The S&P/ASX 300 A-REIT Accumulation Index continued its strong recovery from its March lows, gaining 13.3% over the quarter. Property stocks marginally underperformed broader Australian equities, with the S&P/ASX 300 Accumulation Index adding 13.8%.

As the likelihood of the delivery of a successful COVID-19 vaccine increased, so did the prices of retail property stocks. Scentre Group (SCG) provided a quarterly update in November, with reasonable outcomes including September quarter foot traffic of 90% compared to the same time last year (excluding Victoria) and occupancy of 98.4%. SCG gained 26.4% for the quarter. Vicinity Centres (VCX) reported similar results in their quarterly update, with moving annual turnover (MAT) down only 1.7% excluding Victorian and CBD shopping centres. VCX added 19.2% in the December quarter. Other strong performing retail property owners included Unibail-Rodamco-Westfield (URW), up 110.7%, and Elanor Retail Property Fund (ERF), which lifted by 37.8%.

The key underperformers during the quarter were those with lower risk income streams, supported by longer weighted average lease expiries (WALEs). These REITs outperformed earlier in the year as risks around the effects of restrictions implemented to supress the spread of COVID-19 were less impactful to this property type. Similarly, positive news surrounding COVID-19 vaccine development is also less relevant for these exposures. The owners of service station properties underperformed the index, with APN Convenience Retail REIT (AQR) down 6.6% and Waypoint REIT (WPR) gaining 3.6%. Owners of pub properties were also underperformers, with ALE Property Group (LEP) up 8.7% and Hotel Property Investments (HPI) rising by 6.6%. Charter Hall Long WALE REIT (CLW) was a significant underperformer, giving up 5.9% over the quarter.

Office property owners broadly moved higher over the quarter, but could not keep up with the broader, strongly performing property sector. Dexus (DXS), Growthpoint Properties Australia (GOZ) and Cromwell Property Group (CMW) rose 9.0%, 7.1% and 4.6% respectively. Suburban office owners performed mostly in line with their larger counterparts. Australian Unity Office Fund (AOF) lifted by 4.7%, whilst Centuria Office REIT (COF) gained 6.9%.

Strength in residential property markets supported residential property developers, as sales rates and pricing appeared to be robust over the quarter. Stockland (SGP) added 13.6% and Mirvac Group (MGR) moved 23.3% higher. Smaller residential property developers also performed well with Sunland Group (SDG) and Finbar Group Limited (FRI) up 82.7% and 47.1% respectively.

Market outlook

Since the onset of COVID-19, the listed property sector has been amongst the most volatile core asset classes both domestically and globally. The 35.1% fall of the S&P/ASX 300 Property Accumulation Index in March 2020 has been followed by a swift recovery, with the sector now almost back to its value as at the end of February.

Such extreme volatility can partly be explained by the uncertain impacts of the crisis, where a once very forecastable sector had suffered from the withdrawal of earnings guidance, expected cuts to contracted rents in support of tenants and a renewed focus on balance sheets and the cost and availability of debt. In many cases, a strong recovery is now priced into securities, however this varies significantly across the sector.

In times of stress, one’s true character is often revealed. In recent times this has been true across the companies under Phoenix’s coverage. Some chose to protect the interests of themselves and other insiders, whilst others clearly demonstrated their shareholder and broader stakeholder focus, even if it increased the risk to themselves. This period has reinforced Phoenix’s strong emphasis on governance and alignment of interests.

Phoenix does remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent events will likely accelerate these changes. Furthermore, in the short term, discretionary retail sales are likely to be driven by government stimulus and may be highly varied across retailers and dependent upon social distancing restrictions. These issues are well understood and the trajectory to a new ‘normal’ is only now beginning to reveal itself. These factors explain why retail stocks have been the most volatile of all property sub-sectors.

As COVID-19 passes, and earnings become more forecastable again, the market will be able to refocus on a resilient sector that is likely to continue to be supported by low bond yields for the foreseeable future. This has already been seen to some extent, with companies that have demonstrated predictable earnings performing well since the nadir in March.

While the risk of inflation currently seems remote, the enormous fiscal stimulus and extreme monetary policy setting that we now live with, increases the risk of inflation over the medium term. Historically, real assets such as property and infrastructure have performed well during inflationary periods.

Phoenix remains focused on the medium to long term and what impacts, if any, will endure. We have increased our exposure to some defensive stocks with strong balance sheets and long lease terms to financially robust tenants. However, we are also prepared to support capable management teams to navigate their way through the current crisis where we see sufficient long-term upside.