Listed property was on song in 2019 before losing its mojo this year as the coronavirus struck. But are the real estate blues simply a crisis-triggered reversion to the mean or is something more fundamental at play? Mint Asset Management senior real estate portfolio manager, Carlie Eve, puts property in its place...
Investors having a sizeable allocation of property in their portfolio at the end of last year would have had good reason to celebrate.
The S&P/NZX All Real Estate index was up 32.4 per cent over the 2019 calendar year, the best-performing asset class for the period for local investors, according to figures from Melville Jessup Weaver (MJW).
Just three months later NZ listed property investors were staring down a 12-month benchmark loss of almost 3 per cent, a differential of more than 35 per cent compared to the December 31 numbers.
For the March 2020 quarter, the local NZ real estate sector was one of the worst-performing asset classes in the MJW survey with a return of -20 per cent, well adrift of the broader NZX index result of -14.5 per cent.
From the highs of 2019 those invested in property are quite likely questioning the value of holding it anymore. But why did NZ listed property deviate so much from the S&P/NZX50, shredding its reputation as a defensive sector?
High-rise returns revert to mean
Part of the answer to that question lies in the outstanding performance of listed NZ real estate in 2019.
The tear-away performance of local real estate (a phenomenon not restricted to the listed market) saw investors of all stripes piling into the asset class, exacerbated by falling interest rates and the hunt for higher yield.
As a proxy for retail demand, the direct-to-consumer platform, InvestNow, noted the proportion of its investors holding property funds rose from 17 per cent to 33 per cent in the six months to the end of October.
Even prior to the COVID-19 crisis, then, the listed real estate sector was coming slightly off the boil with the New Zealand property index falling behind the broader NZ share market in the final quarter of last year.
In its 2019 financial stability report, the Reserve Bank of NZ (RBNZ) flagged the commercial property sector as a potential area of concern for investors.
The RBNZ said at the time that while low interest rates and high rental demand were “helping to mitigate the imminent risk of a sharp repricing, the overall trend is contributing to a build-up in the vulnerability to future shocks, such as unexpected increases in interest rates or an economic downturn”.
Down another level
However, reversion to the mean – a process accelerated by the COVID-19 crisis – does not fully explain the performance of listed real estate in the first half of 2020.
Property has been hit harder than many other investment sectors due to some idiosyncrasies of the coronavirus economic fallout. By decree, shopping malls, factories and office blocks had been emptied for weeks creating a clear risk of rental default clattering through the sector.
Government relief packages and tax breaks (note the reinstatement of building depreciation deductions in March) helped landlords and tenants through the initial Level 4 lockdown.
Of course, not all real estate was abandoned: many essential services including manufacturing, logistics, some offices and – most obviously – supermarkets, continued to operate.
Overall, the NZ property sector was also well-provisioned to handle a short-term shutdown. As AMP Capital noted in March, landlord “balance sheets do not carry a level of gearing that will see covenants breached and emergency capital raisings triggered”.
During the following three months as the country ratcheted down through Alert Levels to our current almost-normal status, a clearer picture of the damage emerged for tenants, landlords, valuers and investors.
In May many listed property companies updated the market with what in the main was relatively good news.
In most instances, the impact on rental income was lower than anticipated after the majority of firms progressed negotiations with tenants.
The recovery position
Despite escaping the worst-case scenario outcomes, COVID-19 has likely inflicted some immediate and long-lasting changes on the listed property sector.
Already, for example, demand for warehouses and logistics facilities has waned as the economy reopens. The retail sector, meanwhile, has seen a strong bounce back with shoppers flooding the malls and big box stores. White-collar workers are slowly repopulating office buildings, which in turn is propping up surrounding hospitality services.
The Mint portfolio evolved through COVID-19 and continues to do so. The selloff in retail and office related property, gave us the opportunity to re-weight into those sectors as industrial property got relatively expensive. Opportunities also cropped up in the Australian listed property sector and the Auckland Airport capital raise.
The focus on such short-term factors is, perhaps, understandable. But real estate is also in the grip of long-term ‘mega trends’ - the effect of online shopping on retail, changing work patterns, and demographic shifts, for example - that may have been deflected only slightly off-course by COVID-19.
However the economy evolves, real estate will play a leading role. It still offers an attractive yield, it’s very cheap relative to the broader NZX market, and there are still high occupancy rates. As long-term investors we need to make sure we’re in the right place to take advantage of the steady income and capital appreciation that the listed property market will ultimately deliver.
Disclaimer: Carlie Eve is Senior Property Portfolio Manager at Mint Asset Management Limited. The above article is intended to provide information and does not purport to give investment advice.
Mint Asset Management is the issuer of the Mint Asset Management Funds. Download a copy of the product disclosure statement here.
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