WEALTHCO. ASSET MANAGEMENT
SECOND QUARTER 2020
Private real estate investing in a pandemic
The real estate sector suffered its worst blow in years as a result of COVID-19, with many tenants not paying rents, and borrowers missing mortgages payments. The impact was so sharp that governments stepped in to support both tenants and borrowers, somewhat softening the blow. From an investment perspective, however, the impact varied significantly based on a number of factors, including the property-type, the terms of the investment, and the location.
Minimal impacts to multifamily & industrial; retail the worst hit
From a property-type perspective, retail assets have been impacted the most. According to Nareit, rent collections in May were >95% for industrial and residential properties, >90% for office, ~70% for free-standing retail, and ~45% for enclosed shopping malls. Rent collections across our portfolio are similar, with the impacts of COVID-19 largely affecting our retail real estate holdings more than other asset classes.
Mortgages fared better than equities
Commercial mortgages have performed much better than real estate equity in 2020. Real estate equity, as measured by the S&P TSX Capped REIT index, has shed more than 20% of its value year-to-date in 2020; whereas most well-secured mortgage debt has barely been impacted (see Timbercreek Financial comment below).
To illustrate why mortgages held up better than equities, here’s a quick example:
If a property was worth $20 million before the crisis and $18 million after the crisis (a 10% drop in value), it’s possible that the equity holder could see a 40% drop in their carrying value, while the mortgage lender sees no impact to their investment. This is because the mortgages are first in the “priority of claims”, therefore receive payments ahead of equity holders.
Our US real estate generally performed better than our Canadian properties, particularly those in Calgary. Calgary’s real estate fundamentals have deteriorated even further with the impact of low oil prices causing significant weakness in the office market as well as retail.
Second Quarter Highlights
On May 5, 2020, Timbercreek Financial stated “COVID-19’s impact on April’s interest and principal payments was negligible, and there have been no material signs of deterioration in the portfolio to date”. Timbercreek Financial invests in Canadian commercial mortgages and generates a yield of ~8.1%.
We made a new investment in Timbercreek’s US Commercial Mortgage Fund in the second quarter. The fund invests in mortgages on real estate assets in the US, focusing on first mortgages with an average of ~70% loan-to-value in target cities such as Portland OR, West Los Angeles CA, and Tampa Bay FL. The fund is well diversified by location and property type, and has a target return of 9.0%.
Adventus Realty Trust, which operates suburban office buildings in Atlanta GA and Chicago IL, collected 96% of rents in June. The company stated on its conference call that management is in discussions to refinance our 8.0% convertible debentures, to take advantage of lower interest rates.
We reduced our fair value estimates for our retail-related real estate projects in the second quarter, including: the Tsawwassen Power Centre in Tsawwassen BC, the Blue Oaks Plaza near Sacramento CA, and the Poplar Medical Centre in Calgary AB.
Subsequent to quarter-end, we reduced our fair value estimates for our Enercapita preferred shares, and our real estate holdings in Calgary.
Diversification within real estate
Our approach to real estate investing is much like our approach to our managing our client’s wealth. We believe in the benefits of proper diversification. In addition to roughly 55% of our client’s portfolios that are invested in public equities and fixed income, our typical client has a 14% allocation to private real estate equity, and a 14% allocation to mortgage debt. Further, within each of those asset classes, our real estate holdings are well-diversified by location and property type. The result is that our client’s exposure to any one property-type or location is limited, and manageable during a crisis.
COVID-19 and social distancing practices have had an adverse effect on the global real estate market. Some sectors have been hit harder than others, with retail and commercial properties being the most impacted. However, during the downturn private mortgages have held strong and outperformed equity positions. This is due to mortgages having a higher priority of claim on an investment property’s cashflow. Using a robust diversification strategy, WealthCo has mitigated its downside risk by holding private mortgages and differentiating its real estate assets by property type and location. Despite some revaluations of our retail holdings, our mortgage investments have endured little volatility to date; and our strategic partners share a positive outlook on the sector. Overall, the real-life stress test of COVID-19 has showcased how alternative strategies offer greater market resiliency while driving consistent results.
The results speak for themselves.
OUR HARD WORK, AT YOUR SERVICE.
Download the WealthCo Asset Management second quarter fund fact and see how they have weathered market volatility now, and over the past 20 years.
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