The Coronavirus has wreaked havoc on markets and economies the world over. What was initially viewed to be China’s problem became the World’s problem, as countries powered down their economies in attempt to stop the spread of the Coronavirus via social distancing. Never have countries simultaneously quarantined themselves, shut down supply chains, suspended sporting and cultural events, closed schools, boarders and experienced this level of consumer-related demand disruption from travel, tourism and normal, everyday, working patterns.
Peak-to-trough, global equity markets lost a combined USD ~$27 trillion in market capitalization, nearly the size of the GDP in the European Union and China combined. It took just 16 days for the U.S. to enter a bear market, quicker than 1929 and second only to 1987. Bonds also took it on the chin with credit markets seizing, spreads blowing out and a record USD $243 billion in redemptions from investment grade, high yield, mortgage backed securities and municipal Funds. Oil prices collapsed to $20 a barrel as Saudi Arabia and Russia agreed to disagree, hitting the lowest level since February 2002. Unemployment claims around the world have soared to record levels and market volatility1 exceeded levels reached in the global financial crisis.
REITs were not spared from the carnage, Global REITs suffered their worst performance quarter since the depths of the global financial crisis, declining -28.3% (USD)2. However, lower stock prices have resulted in valuations becoming meaningfully more attractive than three months ago, with some companies already pricing in a potential worst case scenario, while others are not. Dividend yields have expanded to ~5% (on an 85% payout ratio) at a time when bond yields have collapsed and cash flow multiples in many markets have reverted back to or fallen below their historical average. Global REITs are currently trading at a -30% discount to our intrinsic value which implies 58% upside potential in price. If we stress test these valuations to assume declines in occupancy and rent in 2020 and 2021 with a recovery in 2022, the discount to intrinsic value is still -21% implying an upside potential of +41%. Very attractive either way you cut it.
What are we doing now?
We used this underperformance as a buying opportunity. Ahead of and during the correction that gripped markets beginning near the end of February, we took advantage of the spike in volatility to upgrade the quality of the portfolio's underlying real estate and balance sheets. We added REITs with lower leverage and less near-term debt maturities while lowered or eliminated exposure to REITs that are more cyclical in nature, and which had a greater risk of not being able to maintain earnings and cash flows in an economic downturn.
More specifically, we have increased exposure to:
- technology-focused REITs in the U.S. and Europe which are seeing higher demand for data storage and mobile usage;
- industrial REITs in Canada, Europe and the U.S. that are poised to benefit from the increase in online shopping;
- less cyclical property types such as non-discretionary retail centers in Hong Kong and self-storage in Australia that should continue to experience steady demand in the face of slower economic conditions;
- apartments in Japan and medical office properties in the U.K. whose cash flows should be more resilient vis-a-vis other property types; and
- ·our highest conviction ideas in sectors that have been hardest hit, such as gaming.
And we have reduced exposure to:
- retail REITs in the U.S., Europe, Hong Kong and New Zealand, given online shopping headwinds;
- senior housing properties that may see an increase in vacancy rates over the coming quarters as new move-in activity slows due to facilities restricting access to outside individuals; and
- hotels, where we have exited completely due to rising concerns of slower business, group and personal travel in the months and quarters ahead due to COVID-19 and the need for social distancing.
Although we are comforted by the quality of the companies and assets we own, and how we have repositioned our portfolios in the face of the crisis, in the near term, no company is immune. A coordinated world quarantine will have a meaningful impact on current earnings creating the potential for more volatility and downside. That said, what allows us to sleep at night is that the global REIT industry is very well positioned from an asset quality, liquidity and balance sheet point of view to weather an economic storm, and certain segments will thrive, not just survive.
1Cboe Volatility Index .2Bloomberg. Represents the FTSE EPRA NAREIT Developed Total Return Index.
This document is for informational purposes only and is not an offer or solicitation to deal in securities. Any opinion or estimate contained in this document is made on a general basis and is not to be relied upon for the purpose of making investment decisions. The statements made herein may contain forecasts, projections or other forward looking information regarding the likelihood of future events or outcomes in relation to financial markets or securities. These statements are only predictions. Actual events or results may differ materially, as past or projected performance is not indicative of future results. Readers must make their own assessment of the relevance, accuracy and adequacy of the information contained in this document and such independent investigations as they consider necessary or appropriate for the purpose of such assessment. This document does not constitute investment research. Consequently, this document has not been prepared in line with the requirements of any jurisdiction in relation to the independence of investment research or any prohibition on dealing ahead of the dissemination of investment research. Any research or analysis used in the preparation of this document has been procured by Timbercreek Investment Management Inc. for its own use. The information is not guaranteed as to its accuracy.