Brace yourself for big yields and big potential

When you consider the Australian commercial property market, low-interest rates, stay-at-home orders and a worldwide pandemic is a recipe for disaster, right? Yet 2020 was not the nightmare property investors braced for. Instead, these investors were met high dividend yields and a lot of unexpected opportunities. 

According to Tim Slattery, CEO at APN Property Group, the luck for these investors isn't running out any time soon. With galeforce tailwinds including the rapid move to e-commerce, and the increase in car usage across Australia, Tim believes now is as good a time as ever to enter the commercial property market. 

In this extended interview, Tim discusses the year that was and reflects on the most resilient elements of his portfolio. 

He also shares his outlook for, what is expected to be a very different year, highlighting the promising areas of commercial property including industrial warehouses, service stations and suburban offices spaces. 

Edited Transcript 

What is unique about APN Property Group? 

It really is two things. First, all we do is commercial property. That's all we've done since we started out in business in 1996. And then the second thing is, it's old fashioned, but really everything we do is all about cash. Our entire investment philosophy is based on this idea of property for income. So all our investment process and everything really comes back to generating sustainable cash income yields from our investors. So whether it's looking at tenants or debt levels or different property types, that's really everything that we do. 

Can you provide a run-down of commercial property in 2020? 

We invest in a broad range of different commercial property types, and I think in some ways, 2020 with COVID was like dropping a bag of groceries. Everything hits the deck, you don't know really what's broken, what's a bit bruised and what will be fine, and that's really how the year played out.

So as the year I think unfolded, we had a huge sell-off in markets, a lot of uncertainty about what was going to happen with tenants and whether assets can continue to trade or whether they'd be closed. But then as things became clearer, there were some parts of the market that needed to raise capital, but it really became clear that industrial warehousing and those sorts of assets that were relatively insulated - service stations, those sorts of assets, traded particularly well. And then depending on which location, shopping centres and some of the CBD office assets obviously were quite affected. But by and large, I think the sector had a big dip and got through the course of the year. But yeah, certainly, early days, it looked like there was a lot of panic and the investors that did well with those that held through and were patient through the year.

What proved to be resilient in the portfolio? 

2020, it was quite interesting because what it showed is all the decisions that investors had made in the years before 2020. The Warren Buffett saying, "You can see who's swimming naked when the tide goes out," that was really a bit of, I guess, what we saw during the year. So we traditionally have been more conservatively positioned. We'd perhaps avoided assets that we thought were overpriced and certainly avoided taking on too much debt, but the sectors that we were, with a mixture of good luck, but also I guess good decision-making that we'd managed to avoid were most of those ones that were most particularly affected. So we didn't own a lot of shopping centre assets and also CBD office assets were probably most significantly affected.

The things that traded particularly well was industrial warehousing as there was a whole lot of growth in online retail sales, and I think it's about three times the amount of floor space that's required in an industrial asset to manage the delivery supply chain for a given item, a pair of runners. So there's a big growth area in that part of the market, so our industrial and warehousing properties performed very strongly. Our portfolio service stations, again, non-discretionary type of retailing, so they perform well. And we also found our suburban office and business portfolio traded well. So, again, that's a cheaper space, typically in locations that were not in those CBD markets that had more of an issue. So yeah, overall, I think, our positioning going in was good and that certainly helped us navigate the challenges that came to bear.

What opportunities are you seeing in commercial property for 2021? 

The property sector really did have a challenging period throughout 2020, but I think in some ways it's still on that recovery path as some shopping centres and some office buildings in some parts of society re-open. So there's probably still more upside in terms of occupancy levels picking up and rents. And I'd say, depending on which market or which asset, we might've seen rents come off in the office space at 20 odd per cent, so that's quite a significant fall. So I think that we have a bit of a continued recovery through 2021 and beyond, as hopefully, we navigate through COVID with a better system of managing it, including the vaccines. But then there are also other asset classes that'll continue to trade well. I think some of the non-traditional asset classes, such as childcare and some of these other areas, have been shown to be quite resilient.

