First Light Capital Market Commentary - March 2022

A lot has been happening in New Zealand’s economy over the past six months – with inflation now clearly evident across all sectors of the economy from food and fuel, through to interest rates and retail goods.
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In this report, we look at how the New Zealand economy is evolving, what impact emerging changes will potentially have for the real estate investment sector, and how your investments with First Light Capital properties shape up to weather these business cycles.

A lot has been happening in New Zealand’s economy over the past six months – with inflation now clearly evident across all sectors of the economy from food and fuel, through to interest rates and retail goods.

Concurrently, the effects of Omicron have seen some business sectors such as hospitality and tourism struggling, while other industries in the likes of the building, construction, logistics, manufacturing, and primary production sectors are performing strongly.

All that has come off the back of an extended period of low mortgage interest rates in New Zealand – down to the likes of 2.69 percent several years ago. However, inflation is now back in the New Zealand vocabulary for the first time in some five years. And that means a corresponding rise in mortgage interest rates – which impacts those who have borrowed to purchase assets, such as First Light Capital.

First Light Capital’s management has received several calls and email enquiries this year asking about the effects and impacts which events and trends in the economy may have on their investments.

This simple Q & A format replicates the enquiries we have been fielding and should provide our investors with a clearer picture of what is happening in the New Zealand economy in relation to their real estate investment assets, and reasons for maintaining confidence.

Q: What impact do rising mortgage lending rates have on my investment?

A: There will be some impact on the return rates for First Light Capital’s investments, as First Light Capital’s lending terms are predominantly on floating rates, which are now rising.

However, the impact of mortgage interest rate increases on investment returns will be mitigated by increasing tenancy rental returns. We explain this further below. Banks’ mortgage rates are heavily influenced by the Official Cash Rate which is set by the Reserve Bank of New Zealand. The official cash rate was lifted by 0.25 percent in both October and November 2021, and by a further 0.25 percent on February 23.

More increases have been foreshadowed by economists. The OCR is directly related to the rate which retail banks – that is the likes of ANZ, BNZ, Westpac, ASB, Kiwibank – can access some of their funds. So, increases in the Official Cash Rate have a knock-on effect to bank borrowing rates.

Q: I see some of the tenants in my investments have lease conditions linked to the Consumer Price Index (CPI). With the CPI rising sharply over the last year, does that mean their rents will also rise sharply?

A: Yes, lease rents will adjust upwards – but with a caveat. Statistics New Zealand record in their latest data that the inflation rate for the September 2021 quarter was 4.9 percent – a rise of 2.2 percent from the June 2021 quarter.

So, for First Light Capital tenants whose lease terms and conditions are linked to the Consumer Price Index, rents will rise by at least that amount. Some will rise by up to two percent more depending on their individual terms and conditions.

The timing of these CPI linked rental adjustments will vary depending on the lease periods and the lease rental review periods. As and when these lease reviews do come up rents will rise accordingly.

Other leases within First Light Capital’s portfolio of tenants are on fixed rates, and their rents will rise by that amount at the date of rent review.

Q: So, when fixed rate rental leases come up for review, can those tenancies be converted over to CPI-linked lease contracts?

A: We wish they could, but very few tenants, if any, are likely to want to now be linked to CPI levels.

Consumer Price Index linked increases work well for tenancies in times of low inflation – such as the New Zealand economy has experienced for the past six years or so until the middle of 2021. However, as inflation comes back into the broader economic equation, most tenants prefer to have their rental increases secured on fixed terms and/or set to market rates.

Q: Some sectors of the economy are struggling in business as a result of the ongoing Covid-19 pandemic. What effect will that have on my investment?

A: First Light Capital is very comfortable with the profile, quality and stable operations of its tenants.

In choosing which assets to include in syndications and funds, First Light Capital always looks carefully not only at the property asset but also its tenancy mix – undertaking due diligence on the tenants. Many of the properties within First Light’s portfolio are tenanted by well-known New Zealand brands and Government departments.

For stand-alone syndications, these include companies such as Coca Cola Amatil, Bunnings Trade, Waitemata District Health Board alongside multiple sites tenanted by the Ministry of Social Development.

Meanwhile, the two real estate assets within the First Light Property Fund – encompassing commercial office properties in South Auckland and Central Hamilton – are occupied by such prominent tenancies as workplace health and safety services organisation WorkSafe NZ, insurance giants NZI and Aon, and property agency Bayleys Real Estate.

First Light Capital’s property acquisitions are within the industrial and commercial sectors – we do not invest in retail, which has been one of the hardest hit sectors in the Covid-19 economy.

Q: Does this mean there are opportunities for First Light Capital to make new acquisitions?

A: Yes - in the industrial and the commercial sectors in which we specialise, particularly where there are Government tenants in place in a quality building on a long lease.

Our First Light Property Fund for example has always had the intention of acquiring more commercial and industrial properties. However, we will not be rushing into any decisions, and will be subjecting any potential property purchases to the same rigorous due diligence process as we have always undertaken.

Existing fund shareholders will of course be offered the first opportunity to invest in the expanding fund as and when that point is reached.

Q: Won’t other investors be eyeing up the same commercial and industrial property opportunities?

A: Quite likely. However, this scenario highlights the benefit of being part of collective investment syndicates or funds such as those operated through First Light Capital – where many smaller stakeholders combine their investments into a consolidated fund which allows them to be a structured co-owner of a real estate asset which they would otherwise not be able to invest in.

Essentially, being a First Light Capital investor allows our clients the opportunity to truly compete with ‘the big boys.’

Q: I am hearing chatter in the media about house price values flattening off or decreasing. How does that effect my investment in my First Light Capital syndicate or fund?

A: House price values are irrelevant for all of First Light Capital’s syndicates and funds – which are all commercial and industrial properties. There is no comparison.

Toby Hunn
March 1, 2022

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