rise central business district offices.
Property sectors less affected by the present crisis, such as medical, logistics, large format – such as Bunnings Warehouse – and non-discretionary retail, have been less volatile, says Paul Moran, principal of Moran Financial Partners.
Office occupancy has ranged from less than 10 per cent in Melbourne, which is beginning to ease lockdown rules, to 40 per cent in Sydney, 60 per cent in Brisbane and about 70 per cent in Perth, according to Jones Lang LaSalle, a real estate services company. Adelaide is easing after another lockdown.
The ASX 200 A-REIT Index fell more than 60 per cent from its February 20 high to the trough of March 23. It has since reduced the shiortfall from its peak to 17 per cent.
Selina Short, EY managing partner for real estate and construction, says: "What we know is that businesses and office owners must consider how the crisis will reshape the relationship between people and place. The fact is that there are good and not-so-good parts to the recent working experience.
“There is no simple answer but we need to use the data, feedback from employees and customers, and reimagine a different future for the workplace."
Oryana Angel, director of In the Media, a public relations company, says she has already discovered that workplace. Angel operates without an office with a staff spread from Bundaberg, which is more than 360 kilometres north of Brisbane, to Albury-Wodonga, on the Victorian-NSW border.
“Companies are reinventing themselves,” she says of working from home, which compares to paying between $15,000 and $2000 a month for a Sydney office.
Daren McDonald, a partner at consultancy ShineWing, says many companies are still considering what space they “actually need”, possible new formats and how “working from home has impacted business and future plans”.
Shane Oliver, AMP Capital’s head of investment strategy and chief economist, suspects the trend towards more space for office workers will be offset by a reduction in overall space because more people will be working at home.
Oliver believes the next reduction in space demand could be at least 20 per cent.
“This in turn will depress office rents as leases come up for renewal and vacancies rise further, which in turn will weigh on office REIT distributions until the supply of space adjusts to the new lower level of occupancy – which could take years,” he says.
“Distribution yields may not fall as much as rents because values will likely also decline – but they are still likely to fall further. In a way this is not inconsistent with the decline already seen in interest rates and dividend yields on shares.”
The share prices of leading REITs with a high exposure to office property received a sharp boost this month when a possible cure for COVID-19 was announced, raising optimism for a return to the office.
Key office funds include Charter Hall Long WALE, Centuria Office, Dexus Property Group, Abacus Property and GPT group. Australian Unity and Centuria Capital are among the managers offering specialist funds. Dexus and diversified property group, GPT have recently been selling assets.
Forecast yields for major funds, such as Dexus, which has an office portfolio of more the $23 billion, 96 per cent occupancy and average leases of more than four years, are about 5 per cent.
That compares to the 10-year government bond yield at 0.87 per cent and the Reserve Bank cash rate of 0.10 per cent.
Moran says: “Everything seems to be viewed through the lens of effective zero interest rates, and so REITs that can provide income of 3 to 4 per cent and above will remain attractive.
"Importantly, the yield needs to be maintained, and so investors need to look a little under the bonnet to understand what type of properties they are investing in."
Macquarie Bank warns there will be continued volatility in the short term as occupancy rates reduced for all major REITs during the September quarter, incentives paid to tenants increased and working from home became a “structural headwind”. It recommends investors target quality.
That means investors need to identify funds with the best buildings, blue chip tenants, long leases and new fit-outs, Shinewing’s McDonald says.
Higgins from Zenith says the office investment market is “still in a transitional stage”.
“In the short term we would expect some decrease in floor space demand. The longer term picture is less certain,” he says.
“Many trends were already playing out prior to the pandemic, such as co-working, mixed-use developments and flexible arrangements. However, these trends have accelerated materially.”
Grant MacKenzie, a senior portfolio manager at Freehold Investment Management, says: “I don’t buy the investment market pessimism. People are going back to their offices, rents are coming back and prices in the listed market are more competitive. This is an opportunity."
Damian Diamantopoulos, portfolio manager REITs and head of property research at Australian Unity, says: “It is clear to us the office will remain central to business and office property will remain a key sector for commercial property investors."
Source: Originally published by Duncan Hughes in the Australian Financial Review on November 25, 2020.