FIS Astec Analytics’ David Lewis addressing risk as a central theme of the year and how REITs are among the institutions bearing the brunt of the COVID-19 market restructuring
Everything carries risks. Every action, inaction, decision or indecision, divestment or investment. The trick is minimising those risks to an acceptable level, with the definition of ‘acceptable’ being a wholly personal and almost infinitely variable value. 2020 has been all about risk. Risk of infection, risk of unemployment, risk of loss and failure, both personal and professional. Managing those risks has become the responsibility of every person and every government, with a very wide range of interpretation and application to the task at hand. It is, at least in part, the subject of every conversation, whether over the internet or in person but socially distanced. For the British people, the subject of risk management has even pushed Brexit and the weather to minor mentions in passing.
For the financial industry, the response to this new risk, previously a hypothetical scenario on a disaster recovery exercise, has been as varied as the divisions and types of activity that can be found in any major financial centre. The ‘square mile’ and Canary Wharf in London, along with many similar financial centres in most developed countries, resemble a quiet Sunday every day in terms of the footfall and presence of office workers, but this is just the tip of the proverbial (melting) iceberg. It is not just where we are all working now that is different, but how and within different parameters.
Thirty years ago, the S&P 500 stood at almost exactly 10 percent of the level it closed at last week (316 points compared with 3,319). There was, of course, the financial crisis driving a train through the global economy in 2007/8/9 when the index fell to just under 700 points, but until last February/March, when it fell from around 3,370 to 2,230, it has been on an almost inexorable rise ever since, peaking at 3,580 earlier this month. This is just one index and share prices do not necessarily relate to prosperity for all, but there are those that think the end of one of the longest bull-run periods may now be in sight.
When the balance of risk starts to tip beyond what investors consider acceptable, they make changes to their investment profile to adjust their perceived exposure. The last quarter saw an influx of money into US high-yield and core fixed income assets as investors sought to cash-in equity gains and find safe havens of reliable yields. High-yield bonds saw the greatest net influx at around $58 billion, suggesting some levels of risk appetite remained, but the move away from equities was demonstrable. US real estate investment trusts (REITs) also saw an uptick in investment money of around $1.2 billion in the second quarter, but such a statistic should not be taken in isolation; the prior quarter saw five times that sum withdrawn from REITs. There are significant questions around corporate real estate at present and the longer those that can work from home continue to do so, arguably the less likely it is that they will ever return in the same way.
Large and small companies all over the world will be looking long and hard at their corporate real estate portfolios and the expense of large buildings with prestigious addresses. With almost every industry in the world looking hard at their bottom lines, expenses such as empty or under occupied office blocks are bound to attract attention.
REITs have seen significant borrowing activity as short sellers recognized the increasing rate at which risks were piling up for such property portfolios. Pressure on corporate real estate, particularly regarding bricks and mortar shopping centres and the like, has been on the rise for some time as online retailers grab market share and make footfall a virtual activity and not a physical one. However, in the same way that the COVID-19 pandemic has accelerated online shopping, it is now accelerating what had already been a general trend toward more flexible and remote working. As a result, the REIT markets have seen additional pressure come into rapid focus as corporations consider downsizing their physical locations.
Looking back at September 2019, one well known financial analysis company highlighted the five best REITs for investment opportunity, arguing for the REIT as a good investment based on low tenant turnover, excellent capital growth and strong dividend income (dividend yield being the primary measure). Figure 1 shows how the borrowing volumes in shares for these five US REITs, which together gave a broad geographic exposure to office buildings right across the US. The five companies were Boston Properties (BXP), SL Green Realty (SLG), Hudson Pacific Properties (HPP), Highwoods Properties (HIW) and Mack-Cali Realty (CLI).
As Figure 1 shows, borrowing volume increased by 146 percent over the past 12 months, peaking at the start of the second quarter before falling back somewhat. The fears of a second wave and the realisation that a short-term mandate to work from home could become a long-term strategic change for many organisations started to ring more alarm bells. The prospect of falling occupancy rates for REITs, which are typically highly geared in terms of debt burden, drove renewed interest over the past month.
Over the same 12-month period, the share prices of these five companies have fallen an average of 35 percent wiping some $14.9 billion from their total market capital.
The US is not alone of course. This is a global pandemic. In the UK, there have been many high-profile casualties in the hospitality industry for example, such as Pizza Express (closing 73 restaurants and shedding 1,100 staff) and Pret A Manger (30 stores and almost 3,000 job losses). Between these two, there are more than 100 newly empty properties on the retail market at a time few would be considering opening new restaurants. With a potential second wave, several countries are considering more focussed lockdown restrictions: in the UK, the focus is moving towards the drinks manufacturers as new lock-down rules are being considered. Socialising in pub environments has been cited by Dr. Anthony Fauci, the much-quoted the director of the US National Institute of Allergy and Infectious Diseases, as being one of the riskiest activities you can undertake with regards to the risk of COVID-19 infection. Such views add further weight to the expectation that such social activities will be curbed to bring down infection rates.
Few could have predicted the impact of COVID-19 on so many parts of the economy, or just how fast such a pandemic could change everything. But as the data shows, significant positive sentiment towards an investment class can change rapidly, and the value of knowing where the next wave of potential economic loss could be, is writ large in share prices.
