Stock story: Charter Hall Retail REIT
As extraordinary policy settings including record low interest rates, quantitative easing and fiscal stimulus normalise, markets are increasingly concerned about the global economic outlook and the emergence of inflation. Therefore, we look for companies with resilient inflation-protected income streams and strong balance sheets, two key characteristics that Charter Hall Retail REIT holds.
A REIT, or real estate investment trust, holds a portfolio of income-producing real estate assets. As REITs are publicly traded, they allow investors relatively easy and liquid access to these real estate assets. Charter Hall Retail REIT is externally managed by Charter Hall, one of the largest ASX-listed real estate owners and fund managers. The Charter Hall Retail REIT portfolio consists of supermarket-anchored sub regional and neighbourhood shopping centres, and other non-discretionary, convenience-focused assets.
Approximately 35% of the portfolio’s income is derived from the major supermarkets which have defensive revenues that will rise with inflation. Further to this, supermarkets pay turnover rent, whereby a percentage of sales over a threshold is paid to the landlord. Charter Hall Retail REIT has additional inflation hedges, with 55% of its rental income linked to the Consumer Price Index (CPI). Outside of the supermarkets, a further 25% of tenants are national retailers, with strong covenants, which provide essential goods and services such as Wesfarmers (Bunnings), BP and Ampol.
During periods of rising inflation, asset values come under pressure as central banks hike interest rates to combat inflation. As interest rates rise, the yield on assets also increases which causes values to decline. The listed market expects asset values to decline in the near term and therefore is pricing in an increase in property yields of approximately 100 basis points across the Australian REIT sector.
We believe Charter Hall Retail REIT has buffers to mitigate the impact of these higher yields and lower asset values including 1) a healthy balance sheet with gearing levels at the low end of their target range of 30% to 40% 2) availability of assets to buy with sub-regional and neighbourhood shopping centres becoming increasingly institutionalised 3) rental growth linked to CPI and 4) the structural and long-term support for the land value of these assets.
The support for values of neighbourhood shopping centres is driven by the key role they will play in ‘last mile logistics’. The hype around industrial assets over the last ~12 months has driven urban infill industrial assets to transact on yields as low as 3%, while neighbourhood shopping centres have changed hands for 5% to 6% yields. However, tenants such as the major supermarkets increasingly view neighbourhood shopping centres as last mile real estate by utilising their retail stores as final delivery points and introducing click & collect. These assets are located in the heart of residential communities, providing the perfect real estate to form part of retailers last mile logistics operations.
Other property asset classes like retail, office and residential have less inflation protection, less resilient income profiles and are more cyclical, making them less attractive in an environment of rising inflation and lower growth.
Still, the convenience real estate sector is not without risk, with pressure on retailers’ ability to pay rent with rising inputs costs, the rising cost of debt, and the broad downward pressure on asset values. We acknowledge that Charter Hall Retail REIT will not be immune to these headwinds, however, we do believe it is a relative safe haven with low exposure to discretionary retailers and structural tailwinds to support long term asset values. Finally, the group provides value to shareholders as it currently trades below its net tangible asset value (the value of the physical assets less any debt and non-physical assets) and at an attractive dividend yield.