Just when you thought it was safe to go out maskless, Omicron has sent markets into another fit. In the crosshairs are the usual suspects, particularly airline and energy stocks. As for volatility, as measured by the VIX index, it rose 50% in a day. As Yogi Berra said, “It’s like déjà vu all over again.”
I do not need to remind you that we have been here before. What does it mean for income investors?
We have no idea what Omicron’s impact will be. But we do know that recent experience is a good guide to how things might pan out in the coming year.
There are three major observations I would make. The first is that vaccines have been quickly developed to deal with COVID and its variants thus far. Further modifications and time may be required but we are equipped better than ever to deal with it. The mindset AREIT investors should therefore adopt is optimistic and opportunistic.
The next observation is around AREIT income streams (predominantly rent). While some thrived through lockdowns, some suffered. With future widespread lockdowns unlikely, 2022 should see an improved outlook for a sustained recovery as trading conditions begin to normalise. Those most impacted will see earnings recover further, underpinning the attractive growth AREITs are forecast to provide for FY22 (and beyond).
Third, investors don’t cope well with risk and uncertainty. There has been a lot of that recently and it may not be over yet. While AREIT prices have been on a rollercoaster, similar to the GFC, operationally they have shown a level of resilience beyond what doomsayers expected.
If there is more volatility as a result of Omicron, all the evidence suggests this will be another buying opportunity leading into 2022. So, where should investors look?
The industrial sector has benefitted from structural trends accelerated by the pandemic. Demand for warehouse space has been surging. Leasing demand this calendar year is set to surpass that of 2020 by 20%+. This would be 67% higher than the 10-year average.
Record low vacancy levels have driven rents upwards. Prime industrial has averaged 3.1% rental growth over the most recent quarter and some key markets have delivered more than 10% growth over the past year.
The performance of industrial REIT share prices has stunned the market, however in this sector the pickings are thin.
Goodman Group (ASX:GMG) is more of a fund manager and developer nowadays. With exceptional growth, high expectations reign. The stock trades on a price-to-earnings ratio (PER) of 33x and a 1.2% distribution yield. For income-focused investors like us, these metrics make us want to look elsewhere.
A name that we see strong potential in that suits investors looking for exposure to the booming Australian industrial market is Centuria Industrial REIT (ASX:CIP). It currently trades at a discount to net tangible asset backing and should continue to grow even in a more uncertain climate, providing investors with a strong risk adjusted return underpinned by a compelling 4.7% distribution yield which is high for this asset type.
Growth focussed fund managers have done well through COVID and look likely to do so into 2022 no matter what Omicron brings. Charter Hall (ASX:CHC) is the other significant player in this space and while it trades on a much lower PER of 22x, its 2.1% distribution yield makes it less interesting.
Thanks to Omicron, retail is again front and centre. Non-discretionary is again holding up while the share prices of large mall discretionary spend focused landlords are facing renewed pressure. With the prospect of lockdowns unlikely this time round, any impacts will be less severe, and landlords should not have to provide support to their tenants for a third time.
With pandemic proven cash flow certainty and yields of up to 6%, convenience REITs look attractive. Service stations now sell far more than petrol and are highly resilient. Waypoint REIT (ASX:WPR) trades at a 10% discount to NTA and is currently operating a share buyback after providing a 17 cents per share capital return to shareholders in November. While fossil fuel-associated entities have taken a bashing post COP26, WPR has a portfolio of assets that offer significant alternative use potential and provides investors with a sustainable 6.3% distribution yield.
Alternative assets have also grown in popularity through the pandemic. Any weakness due to a sell-down should be seen as an opportunity. We like what alternatives bring to our portfolio, a great mix of sustainable income and asset value growth with several fragmented asset classes gaining the attention of both domestic and offshore institutional investors. Specific sub-sectors we like include:
- Childcare is underpinned by continued state support for the childcare sector, solidifying its position as a key part of Australia’s social infrastructure. Operators are committing to 20+ year leases, which has resulted in high demand for this asset class from private and institutional capital. Both now appear to be valuing childcare REITs as quasi-government bonds.
- Healthcare has huge potential and is under-represented in Australia relative to other REIT markets around the globe. It was great to see the specialist HealthCo REIT IPO in September supported by strong investor demand. Most are aware of the healthcare megatrends that will underpin its growth well into the future. Opportunities in this asset class will therefore be significant well into the future.
- Self-storage has proven itself to be a resilient asset class amidst a structural change in the demand and use for storage space. Demand has been driven by e-commerce operators, and tradesmen utilising self-storage for inventory purposes, alongside clearing out the spare bedroom to convert it into a home office due to hybrid working. The sector continues to evolve within Australia and remains well supported by the increasing housing turnover within the residential market which continues to drive occupancy and rents in major metro markets despite the recent lockdowns.
The importance of diversification
One final point: the importance of diversification. This is best illustrated when comparing sub-sector AREIT returns (S&P/AREIT300 Index) over the rolling year to October and November in the table below.
The news of a COVID vaccine in November 2020 was hugely positive for an oversold retail sector burdened by pandemic uncertainty. Retail REITs returned a staggering 25.5% that month.
While rocky through the year due to lockdowns, renewed positive sentiment around reopening in NSW and Victoria lifted the retail sector resulting in it providing the best one-year rolling return to October 2021. This was well ahead of market darling industrial which was no doubt a surprise to many.
Fast forward a month and things have changed again. Industrial is back on top (equal with alternatives) while retail is lagging primarily due to the uncertainty created by Omicron (and the roll-off of the staggering November 2020 rebound).