Ask a fund manager
The Motley Fool chats with fund managers so you can get a glimpse of how the experts think. In the second part of this issue, we follow Jesse Curtis, fund manager of $4.1 billion Centuria Industrial REIT (ASX:CIP), Australia’s largest domestic pure-play industrial company real estate investment fund. Today, Curtis addresses the threats and opportunities for investors in public commercial real estate.
The Motley Fool: In the first part of our interview, you mentioned real estate as an inflation hedge. And that 20% of the Centuria Industrial REIT’s portfolio is linked to CPI rental ratings. How do you see interest rates developing over the next 12 to 24 months?
Jesse Curtis: We recognize that inflation has changed the interest rate environment and created a degree of uncertainty throughout the market. What we assume in our operating funds for FY23 [FFO] The forecast is an average interest rate of 3% over the course of FY23. While we may see short-term volatility, we expect interest rates to normalize towards the end of next year.
It’s also important to note that our leverage currently stands at 33% with an average interest coverage ratio of 5.4%. Both provide significant headroom for our debt obligations.
MF: In FY23, CIP expects a dividend yield of 16 cents per share (cps). That would be another year of more than 5% returns. Are you adjusting your investment and leasing strategies in the logistics markets to achieve this in the face of higher rates and inflation?
JC: We have been pursuing a consistent strategy since we took over the management of the industrial fund five years ago. And that means owning a quality portfolio of urban industrial assets where we see the highest tenant demand and the lowest supply to add. And that has enabled us to offer our investors income and capital growth.
But in an environment of higher inflation with limited vacancy across all developed markets, we see an opportunity to generate higher rental growth across the portfolio. This can be done through re-letting or by implementing our value-add strategies. With near zero vacancies in our portfolio, we find that we can really expand on this rental growth theme.
MF: Have you noticed an increase in tenants struggling to meet their rental obligations?
JC: We have focused on building a portfolio with very strong rent-paying clients. They like Woolworths Group Ltd (ASX:WOW), Telstra Corp Ltd (ASX:TLS), Australian Post and Arnotts. We have blue chip customers who pay the rent.
As part of our strategy, we tried to add short WALE [weighted average lease expiry] urban infill assets in the portfolio, giving our investors the opportunity to capitalize on this rental growth.
So we have a nice balance of secure income and also being able to take advantage of our short term expiring leases to capitalize on the strong rental growth in the market.
Overall, we have an occupancy rate of over 99% and a WALE of more than eight years with good earnings security.
MF: Can you name some of your other successful strategies?
JC: One really successful strategy for us has been to consolidate property in these urban infill markets. We now have 10 examples across the portfolio where we have consolidated either neighboring or district assets.
This offers our investors a number of opportunities. On the one hand, it allows us to use our network effectively by being able to move tenants within the portfolio and within markets by being diverse in both size and asset type. This strategy reduces downtime and increases our tenant retention.
On the other hand, it also offers our investors long-term development opportunities. By consolidating large sites, this not only offers the opportunity to develop more modern industrial facilities, but also maintains the income from the existing buildings, giving us great flexibility.
MF: What is the biggest threat for investors in public industrial assets in the coming year?
JC: Nobody can hide from higher interest rates. The biggest risk is if the RBA fails to provide a soft landing and inflation picks up.
MF: And what is the biggest opportunity?
JC: The market for industry is still extremely strong.
We have structural tailwinds like e-commerce that will continue to drive tenant demand. There’s no greater correlation than increased ecommerce spending and the need for warehousing to stock products. We will continue to see this demand come through the market.
We have also seen a trend towards onshoring or reshoring of manufacturing and warehousing operations. Every tenant we speak to needs more space to store more inventory and avoid supply chain disruptions.
We see very large e-commerce brands as well as local brands promising next day or second day delivery within their product range. You need storage space close to a population to be able to fulfill these promises. This has resulted in much more storage taking place in industrial markets, where CIP has focused its portfolio due to the proximity to a large population within a short driving distance.
These are all longstanding trends that will set the stage for strong industrial rental growth.
In case you missed part one of our interview series with Jesse Curtis, you can find it here.
(You can find out more about the Centuria Industrial REIT here.)