Fortress positioned to hold out for better times
The property sector has been one of the hardest hit in the Covid-19-related equity market sell-off, declining on average 48% since January. Highly geared balance sheets, unsustainable distributions and a generally oversupplied market in an increasingly challenging macroeconomic environment have been a near perfect storm.
The sector has three principal activities: retail, office and commercial/logistics. The longerterm outlook for retail property is challenged by weak consumer spending and social distancing measures. Office rentals are likely to suffer as more employees work from home, and commercial and logistics depend on overall economic activity, which is likely to be very muted.
The closure of non-essential retail and the subsequent refusal of the Clothing Retailer Group to pay rentals has exacerbated sectoral challenges and for the first time many real estate investment trusts (Reits) are not paying a dividend. But it is within this market carnage that astute investors must seek long-term opportunities.
We believe that Fortress Reit B shares could be one of the opportunities. It has been among the worst-performing shares in 2020, losing an incredible 73% of its value since January 1.
This decline comes on top of a precipitous fall that began in 2018 when the company faced allegations of market manipulation, concerns over the crossholding with Resilient and governance issues related to previous property transactions. The Financial Sector Conduct Authority cleared the fund of all allegations in late 2019.
After the unproven but damaging allegations in 2018, there has been a change in leadership, the adoption of several positive steps to strengthen governance processes and a strategic focus to simplify the portfolio into three key areas: commuterorientated retail centres; a listed holding in Nepi Rockcastle; and logistics. This provides diversified exposure across sectors with relatively positive longterm growth outlooks.
Nepi Rockcastle provides access to dominant Central and East European retail centres with strong underlying growth fundamentals. Logistics has stood out globally as extremely resilient and a potential beneficiary of the Covid-19 pandemic in the acceleration of the trend towards e-commerce.
At this point it is still uncertain as to how long we will remain in lockdown, and projecting the effect on businesses is difficult. But the long-term ramifications for unemployment and GDP growth will be severe and the demand for commercial real estate is likely to be permanently lower.
It is important that companies take steps to ensure they can manage financially through the period of disruption. We are encouraged by the steps taken by Fortress to manage its liquidity, together with industry calls for JSE-listed property funds to be allowed temporary relief from the requirement to pay out at least 75% of their income to investors while retaining Reit status. The reduction in interest rates by the Reserve Bank should provide more relief.
Companies that have conservative balance sheets and exposure to more defensive assets are likely to emerge as relative winners. We believe that Fortress B shares, which trade at a near 80% discount to the last reported book value, are an opportunity where certainly the known risks are more than fully reflected in the share price and there could be very significant upside for patient investors.
● Houston is a property/ financials analyst at All Weather Capital.