COVID-19: This too shall pass … like a kidney stone

Given moderate economic growth, quantitative easing and generally falling interest rates, it’s been a prolonged period of favourable investment conditions, real estate included. Save for US-China trade war sabre rattling, we haven’t had a serious stress test for more than eight years.

Coronavirus presents a challenge to the robustness of the increasingly integrated global economy, in which people and goods move relatively seamlessly and consumers expect increasingly rapid delivery times. Hence, COVID-19 is a test of the burgeoning e-commerce world.

Health officials work to diagnose people who may have coronavirus at a hospital in Daegu, South Korea.Credit:KIM HYUN-TAE

From a real estate investment trust (REITs) perspective, the sector is reasonably well positioned to deal with the challenge. Investors can take comfort that the sector’s balance sheet is broadly in a strong position: financial leverage is generally moderate and there are but a few facing short-term debt maturities.

Furthermore, many REITs afford multi-year contracted lease income, which provides a relatively secure cash-flow bridge over short- to medium-term periods of economic weakness.

Consequently, while it's early days, REIT earnings have not been significantly impacted. Naturally, hotel REITs have borne the immediate brunt. With its global logistics platform, Goodman Group would seem vulnerable but has thus far batted away the issue. Indeed, it upgraded its earnings guidance in mid-February.

Tourism-related retail has also been a focal point. Vicinity Centres is possibly the only Australian REIT to attribute a softer earnings outlook to weaker Chinese tourism spending in its properties.

Overseas markets provide interesting pointers. Hong Kong retail landlords have afforded significant rent concessions in response to meaningfully lower retail spending, albeit coming after civil unrest inducing generally softer spending in the past six months.

However, successfully managing COVID-19 will not necessarily see a return to smooth sailing for retail REITs, as they continue to deal with changing consumer tastes and spending patterns. In the UK, arguably the market with the world’s highest e-commerce penetration, mall rents are falling by 20-30 per cent.

Furthermore, coronavirus is overshadowing broader economic challenges of sluggish business investment, the distorting impacts of quantitative easing, climate change and a US presidential election. The market has much to ruminate on beyond the impacts of the virus.

Hence, REIT returns are likely to be more moderate and investors should expect choppy conditions. Never has it been more appropriate to say it will pay to be prudent and selective.

In the all-important context of people’s health, for REITs it is appropriate to offer: “This too shall pass.”

But for financial markets, it could be as painful as trying to pass a kidney stone.

Andrew Parsons, is the chief investment officer for Resolution Capital

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