Winners and losers in real estate
Retailers sink, warehouses thrive
The effect of the Covid-19 pandemic on the real estate industry has been extremely mixed. Initially all companies investing in real estate sold off sharply, as the shutdowns of developed-market economies during the first wave of the virus led to apocalyptic predictions of massive tentant defaults and subsequent mass bankruptcies of landlords.
As governments introduced various offsetting measures, such as protection from evictions and suspension or reductions of property taxes, some logic was restored to the market. Investors began to sort out which sectors were suffering and which were benefiting from the effects of the pandemic lockdowns.
The most obvious sufferers were the owners of bricks-and-mortar retailers, many of whose premises were completely shut down for a quarter at least. Other included owners of residential retirement and long-term care homes where mortality rates soared, owing to lack of staff, equipment, and training. Owners of central business district (CBD) offices, where working from home (WFH) became the norm, also suffered badly as did owners of hotels and resorts with the collapse in international travel.
On the other hand, owners of warehouse properties used for distribution of goods purchased online enjoyed strong performance, as did supermarket and essential-retailer-anchored retail parks. In between the winners and losers were such sectors such as owners of industrial properties, whose tenants were able to return to relatively normal working rapidly, and residential landlords, as it became apparent that tenants were continuing to make rental payments, in some cases helped by government support programs.
As the initial wave of lockdowns came to an end in mid-2020, the outline of the “new normal” emerged in how consumers were adapting to living in a post pandemic world. This included a migration to smaller cities and outer suburbs, the trend towards working from home and e-commerce, and fewer but larger food and grocery stores.
Now, over a year later, it’s becoming clearer which sectors within the real estate market have long-term viability and which ones may have had a fundamental change in their business model.
Over the last year, the Bloomberg US REIT Index is up a healthy 32.7%, while the iShares S&P/TSX Capped REIT Index ETF is ahead 31%. However, over the last five years, the Bloomberg US REIT Index is up only 20%, as is the Canadian index. This, of course, doesn’t include income, which is the reason for the establishment of the REIT structures in the first place, as they are required to pay out at least 90% of their cash flow to retain their tax advantaged structure. Even including income, the total return over the last five years is less than 50%, reflecting the decline in such sectors as traditional malls, residential homes and hotels offsetting the success of industrial properties, residential, and warehousing.
Certain new sectors have become attractive, such as owners of digital facilities for cloud computing, medical facilities, and single-family rental properties as opposed to apartments. The growth in these sectors reflects the changes in the economy. Investors should not treat the REIT sector – or real estate more generally – as one asset class, but should rather be selective within them and attempt to gain exposure to those sectors that are beneficiaries of changes in the economy. The pandemic has accelerated many of these changes, compressing five or even 10 years of change into the last 18 months.
Investors seeking higher absolute yields might consider supermarket and essential-retailer-anchored REITs, as they have come through the most severe test of the retail industry imaginable, while maintaining payouts and showing steady same-store revenues. Food retailers, drug stores, and convenience stores remained open and indeed gained market share as they were in many cases able to sell non-essential goods as well those deemed essential.
Residential landlords, whether apartments or more recently single-family homes, have benefited from the rapidly rising price of property. That’s because buying a home has become increasingly unaffordable due to generational lows in interest rates leading to increased demand for larger single family homes.
Despite rising 8.3% over the last year in the U.S., rents are still affordable compared with mortgage payments, and as a result, apartments have become an attractive asset class for many investors, with US$53 billion spent in the second quarter alone. Investments by larger investors have helped drive apartment prices up 12% in the U.S. in the last 12 months. For example, Morgan Properties spent US$2.5 billion on 20,000 apartments in the last year, making it the second largest owner, and Blackstone spent US$5.1 billion.
Warehouses, known sometimes as the “distribution and logistics” sector, whose properties tend to cluster close to major cities to aid the last mile distribution of goods, have seen numerous acquisitions driven by the explosive growth in demand during the pandemic. Most recently Blackstone bought out Canadian-listed WPT Industrial this month for US$3.1 billion, for its 110 properties near Atlanta, Chicago, and Houston.
While yields are lower in this sector, as in residential, the low cost of capital and the ability to improve yields by relatively small expenditure on improvements combined with strong revenue growth continue to make this a long-term secular growth story.
The specialist sectors, such as digital (computing) and medical facilities, also have attractive fundamentals and remain strong performers.
Underweighting such sectors as traditional retail, residential care homes, and hotels, except for certain sub-sectors such U.S. domestic budget operators, should ensure investors enjoy the income that the sector generates along with some degree of inflation protection as asset prices rise.
Gavin Graham is a veteran financial analyst and money manager and a specialist in international investing, with over 35 years’ experience in global investment management. He is the host of the Indepth Investing Podcast.
Notes and Disclaimer
© 2021 by Gavin Graham. This article was originally broadcast as a podcast on Indepth Investing, hosted by Gavin Graham. Used with permission.
The commentaries contained herein are provided are provided as a general source of information based on information available as of July 8, 2021, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.