Investment markets for REITS in Australia (A-REITs) have been volatile, as corporate reporting suggests both the recent bushfires and growing coronavirus (COVID-19) concerns have already had a significant impact on trade. Principal Global Investors Portfolio Manager Janine Yoong says regional shopping centres have been particularly affected.

“Lower foot traffic has hurt centres in Australia’s regional areas because of this summer’s devastating bushfires, but has now become a problem for retail shopping centres across Australia as coronavirus fears have risen,” said Ms Yoong.

Australian real estate faces delays because of coronavirus impact on China

“China is Australia’s biggest trading partner and we’re already seeing an impact from the coronavirus on education and tourism. But there’s also a long-term concern – construction supply chains,” said Ms Yoong.

“Delays are going to hit Australian REITS and property once current stocks are used up. Big high-rise developments in particular will be affected, because taller office towers and apartments use lifts and bathroom fittings that are mainly imported from China.”

A-REITS may benefit overall from tighter markets

A-REITs overall, however, may benefit as the construction delays give an advantage to existing landlords. “Australia has more landlords than developers, so overall A-REITS should benefit from a tighter market,” said Ms Yoong. “Overall, Australian REITS are appealing because they’re transparent, and give high yields, particularly compared to Hong Kong and to some extent, the US.”

“The recent official cash rate cut by the Reserve Bank of Australia makes A-REIT yields even more attractive. A-REITS now yield about five per cent – a lot better than the less than one per cent yield of a 10 year bond. And REITs are still seen as a defensive investment in volatile times.

“That’s attractive to international investors, who already like Australia because of our deep real estate market and also good stable government and politics.”

Virus to slow global REITS

US-based Principal Global Investors Client Portfolio Manager Todd Kellenberger said: “The coronavirus outbreak has put a brake on the nascent global markets recovery.

“Even though China is close to gaining control over the virus, unfortunately it is accelerating globally, in particular in the U.S. That means other governments may have to follow the draconian measures seen in China and Hong Kong, which will crimp global growth.”

Mr Kellenberger said COVID-19 will have a meaningful negative impact on first and second quarter for the US economy and more economically sensitive property sectors.  “We have seen hotel REITS in the US withdraw their 2020 guidance,” he says. “Hotels and travel companies are seeing a falloff in bookings and increasing cancellations from business and leisure travellers.”

While Italy has seen the most cases of COVID-19, it has not directly impacted global REITs to date, Mr Kellenberger said there is only one small retail REIT in Italy and it’s already struggling with structural problems in retail property. “The larger concern in Europe is how the change in human behaviour in response to controlling the spread of the virus will negatively impact economic activity within the region. UK homebuilders are seeing a softening in demand, for example.”

“In Asia, China and Hong Kong landlords are offering rent relief, and footfall in malls and discretionary shopping centres has been very weak. Residential property has also been weak because prospective buyers are nervous about showing up to crowded grand opening for-sale launches of condominiums.”

Mr Kellenberger, however, agreed with Ms Yoong that REITS may be at an advantage, saying “REITs around the world won’t be immune from these market selloffs. Relatively speaking, however, they should hold up better because they have durable income streams from domestic exposure to contractual rents and lower long bond yields should provide support to valuations.”

“The equity market should rebound once it is clear that the global virus spread is coming under control, and REITS will also participate in the rally.”

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Janine Yoong, Portfolio Manager, Principal Real Estate Investors, says while AREITs continue to lag behind the broader market year-to-date, there has been a tailwind to AREITs as the second quarter has begun.

“Following the FOMC meeting in March, and despite the Fed raising interest rates, commentary from the Fed has pointed to gradual rate hikes for the remainder of the year. This has resulted in bond yields retracing since the middle of March and lending support to AREIT valuations,” says Ms Yoong.

The February earnings season delivered mixed results, with cap rate compression continuing to come through. Other key insights include:

• Retail sales have showed signs of slowing; a trend that does not bode well for future rental growth, Meanwhile, office market conditions in Sydney and Melbourne continue to tighten, with rent continuing to grow and incentive levels reducing,
• Residential activity remains healthy, with settlements at elevated levels and default rates remaining low,
• Fund managers continue to enjoy elevated performance and transaction fees, and
• AREITs continued to report cap rate compression in their portfolios, underpinning Net Tangible Asset growth over the period.

The first quarter of the year saw growth names outperform while retail names underperformed. Stocks offering higher growth profiles generally outperformed, while AREITs with discretionary retail exposure lagged, especially at the large cap end of the market. Discretionary retail names were weighed down by concerns around retailer bankruptcies as well as the impact of growing market penetration of online retail.

Ms Yoong says global risks are weighing on investors’ minds, lending support to AREITs of late.

“As a defensive market in the APAC region, AREITs are the beneficiaries of heightened geopolitical risk. The market will be watching North Korea closely, particularly following Trump’s recent actions in Syria, which may be a sign that he is prepared to act unilaterally. With European elections adding to the uncertainty and the feeling that we are in ‘limbo’, this could be supportive for defensives in the second quarter.”

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