Investing in real estate: beyond residential and retail

With real estate’s Covid-related challenges in the news lately, Shannon Murphy sat with Shane Solly, Portfolio Manager of the Harbour Real Estate Investment Fund, to discuss where he sees opportunities in a sector with increasing dispersion of returns.

BY SHANNON MURPHY AND SHANE SOLLY

Murphy: When we’re talking about investing in real estate, many of us think mostly of offices and retail. What sorts of real estate do you look at?

Solly: Offices and retail are a part of the sector, but there are many other types of real estate which can add diversification to a portfolio. For example, industrial real estate is an increasingly disrupted space. Manufacturing, distribution centres, transport logistics, data centres (for example Amazon Web Services) and cold storage are all benefiting from automation and business change. They also tend to have longer lease terms, between four and 20 years, and therefore lower volatility in cashflows.

Examples of the types of real estate Harbour invests in include childcare centres, land lease communities, healthcare and industrial logistics (dark stores and grey stores).

Murphy: What are dark and grey stores?

Solly: With the rapid increase in online sales and home deliveries, businesses have had to rapidly adapt their distribution channels, to deliver great outcomes for consumers and keep costs low for retailers.

When people buy their groceries online, sometimes their groceries come from their local supermarket, but they may come from a dark store or a grey store. Dark stores are industrial warehouses dedicated to rapid dispatching of online orders – they are not open to the public, they feature high product racking and often robotics and automated product picking. As a result, they have very few people working in them and often have low levels of lighting – hence the term dark store. To keep costs down low and be super-efficient these dark stores are massive – some are more than 50,000m 2 in size (more than 3x the size of Eden Park). Grey stores can look a lot like a normal supermarket – but, again, they are not open to the public. Team members physically pick and pack products for grocery deliveries.

Murphy: What about classic retail, like shopping malls? They were already under pressure pre Covid-19.

Solly: Covid has increased the bifurcation of shopping locations. Retailers are separating into high end locations to showcase their products and brands at one end; at the other end convenient locations are key, and where you can easily get into stores grab what you need and get out – like the large format locations where home goods retailers sit with large car parks. This is a challenging environment for locations that don’t meet either end of the split. Shopping isn’t going anywhere, but there has been a strong shift to omnichannel retailing, which is important to note when selecting real estate investment opportunities.

Murphy: What is omnichannel retailing?

Solly: Omnichannel means retailers sell products to consumers in store and online. The move to omnichannel means retailers need to have great logistics and distribution networks, so that all the packages we order turn up on time. According to data from 2019, e-commerce requires three times more logistics space than bricks-and-mortar sales do.

To do this, logistics providers like Mainfreight need to be located close to large populations in large efficient industrial warehouses, which allows efficient product racking and high levels of automation including robotics.

This changes the way retailers use their physical stores – they become more of a place for retailers to reinforce their brands and tell a story, rather than sell on the spot. A great example of this is an Apple Store. In these spaces, people learn about the products, and people visit for the experience of being in an Apple Store. Apple does not actually mind whether you buy the product in store or online.

Murphy: What changes has Covid meant for commercial property?

Solly: Covid has accelerated trends that were there before Covid, like flexible working for office tenants and the importance of online e-commerce for retailers. For investors, it’s highlighted that not all real estate securities are the same and that there is a need for diversity of security holdings across industry exposure like office, retail, industrial and different geographies. It has also highlighted that the debt levels in real estate securities cannot be so high that a drop in rental will reduce ability to pay dividends.

Murphy: Do you think businesses will have to change the way they use office buildings now that working from home has become more the norm?

Solly: Covid has meant many people have learnt that they can work from home to a degree with technology like Teams and Zoom making it easier to share and communicate. For some office workers in process-type roles, they may continue to work from home. But for most businesses, having people in the office will remain key to building their culture and sharing ideas.

But there is no doubt many businesses will retain flexibility for people to work out of the office, meaning they may need to allow for less people in their office at one time. Against this, businesses need to make sure they have a great space to attract their teams back into the office. Interestingly, in NZ we have seen a number of office users (including central government) grow through Covid to the point where they actually need more space, not less.

Murphy: Property or real estate stocks have lagged the recovery in equity markets – why is that?

Solly: Real estate stocks offer an attractive 3.5% tax-paid income yield, with the yield potentially increasing at 2-3% over the next few years. But yes, they have lagged the recovery in returns of other growth assets.

Real estate stocks own physical property like office towers, shopping malls, industrial warehouses and hospital buildings. With tenants unable to access these buildings due to Covid containment lockdowns, there have been concerns about how much rental income real estate stocks would collect and, as a result, the ability of real estate stocks to pay income dividends to investors. What has actually happened is that the degree of rental income has been higher than expected and real estate earnings and asset values have held up better than many investors had expected.

On average, over the last 10 years, NZ property securities have delivered slightly less than NZ equities per annum. But a larger proportion of the real estate securities returns is from regular dividend income, and property securities tend to have less ups and downs than equity stocks.

We are seeing an increasing dispersion of returns in real estate stocks, so active management is key to ensure diversification, and to take advantage of technological disruptions and shifting business needs.

For people with a greater need for near term income, or less ability to withstand movements in their nest egg, property securities may be a good investment option for them. A

This does not constitute advice to any person. www.harbourasset.co.nz/disclaimer

If you would like more information on the Harbour Real Estate Investment Fund, or any other Harbour Fund, please contact:

Shannon Murphy, Investment Specialist Shannon.murphy@harbourasset.co.nz (09) 365 1925