Property sectors to beat the macro blues

Australian listed property has ranked among some of the hardest hit sectors of the ASX since interest rates started rising earlier this year. But the changing macro environment, including rising interest expenses and the effect this has on the availability of capital, emphasises the importance of company selection.

This was a point made during my recent interview with Jan de Vos, portfolio manager of the Resolution Capital Real Assets Fund. In the current environment, his team has been increasingly selective in choosing Australian-listed real estate assets – which comprise the bulk of the portfolio. This also underlines why the fund broadened its investment universe to also include listed infrastructure assets.

An area to avoid…

The struggling office space is one part of the property sector De Vos is actively avoiding. That’s because of the sector’s double-digit vacancy rates and declining tenant demand – in a market where stock levels are at historic highs and prospective tenants are demanding all manner of sign-on incentives.

“For some time, pre-COVID, we were actually overweight the sector, because office landlords have strong pricing power when vacancy rates are low,” De Vos says.

“But in mid-2020 we reduced our holdings in this area and currently we have only minimal exposure to pure office REITs.”

…and a favourite sector

“A sector we do like is what we refer to as the ‘triple-net sector’ – which includes childcare centres, petrol stations and pubs,” De Vos says.

Such tenants appeal because of their long leases, high cash conversion levels, and other characteristics that make them steady, long-term compounders of capital.

Another overweight that has done well for the fund is the self-storage category, particularly Australia’s biggest listed player in the space, National Storage REIT ASX: NSR.

“We’re long-term fans of those asset classes that are slightly more niche. It’s a great long-term asset class, again with high cash conversion, good long-term rental growth dynamics and COVID was pretty good to this company – it’s got a great long-term story,” De Vos says.

The childcare sector is another that has similar traits. One of the local leaders in this space is ARENA REIT ASX: ARF.  As De Vos explains, this A-REIT has an average lease of 20 years, along with very good cash conversion with rents that increase in line with the greater of inflation or 2.5%, coupled with low leverage and a good management team.

“It’s just a really simple and good story, and that’s been in the portfolio for a long time,” he says.

Hotels are another type of tenant his team is fond of, with Hotel Property Investments ASX: HPI a holding of his fund. The hotel operators (tenants) are already generating strong sales that exceed pre-pandemic levels, despite sometimes limiting their opening hours due to labour staffing challenges.

The biggest surprise in property

The retail sector is another that contrasts sharply with the struggling office sector. As inflation has ticked up and cost of living pressures have increased, much has been said about the difficult times retailers would face. But the results so far remain encouraging, De Vos believes.

He cites strong performance from some companies in the sector, on the back of strong demand. Occupancy is increasing and is edging close to pre-COVID levels, with healthy tenant demand for many locations.

“Leasing spreads (the difference between new rents and the prior expiring rent) that were slightly negative have improved, so the sector has proved the naysayers wrong again. I’m not saying it’s off to the races, but it’s a good sector with some inherent positives,” De Vos says.

As a sector that he likes, retail property currently comprises around 20% of the portfolio.

"We're disappointed"

Turning to the infrastructure component of the fund, De Vos returns to a point he raised earlier about listed assets in the space. Specifically, the disappearance of some of Australia’s most prominent infrastructure companies from the local share register.

Sydney Airport was bought by a conglomerate of private equity and super funds in December, followed by energy infrastructure firms AusNet and Spark Infrastructure earlier this year.

“We’re enormously disappointed that we don’t have these opportunities any longer, particularly Sydney Airport and AusNet,” De Vos says, calling out the inflation-linked attributes of the latter, which would currently have been an excellent inflation hedge.

“But we’re now just trying to find great companies offshore that have similar profiles. And if you think about airports, you don’t have to go too far to find others.”

He refers here to Auckland Airport ASX: AIA, which has long been a portfolio holding.

Company selection criteria

“We’re always looking for high-quality assets with strong balance sheets and aligned management – that’s the first hurdle,” De Vos says.

“They also need something else, such as pricing power and valuation support.”

His team also tends to hold companies for at least three years but is slightly more opportunistic in the global sleeve of its portfolio – which can comprise up to 20% of the total.

“There’s also a lot of changing of weights that occurs, without necessarily selling a stock entirely,” De Vos says.

What are your sell signals?

“If a company does something which violates those three things, either asset quality, balance sheet strength or leveraging up – they’re big red flags for us.”

“We remain aware of any strategy shifts or changing risk profiles and keep watching the inherent pricing power of particular companies in developing our valuations,” De Vos says.

A recent example includes large-scale retail A-REIT Aventus Retail Property Fund, of which Resolution owned a significant stake. This firm was acquired by an externally advised company, leading to a significant worsening of management alignment and corporate governance, in addition to having higher gearing levels “That was a clear sign to reduce our exposure,” De Vos says.

Some other recent moves include also selling down some of its allocations in childcare company Arena REIT – not because they see any problems, but because the share price has become quite high.

US home-landlord a recent buy

And finally, De Vos discusses US-based residential property company Invitation Homes NYSE: INVH as one of his most recent portfolio additions. Owning around 80,000 homes in the so-called “sun-belt states” – which include Arizona, southern California, Florida, Georgia, and Texas – the company has performed well even during COVID, as more families were shifting to these areas. This has seen rental increases of around 10% across much of Invitation Homes’ property portfolio.

“And the portfolio is significantly ‘under-rented,’ with a good balance sheet and aligned management, it’s a simple but compelling story.”

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The Resolution Capital Real Assets Fund gives Investors access to a professionally managed portfolio of Australian listed real estate and Australian listed infrastructure investment securities. You can find out more here.