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Simon Brown: I'm speaking with Evan Robbins, public real estate portfolio manager at Old Mutual Investment Group. Evan, thank you for today. Real estate probably had a pretty rough time in the last quarter and did poorly. Some classify this as a permanent loss, while others argue that it started before the coronavirus. Indeed, the index peaked from late 2019 to 2018. Have we seen the bottom for this sector and what kind of recovery can we expect going forward?
Evan Robbins: I think we are reaching the bottom when it comes to fundamentals. Things are stabilizing.
Real estate suffered a net loss due to the impact of the coronavirus. Therefore, in other sectors, where revenues are much higher than coronavirus levels, there is no real estate at all, and rents have fallen significantly, so the level of rents is below pre-coronavirus levels. It will be. So the stock price and everything is below pre-coronavirus and rebased there.
What has happened is that the situation has now stabilized and the base has been reset. This means rent levels are at a new sub-baseline level where things can grow. Until now, things have continued to fall, fall, fall. We have now reached a stage where things are leveling out and we will start to see growth in this sector over the next year or so.
Simon Brown: I accept your opinion. Because the rent refunds that we've been seeing are going to get smaller and smaller and at some point stop coming down. We'll hit a bottom and then we'll see some upside, though perhaps sub-inflation.
Evan Robbins: that's right. Please note that these returns are leases entered into several years ago, so when they expire they will be reset to a new, lower rental level. Therefore, there will always be a negative reversion lease. The longer it takes for a signature to be reinstated, the more times it will be revoked.However, after a while, almost [all] Many of the leases within the company are signed at a fairly low level, from which the base is established and growth begins.
Simon Brown: It's certainly a sector that has faced many headwinds in the past, but it does seem to be on the decline. I mentioned earlier about leasing and renting there. Are there other companies considering cuts that could be a tailwind rather than a headwind?
Evan Robbins: I think another tailwind will be interest rates. This is why some of these improvements haven't really been seen yet. To some extent it doesn't show up in the numbers because rising interest rates have completely taken over and drowned it out.
Interest rates are likely to be lowered this year, which should provide a bit of a tailwind.
The other is load shedding.Load shedding reduces numbers or incurs additional costs [associated with load shedding]. I would argue that they are on the basis and the companies are probably claiming the debt and collecting even more. So that's also what's currently based. It has been drawn and is now there. it happened, [and] Further tracking is unlikely unless load shedding worsens significantly, which is not the outlook we expect.
Simon Brown: I understand your opinion. This does not mean that load relief will disappear; it will simply put landlords in a better position.They have generators and renewable energy [energry] Either way, the reasons why investors stick with the asset class are through the roof. Why is it an attractive asset class? One is, of course, its very attractive distribution on a percentage basis.
Evan Robbins: The distribution is attractive. Bond yields are so high that it's not as attractive as it seems. The government is kind of crowding out real estate, but it's still not expensive. You're talking about a sector that investors are shying away from. It fell out of love because its fundamentals kept getting worse and worse.
Now we have a sector with potential for growth. Come to a stable sector with stable performance and dividends.
The income quota will be much higher, but we will not talk about great grades and turn off the light. This requires economic growth. Interest rates need to come down significantly. It does what real estate is supposed to do, which is kind of boring yield and provide a diversification element to your portfolio, and it should be a little more defensive, but this is less defensive. As I said earlier, the COVID-19 performance was worse than other sectors, but this is unimaginable and perhaps we should have been more defensive. However, the essence of what happened during the coronavirus pandemic did not play out that way.
Simon Brown: Also, if we look again at the results obtained over the years, we find that listed companies [have] They've been disposing of some of their non-core assets and their loan-to-value has certainly improved significantly over the last few years.
Evan Robbins: yes. During the coronavirus outbreak, companies went into emergency mode to shore up their balance sheets. They did what they could. Sales were tough. Therefore, these values are not at such extreme levels. Personally, I think the assessed yields of the markets in which things are traded are quite expensive compared to bond yields and listed real estate prices.
Therefore, I think that the assets listed on the real estate balance sheet have low value when looking at the market as a whole. In the real estate market, they are worth what they are. But it's in the stock price.Real estate stocks are trading well below NAV [net asset value], therefore, they are not valued at their valuations. Those companies are being valued at a deep discount compared to them, and as you mentioned, the value has stabilized and the actual physical value that the company is creating, the valuation, has stopped declining. Nevertheless, this situation has been going on for some time.
Simon Brown: Understood. And that means the market probably has a better view of those valuations, but that's reflected in the price and the risk that's there is eliminated.
