While the fallout from the coronavirus pandemic has wreaked havoc on many asset classes, institutional investors in real estate face a unique set of challenges.
Firstly, the shutdown of non-essential businesses has put many tenants in a position where they can’t afford rent, forcing their investor landlords to decide how to react. Institutional investors are handling these decisions on a case-by-case basis, says Benjamin Abramov, a director at LaSalle Investment Management.
For example, if a grocery store tenant is doing fine, an investor will probably say no to deferring rental payments. But, in cases with small local independent retailers in space that would be hard to lease again, an investor wouldn’t want to lose those tenants, he adds. “You’re more likely to help that smaller independent guy.”
To date, Kyle Weeden, a principal at Eckler Ltd., is seeing investors looking to negotiate rent deferral arrangements with tenants rather than implementing permanent reductions or rent abatements. “I think that’s important given that we don’t know how long this crisis is going to go for at the moment.”
In addition, some of the recently announced government support for businesses is likely to help stem some of the issues for tenants paying rent, Weeden adds.
The price is right
In addition to considerations for collecting rent, it may be challenging for an investor to get a proper valuation for real estate assets.
As of March 31, 2020, a lot of investors appraised properties, but the appraisals were qualified, Abramov says. “They essentially said, ‘Listen, there’s just too much uncertainty in this market.’”
For pension plan sponsors, this means they can take the appraisal report and accept that it’s very uncertain, he adds, noting others may choose to make a downward adjustment to it.
Since the economic downturn was near the end of the first quarter, he thinks investors will keep their appraisals flat and then take another look at the end of the second quarter.
When deciding which valuation to use, Weeden thinks most investors will use the first quarter estimates. “I just think more disclosure is probably better than less at this point.”
As such, plan sponsors that are communicating with investment committees should be very transparent that these values are best estimates, and that the asset managers have indicated the long-term impact of this crisis on the value of the properties is difficult to estimate and may change.
Linked to the issue of valuations, some real estate funds have also been closing to redemptions.
In Weeden’s opinion, issues of equality are the driving force behind the freeze in redemptions rather than cash-flow issues.
And, at this time, he suggests plan sponsors ask their managers about policies on redemptions and accepting new contributions. With so much uncertainty around net asset values, existing investors may have reservations about other investors redeeming or coming in, he adds. “If you’re staying invested, you’ll be interested in that issue in that you don’t want your manager being forced to sell things in a market that’s not very attractive just to raise capital for other investors.”
In addition to funds that are totally closing to redemptions, some are moving towards the longer end of their redemption window, Weeden notes. “If you were able to request a redemption, then most funds would have a timeframe of six months to a year to honour that redemption. I think they’re all going to be saying that it’s quite likely that the farther end of that is going to be the best estimate.”
When considering the long term, investors still need to wait until the dust settles, says Abramov. However, he notes there were already issues with retail going into the downturn and the current situation is only exacerbating the problem. “It hard to imagine that this made it so much worse that no one’s going to malls now, but also — over time — one should expect to see even more significant impact on retail.”
On the flip side, he adds, one of the winners of the current situation may be industrial distribution centres. “Because of e-commerce, you need more and more storage space for distribution companies. They did very well going into this downturn. Chances are they will come out of it in even better positions with more demand for that space.”
But he does caution that it’s too soon to say what the future holds for office space, since some people may want to continue to work remotely but others may be looking forward to getting back into the office.
As a result, plan sponsors that are adding real estate to their portfolios should be thinking about diversification and positioning, Abramov says. “A lot of pension funds didn’t think about it. A lot of large pension funds are overexposed to retail [and] underexposed to the more defensive asset classes like apartments and industrial. Having that sector diversification is going to prove to be a lot more important.”
Generally speaking, Weeden’s biggest piece of advice for plan sponsors right now is to stay invested. “We don’t know where the crisis is going to go at this point, so it’s very difficult for a sponsor, an investor, to base their decision to exit or enter an asset class when they don’t have the information required to make an informed decision.”
And returning to real estate, he notes this asset class may help plan sponsors weather the storm they’re seeing in other parts of the market. “With equity markets experiencing the volatility that they have had over the last three months, I think when the real estate funds and the returns do come through — with the idea that it is hard to nail down the valuations of some of the funds right now — you’re not going to see the same kind of losses out of these funds that you’ve seen out of your equity strategies.”
It’s also important to see the forest for the trees, he adds. “You have to look to the long term and understand that sometimes the short term is going to hurt.”