Featuring Michael O'Neill & Daniel Moore
IML is cautious on the real estate sector right now, with high interest rates and difficulties with occupancy and valuations. But, there is one stock that stands out to Daniel Moore right now, he talks to Michael O’Neill about why he likes Charter Hall Retail REIT (CQR).
Michael: So, we’re excited to bring you IML’s stock of the month. The stock today is from the property sector, which has been quite an unloved sector.
Daniel: Absolutely. Yeah.
Michael: Yeah. So, Daniel, this is a sector you’ve covered for over a decade and you’ve been quite bearish with respect to inflation, interest rates, and some of the threats to occupancy evaluations. So we’ve done well as a firm to largely avoid a lot of the REITs, particularly commercial and developers. What do you really like in the property sector? Which one stock stands out to you?
Daniel: Yeah. There’s definitely one stock I think, has something a bit special about it. In a space where there’s lots of issues, and that’s CQR, which is Charter Hall Retail. And they own a $4 billion portfolio of neighbourhood retail assets, and some petrol stations as well.
Michael: What makes this portfolio so strong? What’s so good about these assets?
Daniel: Yeah. So to explain neighbourhood retail, that’s sort of your local supermarket where, with a big car park, and they might have sort of 5-10 tenancies around that supermarket. So your butcher, your baker, your coffee shop, your pharmacy, things like that. So if you think about those tenants, very non-discretionary. About 60% of the rent, comes from the anchors, whether that’s Woolies or Coles or Aldi, or BP or Ampol. And those rents all grow by either the turnover of the supermarket or by in the case of the petrol stations, they grow by CPI. So you’re getting really strong rental growth there.
And then the specialty tenants, their rents grow by 4% fixed. So, really strong growth through the whole economic cycle. The portfolio, unlike almost any REIT right now, maybe apart from industrial, we’re seeing positive leasing spreads as well. So, you know, a great portfolio.
Michael: Quite unusual. And, for those of us less versed in property jargon, the petrol stations benefit from triple net leases. So that means not only does the tenant pay the rent, but they’re also responsible for property tax and any capital expenditure requirements.
Daniel: That’s right, Yeah. Really strong cash flow.
Michael: Yeah. So, one of the biggest concerns we’ve seen in property is cyclicality of occupancy. How do these assets stand up in that respect.
Daniel: Yeah. So we’ve got the data back on this portfolio to 2003 and since 2003, the occupancy at any time, the most it’s ever moved is 1%. So it’s been between about 97.5% and 98.5%, through recessions, through COVID. It’s incredibly resilient, which is not a surprise when you think of the tenancy mix.
Michael: So, when it comes down to it, what sort of yield is CQR trading on? How sustainable is that yield?
Daniel: Yeah. So it’s a really big yield. It’s about 8% right now. That yield will come off a little bit, because they have very low interest costs right now, which they locked in a couple of years ago, which is a good thing, but those interest rate swaps will roll off over the next two years. So if you factor in normal rates, the yield’s around 7%. And that 7% should grow by about 3% per annum, when you back out those interest rate swaps.
Michael: So, as a firm, you can see why we have quite a deal of confidence in our holding in CQR. At the same time, we’re still quite cautious on the REIT sector as a whole, particularly those whose share prices are not yet factoring in higher long-term interest rates and those that don’t have the tailwinds of higher re-leasing spreads or might have higher capital requirements, capex requirements. So CQR really is a gem, a standout in what is quite a beaten up sector for us.
Daniel: That’s right.
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