If you could wave a magic wand, what would be the ideal economic conditions for this sector to really shine again?
Evan Robbins: We need economic growth. At the end of the day, real estate is about supply and demand. Therefore, more demand is needed. It's a shopping center, it's a job for offices, and offices are just one part of the industry. It is necessary.Sure there's still an office [with] There are many empty seats.
In retail, vacancies are not as high, but there is still some element of vacancy. The moment there is enough demand and vacancies start to reach a certain level, landlords are now under price pressure. [the] That's because someone else wants that space, creating pricing frictions that drive up rents. Therefore, price frictions are necessary. we are far from there.
But even if we end up seeing some growth, it's because a lot of things aren't being built. And not only that, but they are also very expensive to build.
So when you look at the implied valuation of a property for a listed real estate company and what it costs to build, that's just a fraction of it. They can't build something and rent it for profit. Because the construction cost is very high compared to their cost. [are] cherished [at] Within a listed real estate company.
So, again, reducing these vacancies and increasing supply will be very expensive if there is enough demand. So rents have to go up, but that requires demand and economic growth.
And the second factor is the interest rate.If the government cooperates, interest rates will rise. [up]when bond yields fall, investors will pay more for real estate. [what] Much less government debt is in supply. Therefore, it can be said that there is less competition for yield.
Simon Brown: Gotcha. And interest rates will fall – that's what everyone expects this year.When will the discussion begin? [what] Will I get any savings from MPC? [Monetary Policy Committee]. Let's put that aside.
Economic growth has not materialized. When can we expect a return to pre-COVID-19 levels? Even if we can get some upside in this sector, without necessarily returning to pre-pandemic levels, this will take time. Is not it?
Evan Robbins: These pre-pandemic levels were too high even pre-coronavirus. So it's easy to blame it on COVID-19, but if you actually look at this sector, take a closer look. Even before the coronavirus, shopping center rent levels were certainly too high.
For shopping centers, rent is basically the ratio of rent to sales. So the landlord calculates the trade value of the shop, you know the turnover of the shop, and agree, very roughly, what percentage of the turnover will go towards rent.
But it has only gone up, reaching levels that are too high for retailers to make any sense at all. So even before the coronavirus, retailers were rebounding and things were difficult. It has now been reset. So if you used to pay him 10% of sales (I'm making up the numbers), now he will pay you 5% of sales before.
That is now 5%. I don't think it will return to 10% unless there is significant pressure or a boom. The settings are now complete. Currently, from that 5%, you can earn an increase in rent based on the increase in sales. But I think there has been a rebase, but I don't expect it to go back to pre-coronavirus levels. I think this amount was too high unless there was a real estate boom. Looking at it at the moment, who knows?
Office is a different field. I don’t know where the office floors are – there are too many empty rooms. [there are] All familiar office problems. But for example, 10% of listed property exposure comes from SA offices, which is a particularly egregious practice. So maybe that too has reached its bottom. I don't know where I draw the line or where this knife ends.
Simon Brown: yes. But I understand your point about that rebase. One of the things that came up several times in this chat is that there has been a rebase in the real estate sector, which bodes well.
Final question – Is there exposure to real estate in a balanced portfolio? It increases quality. It provides some additional downside protection as well as profile. I appreciate that some listeners might say, “What happened with the pandemic?” But while the phrase rebasing you've been using gives you some yield, it also comes with some drawbacks. This is an essential part of a diversified portfolio.
Evan Robbins: that's right. And real estate as an asset class is the largest asset class in the world. Therefore, not having exposure to that asset class exposes you to the risk of being able to diversify that exposure. Leverage is lower than operational leverage. It has financial leverage. So it's all contractual rentals, which has the effect of making things run much slower.
It reduces risk in the short term, which is why it is always an essential part of every portfolio. We have just overcome a difficult situation.
I would argue that we're not going back to the boom days, but we're certainly going back to a normal patch of portfolio focus.
I think in good times, a lot of investors made the mistake of looking at an asset like a bond and saying, “Oh, it's like a bond, but it gives you a 10x return.'' Masu. They forgot that it's not like a bond. It's risky and more like stocks, but it's a mistake.
And I think there were many people who were arrested because they had too much property. It's part of diversification. However, given that real estate risks are more similar to stocks than bonds, it is a mistake to have too many assets and be too aggressive about it. Must be held appropriately in a portfolio.
Simon Brown: absolutely. And it's an important part of your portfolio. Perhaps we were caught up in good times and now in some sense we are caught up in bad times.
But let's leave it at that. We would like to thank Evan Robbins, Public Real Estate Portfolio Manager at Old Mutual Investment Group, for his insights.
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