Retail REITs are ground zero for pain in the Real Estate space in the current social distancing environment. With only essential worker traveling means other than specific retailers (chemist & supermarkets etc) most of the shops are closed.
With no revenue, landlords are feeling the flow on pressure when retailers who are not able to pay rent, temporary solutions via rental abatement or deferral does not address the existential issue that leases (which are contracts) are effectively void in a pandemic.
The major fall in the share prices of retail REITs with Scentre (ASX: SCG) representing the largest and best quality malls reflect investor skepticism and aversion to owning shopping centers.
However based on the current oversold levels, there are value if you take a contrarian view that once the market stabilized and if you look through the immediate income/dividend shortfall there are still value in these REITs.
Here are some of the key points we would suggest to keep in mind when looking at REITs with major retail holdings and avoid some common value traps.
Ignore the NTA
The Net Tangible Asset (Net Asset / Outstanding Shares) is a backward looking metric based on the value of the asset prior to the COVID-19 crisis. What this means is that they are already out of date and the fall in share price reflect the view market is expecting future fall in the underlying value of the assets.
The value trap is thinking that since the current share prices are 0.7x of the NTA per share that there is value there. There isnt because there is no way the previous values are still valid and it will take time for the book values to fall so don’t fall for this value trap.
What this does mean is that even if you are buying in a 0.7x of NTA, the assets values have to fall 30% and you are still paying the reset values of these assets. That is not really end of the world and ultimately value is in the eye of the beholder and if you think that values will drop 20% from pre-crisis levels then this is not so bad at all.
Expect dividends to be cut
Similar to expected fall in book values, dividends will be cut. For the REITs which largely owns discretionary shopping centers such as Vicinity, Scentre and Stockland will have at least 1 quarter of income shortfall. The current dividend yields are inflated and will have to be reset. So don’t buy these if you expecting the income to continue.
Balance Sheet, Balance Sheet and Balance Sheet
In the current uncertain environment, the strength of the balance sheet is crucial to get through the crisis without raising additional capital (i.e diluting existing unit holders). The gearing levels would have to increase from last reported levels simply because asset values have fallen. The cut back of distribution will help in the short term however the share prices of the trusts which came into the crisis with high gearing will struggle.
Now with all the downside risk out of the way, here is a quick overview of the largest retail REITs on the ASX and possible differentiating factors.
Scenture Group (former Westfield Australia)
Traditional blue chip reit and perhaps one of the best positioned shopping mall REIT in Australia. It owns some of the most iconic malls which are simply irreplaceable under any circumstances such as Westfield Bondi, Parramatta and Sydney City. These are simply good real estate assets and if they are not shopping centers in the future, the land can be re purposed for other uses such as office or even residential.
As some of the best Scentre malls are located in prime locations we think it will be well contested if it ever comes to market.
Current gearing level is conservative and if you look through the noise in the short term then there could be some value here.
Vicinity Center
Quality of the assets are not as good, only a few flag ship malls such as Chadstone, Chatswood Chase, QVB and the Strand. However sub-regional malls make up a large portion of the portfolio which are the most exposed with limited upside. For those been around the block, these are the former Centro assets which are good in a normal market but most exposed to ecommerce.
Stockland
Mixed bag of residential and sub-regional malls. History of weak performance vs peers and better value elsewhere.