Not many people want to buy an office building in Manhattan right now with everyone holed up in their apartments during a pandemic. Such is the dilemma for today’s real-estate investors. And nowhere is this more apparent than in real estate-focused mutual funds.
Such investors are preparing for a future with fewer in-person meetings. “We think three to five years from now 20% of the workforce is gone on a daily basis from the existing standing inventory of office space,” says Burl East, manager of Altegris/AACA Opportunistic Real Estate (RAANX), adding that some people may work from home permanently while others will come and go from the office with more flexibility. “We think this is a permanent problem, and we would call it analogous in many ways to the mall situation a decade ago.”
In other words, e-working will kill offices the same way e-commerce killed malls. East is so sure of his thesis that he has established short positions to bet against New York office real-estate investment trusts Vornado Realty Trust (VNO), SL Green (SLG), and Empire State Realty Trust (ESRT).
East’s boldness has paid off. His fund’s 19.7% five-year annualized return beats 98% of his peers in Morningstar’s real estate category. According to the fund’s latest quarterly commentary, over 80% of its assets were in Covid-19 resistant sectors. Instead of the typical office, retail and lodging plays, East has 24% of his portfolio in computer system data centers such as China-based GDS (GDS), the fund’s fourth-largest holding at 6.4%.
“Demand for mobile data is growing at 45% per year in the U.S.,” East says. “Those numbers are probably two times that in China.” The country’s cloud and data center infrastructure is behind the U.S., East adds. “They’re just now ramping up where our data center companies were five to eight years ago, and GDS is at the forefront of that.”
GDS has a 60% three-year annualized return. Meanwhile, another 20% of Altegris/AACA’s portfolio is in telecom cell tower companies such as American Tower (AMT), which has an 19.3% three-year annualized return.
For other top-performing real estate managers, such strong performance has become problematic. After a long economic recovery beginning in 2009, manager Rick Gable of MFS Global Real Estate (MGLAX) was expecting a slowdown coming into 2020, so he “was willing to pay a higher multiple for a business model I thought was just rock solid, and accept some valuation risk for that comfort level.”
But Gable’s thinking has since changed, as the popularity of data centers, cell towers, e-commerce warehouses, and lab space has made those real-estate sectors a crowded trade. Noting the “tailwinds in those sectors, and headwinds in sectors like office and retail, lodging, skilled nursing and so on, I have to believe there’s some disconnect between sentiment and reality,” he says.
Gable is “barbelling” his portfolio by holding growth stocks like data center owner Equinix (EQIX) and industrial warehouse company Prologis (PLD) alongside beaten-up senior housing company Welltower (WELL), down 18% in the past 12 months.
“We’ve found safety in some cheaper valuations in companies that have been deeply impacted by the pandemic,” he says. While the pandemic has caused nursing home quarantines, the housing need for America’s aging population “is as strong as it has been, and probably is going to get stronger.”
The pandemic has exacerbated retail real estate’s suffering as e-commerce continues to grow. Yet the dynamics for the sector differ by geographic region. “There’s a different impact [from coronavirus] to malls in Latin America. They aren’t burdened by the department stores like in the U.S. They’re more of a form of entertainment—safe, clean, and air conditioned. And there’s a lot more draw to the malls there,” Gable says. The fund has a position in Mexican retail, office and industrial real estate conglomerate Fibra Uno Administracion (FBASF), down 22.5% in the past year.
Asia has been recovering quicker than the U.S. and Europe from the pandemic. Asian retailers are better-positioned from a supply and demand perspective, says co-manager Greg Kuhl of Janus Henderson Global Real Estate (JERTX). “There’s much less retail storefronts available there. And the [pandemic] recovery seems to be happening there sooner.” Three of Janus Henderson’s largest positions with commercial property exposure in China are China Resources Land (CRBJY), Sun Hung Kai Properties (SUHJF), and Shimao Group (SHMAY). All three were down in 2020 due to the pandemic.
Hotels are due for a comeback when the pandemic ends, investors say. “There is going to be pent up demand for business travel that is client based and also for the entertainment experience in general,” says manager Rick Romano of PGIM US Real Estate (PJEAX) “Leisure travel will pick up. When you look back at the [Spanish flu] pandemic in 1918, that led to the roaring ‘20s. People are just so eager to go out that we could see a period like that again from a leisure perspective.”
Romano holds Apple Hospitality REIT (APLE). Since the REIT runs smaller hotels such as Hampton Inns that don’t have much convention business subject to Covid restrictions, it will be “first to recover.”
Although it’s impossible to pinpoint the travel recovery’s timing, Romano and other managers see the latter half of 2021 and early 2022 as when some of the pent-up demand will be realized.
But for offices, the world may never be the same.
|For more news you can use to help guide your financial life, visit our Insights page.|