Each property cycle throws up its own opportunities, and the post-COVID cycle could be a period of great opportunity, Mary Power, principal consultant with JANA says. She sees adaptability as the key.
Adaptability has become the operative word for landlords in all forms of real estate, including office and retail, the two sectors whose future has most been brought into sharp focus in the wake of the COVID-19 upheavals.
The intrinsic value of office and shopping centres boils down to one thing – usage. That means people to occupy offices, and buyers to visit shopping centres.
Sadly, lock down measures rolled out as circuit-breakers to the pandemic have deprived both office and retail centres of human traffic.
Much has been said and debated over the future of office and shopping centres – the two mainstays of the property portfolios of Australia’s largest institutional investors.
“Property investment is for long-term hold,” says Mary Power, principal consultant with JANA. “The asset class is subject to periodic cycles.
“Investors need to ensure that they are invested in high-quality assets that are adaptive, with strong covenants and a variety of rent review structures that have protective cash-flow mechanisms, including inflation protection,” she told [i3] Insights. “Astute investors adopt forward thinking strategies.” Investors should “remain diversified”, she says.
Irrespective of the current climate, property remains at an average allocation of 10 per cent but could be lower, says Power, who is also head of research at JANA.
Majority staff-owned and independently-managed, JANA had approximately $600 billion in assets under advice, including real estate, at December 31, 2019.
As Australia’s largest asset consultant, its guidance is key to how many institutions will steer their way forward post-COVID.
I had a call with an Australian manager, who said air-conditioning in office buildings will probably be adapted to hospital grade
Power says key concerns of investors are around pricing and inflation risks, cash-flow certainty, and the question of adaptability. They want to know how they can adapt their assets in the face of economic downturn and technological disruptions.
Over several months now, asset owners and managers have pondered the impact on their portfolios, and struggled with strategies designed to move forward.
What is becoming apparent is that the investment value of people-centric assets can be shored up or salvaged through creative thinking. The focus is the application of new technology, along with new practices, to alleviate public health concerns.
“The key to recovery will require asset owners to be adaptive post the containment period,” says Power, who joined JANA in 1990, seven years after John Nolan established the asset allocation advisory business. She left in 2000, re-joining a decade later.
Her stints with JANA have given her invaluable insights into the thinking of asset managers and owners, and a bird’s eye view of the real estate market.
“The fortunate thing is that the office sector was in a good position as it went into the pandemic-induced crisis,” she told [i3] Insights. “Office vacancies in Melbourne and Sydney were under five per cent. Retail was already facing headwinds.
“Real estate requires physical presence. Offices require very high occupation levels, and retail requires patronage – people purchasing goods to generate revenue so that the retailers can pay rent.”
Discussions on the future of office span two spectrums, Power says. One is that working from home will prevail. The other is flexible working – a combination of working from home and working from the office.
“We are hearing that the office sector is ready to be quite adaptive, particularly at the operational level,” she says.
“People talk about using technology to drive a touch-less experience moving through a building, such as calling the lift and accessing facilities through an app on smartphones.”
Office air-conditioning, she says, may need to be modified to improve air quality. “I had a call with an Australian manager, who said air-conditioning in office buildings will probably be adapted to hospital grade.”
Other issues, such as social distancing requirements, would also need to be considered.
“Today, the common workspace ratio is one employee to 10 square metres of space,” she says. “This ratio will no longer be applicable. The industry is talking about increasing the ratio to 1 to 12 or even 1 to 14, maybe with some glass partitions and 1.5-metre marking on floors.”
Power says people are working through what is practical, including splitting staff into teams to reduce density in their offices.
Power on Retail
She says an adaptive mindset will also have to apply to retail. Recovery is going to be slow in this sector, because it was already undergoing structural change before the COVID crisis.
“Once containment measures are lifted, there will be an initial boost in spending. People are talking about ‘revenge’ spending, because they won’t continue to sit at the computers – they will get out to the shops.
“That initial surge of spending will help. But, over time, retail centre managers and owners will just have to find a model that works well for them.
“That will likely be a level of mixed use, which might include office space and distribution, from a logistics perspective.
“Whatever adaptive use is planned, whether it is some sort of distribution facility or residential, it will have to stack up on its merits.”
Of residential, Power says institutional ownership in the form of built-to-rent is in its infancy in Australia, and requires some level of government assistance to get it going.
Don’t overact on a one- to two-year view,” Power advises, reminding investors that, often, it can be hard to access very good assets. “The only sector to have large write-downs to date is retail, which remains largely illiquid.
She notes that the genesis of the US multifamily apartment sector, now well-established and a key investment option, came from tax concessions to this asset class.
Since the outbreak of the pandemic, some of Australia’s largest investors have reacted to the economic crisis by writing down asset values. Is this the time to sell down exposure to real estate?
“Don’t overact on a one- to two-year view,” Power advises, reminding investors that, often, it can be hard to access very good assets. “The only sector to have large write-downs to date is retail, which remains largely illiquid.”
“Several recent office sales support pre-COVID pricing, and industrial is considered favourably,” she says.
“As of today, we are seeing little impact on office. If you look through the lens of cash-flow, the cap rate hasn’t changed and the discount rate hasn’t expanded.
Yield on some sectors remains attractive and discount rates around 6.5 per cent provide an attractive spread to bond rates. If you are well-diversified across sectors with adaptive asset exposure, hold the position,” she suggests.
Power believes the capitalisation rate in sectors such as office and logistics is likely to hold up because of continuing strong demand for Australian assets.
“Australia – and the wider Asia-Pacific region – look attractive to global capital looking for a home.”
Power says: “Property goes through many cycles, and each cycle throws up its own opportunities. My key message to investors is that this could be a period of great opportunity.”
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.