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For real estate investment trusts, the coronavirus outbreak’s short-term impact on rents is likely to be limited because most tenants are tied into long-term leases. Leases renew every 5-10 years, so only about 13% of a REIT’s tenants are up for renewal in a given year. As long as this pandemic doesn’t dramatically shift all consumer behavior to online shopping, the long-term cash flow outlook should be relatively intact. However, if the virus outbreak is prolonged and leads to bankruptcies, the possible reduction in occupancy rates could take time to replace, which would have a significant short- to medium-length impact.
Industrial REITs have a higher portion of short-term leases relative to retail and office REITs, so there is a slightly bigger short-term impact as a higher percentage of leases come up for renewal each year. Industrial REITs, like retail REITs, are exposed to consumer spending. Therefore, a severe recession would probably have a negative impact in the medium term. However, we think the likelihood that individuals switch channels from physical retail to online purchases provides a significant offset. The severity of a downturn is likely to dictate in which direction this washes out. In a severe or lengthy downturn, the negative impact from lower consumer spending is likely to outweigh channel switching. However, in a less severe downturn, industrial REITs may see improved performance as demand for warehouse space increases. Disruptions in supply chains remain a potential negative factor, but it is difficult to gauge how severe this impact is and will be highly situational. We don’t think this is an issue for the industrial REITs because global supply chains will likely to be able to adjust over time.
For logistics properties, the overall short-term effect is negative due to the hit to the GDP. The long-term effect is likely to be positive for two reasons: First, developments will probably be delayed or mothballed, pushing out the arrival of supply. Second, a trend that was already in place will be accelerated--that of reducing supply-chain risk. That could be implemented by bringing manufacturing onshore, diversifying offshore manufacturing across multiple offshore locations, and most important for industrial property, retailers holding more stock.
In Asian markets such as Singapore, REITs have rolled out some measures to help their tenants. With most retail tenants in Singapore being affected by the coronavirus outbreak through lower footfall and sales, the trusts have rolled out several measures to help their tenants in addition to passing through the 15% property tax rebate provided by the government to the affected tenants.
To ease the short-term cash flow challenges of their tenants, some trusts allowed the use of one month of security deposits to offset rent, while others allowed tenants to convert security deposits into banker’s guarantees. In addition, some trusts are providing up to half a month of rental rebates to affected tenants. To increase footfall and sales, the trusts have increased marketing efforts by giving additional promotions and rebates as well as free parking at selected hours to try to attract people to visit and spend at the malls.
As for the leases that are up for renewal, we expect only a slight drop in rental rates at the moment as we expect the impact from the coronavirus outbreak to be temporary. We think REITs could lower rental rates for this year and bake in some rental escalation throughout the lease as the situation stabilizes. This can help to alleviate the cash flow burden of their tenants and would not affect the average rental yield throughout the lease. However, if economic conditions were to worsen for a longer period, we could see a larger decline in rental reversions going forward.
REITs are unlikely to cut their dividends. They are required to pay out 90% of their net income, so there are restrictions on how much they could cut. However, any cut sends a very negative signal that their long-term cash flow is going to be materially lower. Since the outbreak should be a short-term event, with even the worst-case scenario only having a major negative impact for 12-18 months, we don't think the REITs will want to do something that causes long-term damage to their image with investors. However, we expect many REITs to stop increasing their dividends in the short term until the full impact of the fallout is understood. The risk that industrial REITs will cut their dividends is very low. Unlike retail REITs, industrial REITs are paying much lower dividend yields and have experienced significant growth amid the rise of e-commerce.
Ken Foong, Phillip Zhong, and Alexander Prineas contributed to this article.