Real assets – Feature
says there is no particular intention to increase or decrease its exposure here. He cites its long-dated contracted inflation income at better yields than gilts as attractions, noting that they are the only other alternative for sourcing an asset with UK inflation. He also likes its diversification benefits and rela- tively low-price volatility.
Hard hit Real assets are far from being a homogenous asset class and while they may have characteristics that make them resilient, its sub-classes include those that have been hardest hit by the Covid-19 crisis. Along with the scores of grounded aircraft that have brought a sharp stop to cashflow for airport companies, the strange sight of shuttered pubs, restaurants and hotels the length and breadth of the country bears mute witness to the crushing losses the hospitality sector has experienced as the crisis has swept the globe. The losses suffered by hospitality are upstream from those suffered by the property in which they have tenancies.
The example of a simple coffee shop on one of the premises owned by the Nationwide Pension Fund is illustrative of the decisions which are having to be made in a sector under lockdown. “We decided that for three months we are going to write-off the rent because we’ll never get it back,” Hedges says. “What we’re hoping is when this is over they’ll be back up and running and pay the rent from that point but they’re never going to be able to catch up,” he adds. “It is a low margin busi- ness. It’s not big and most of the arrangements will be the big- ger enterprises.” The Centrica Pension Fund uses the contractual income from property for liability matching. A lot of its property is in the tra- ditional long-lease market where well-known supermarket, hotel and local authority tenants. Hotels, which have slumped to zero revenue but still have fixed costs that need paying, have been hit sharply by the crisis. They are doing what they can to get rent holidays and there are vary- ing degrees to which landlords have been accommodating, whether it’s a holiday or it just gets added on later, but these different treatments are effectively holding positions.
Uncertain times
What is unknown is how quickly occupancy can return to nor- mal in hotels; that could take many months and the problem is that the rent deferrals or rent holidays stop. Then there are questions about the viability of the tenant. They can no longer match the decrease in revenue with the decrease in rent they have to pay. Valuations in the sector need to be more reflective of the uncer- tainty, we have not seen much change in this quarter but would
expect more in the following one, Chetan Ghosh explains, not- ing that even when hotels reopen that full occupancy will not resume immediately. “With Covid there is a lot of price uncer- tainty around these types of assets,” he adds. “The other thing is that there’s quite a long holding period for these assets as well which means you are more exposed to that price uncer- tainty. For us it just makes sense to let the dust settle and see if any attractive pricing emerges.” Ghosh anticipates that stabilisation on valuations and price in the real estate market could take upwards of 12 months and notes that some have painted scenarios in which the worst out- come could be a 40% to 50% drop in commercial property values.
A drop of at least 10% in commercial property values is expected in the near term, while a drop of between 15% and 20% is con- sidered a good scenario. A correction will not be seen instantly as a feature of the property industry, as valuations move quite slowly. Price changes will fully feed through within 12 to 18 months.
Infrastructure seems to have weathered Covid-19 more robustly than mainstream liquid assets. The challenge it faces is that while it has not sold off its rivals are altering its relative pricing attractiveness. Ghosh believes renewables and commodities should weather the storm but cautions that commodities will be more depend- ent on the speed with which economies get back up and run- ning and if there’s a bad economic restart then commodities may continue to struggle. Everyone agrees that the longer the crisis lasts the more diffi- cult it will be for pension funds to recover lost value. There are some success stories filtering out of the crisis which seem counterintuitive. A shopping mall in Spain, one of the countries hardest hit by Covid-19 and with one of the toughest lockdowns in Europe, is in one of the Nationwide Pension Scheme’s portfolios. But while it’s closed and is generating no income, it has sufficient cash to service its debt until March 2021 by which time it is expected to start getting some of its income back from its retail shops. The Covid-19 crisis has hit some sectors in the real assets uni- verse with a vengeance but despite the whirlwind of damage it has caused, Mark Hedges thinks businesses have learned the lessons of the last recession.
“The sense I get is the underlying businesses seem to be better prepared with the cash they have and the length of their cash- flow runway than they were in 2007,” he says. “So whilst there will be losses and businesses go under and there will be oppor- tunities for potential buyers, I suspect there may not be as many as there were in the great financial crisis. “This is a different sort of crisis and the sense is some busi- nesses are better prepared for it,” he adds.
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