And then I think the big question is, well, what's priced in and what's not? There's that Howard Marks saying, there's no asset that's so awful you can't come up with a price that's not low enough to justify it. I think some of the uncertainty in the assets affected by COVID, you're looking at shopping centres that might be on a 7% or 8% yield, how that compares to industrial or office assets that are in the fours or even people are talking of sub-4% yield. So it's what's priced in, and I think taking a contrarian view about some of these sectors and doing the work to look through what happens, how bad is it really likely to be? There's going to be some opportunities emerge in some of those recently unfashionable parts of the market. So that's certainly where we are looking to try and find value.

Why is property an ideal place for income investors? 

Well, for income investors, and sometimes I don't know how many of them are left when we look at some of the tech stocks and the booms in these super high PE stocks. But I mean, I do think income has a critical role to play as part of a long term investors' portfolio. We've had a very significant stress through 2020, so in some ways, we've been able to see the whites of the eyes of the market and been able to understand, okay, well, if it's got through now, that's a pretty good doubt barometer for how things are played. Our three largest funds, they're all yielding cash yield to investors investing today of 6%, give or take. So if you're a retiree and you're looking at where you're putting your portfolio, you've got money sitting in the bank or in government bonds, clearly, there are different risk-return profiles on those assets, but at 6%, with what we've been through, we think that that's still a very attractive proposition. And I think it's easy for people to look at the yields and think, "Well, that's actually come in a fair way." And it's true, we would have been looking at 7% or 8%, maybe in years gone by, but if yields continue to compress, if we see a 6% become a 5% cash yield with everything continuing to increase, then that's about a 20% return on top of the income. So that's probably what maybe some people don't necessarily factor in, but I think if you've got a longterm lease, a strong tenant, a good building, and you're getting a 6% cash yield, I still think that compares very well relative to the other options that people have got. So I'm certainly optimistic about commercial property in 2021.

What opportunities do low-interest rates bring? 

I think we may well see some moments where we do have yields pushing up, but overall, I think our view is certainly that this lower for much, much longer dynamic is intact given how much debt is out there and continuing to be taken on across the world. There are opportunities across various different parts of the sector. We talked about industrial, and there's a great thematic around the growth of online retail, but you have to ask yourself, has that trade gone too far? I think recently we saw the statistics that say something like $25 billion of investor capital is looking to find a home in industrial real estate and the total volume of assets traded last year was about five and a half billion. So you can see how much exuberance there is for particular parts of the market, whereas I think we've touched on shopping centres, suburban office assets, we think there's going to be some good opportunities there. Again, this isn't necessarily the most fashionable parts of the commercial property market, but we think there's going to be some good buying opportunities. And those other non-traditional sectors I think, whether it's childcare, service stations, healthcare, some of these, we think still offer pretty good buying opportunities in the year ahead. 

Why have you decided to enter the global property market? 

One thing about the Australian commercial real estate market, or the listed component of it at least, is that there's a range of assets there - healthcare, retail, office, industrial. When you look globally, we see an even larger range of opportunities. We've got everything from mobile phone, cell phone tower REITs, prison REITs, all these other assets that aren't accessible in the Australian market, and it's also a much deeper market. It's well over 10 times the size of the Australian market.

So what we have identified is, using our income-based investment process, but to apply it the way we've done into our Asian fund that's been running successfully for over eight years now. We think there's a big opportunity to offer investors an income-focused global reach income fund. So we've launched a fund that we think is well-placed to take advantage of investors' demand for income-based commercial real estate investments but also providing the diversification of international exposure, but also across that range of asset classes. So we think that's a really good opportunity for people that are looking to diversify their commercial property exposures but also still looking for a strong and growing income stream. So that's the key priority for us over the year ahead.

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