REITs offer yield solution

The Australian real estate investment trust (REIT) sector has had a good 2014 so far, with the S&P/ASX 200 A-REIT Index racking up a 10.9% gain for the year to date, well ahead of the benchmark S&P/ASX 200 index itself, which is up 3.2%.

The main reason is yield. A sector with an average FY14 forecast yield of 5.9% – and 5.5% among the ten-largest trusts – is going to look fairly attractive.

This average yield figure compares favourably with the average for the broader market, which is trading at about 4.5%.

Top five FY15 distribution yields

Source: Morgans

An improved sector

Another factor in the strength of the local REIT sector is the much-improved balance sheet strength of the A-REITs – with average gearing levels down from about 40% at the end of 2007 to 29% at present (25.7% among the ten-largest trusts) – and investors know in the high-quality REITs they are receiving strong rental flows paid through to them in distributions. However, with FY14 yields ranging from 4% to 8.5%, there is quite a range of quality and predictability that has to be negotiated.

The upsurge in mergers and acquisitions activity in the sector has also given impetus to the REITs’ stock prices. Australand Property, Stockland Group and the Westfield twins have been prominent risers, and this has driven re-pricing of the sector as a whole. (Last week the contentious plan to merge the Westfield Group’s Australian and New Zealand property assets with Westfield Retail Trust, to form a new retail REIT, to be known as Scentre Group, with the remaining Westfield Group portfolio of shopping centres in the US, UK and Italy to called Westfield Corporation, was passed by Westfield retail trust’s unitholders, having already been okayed by Westfield Group shareholders. Scentre Group will also incorporate Westfield Group’s Australian and New Zealand property funds management and development business).

Also, the market fundamentals in the various property sectors are mostly favourable for investors, with residential property leading the way, industrial property a healthy market and retail improving – although the Budget-inspired hit to consumer confidence could, if sustained, derail this recovery, and office property the weakest sector.

Most property trusts go ‘ex distribution’ at the end of June, with distributions to be paid in August. The REIT sector passed through “confession” season with no revisions on guidance, and analysts are expecting a healthy June 30 reporting season from the sector, led by residential and commercial developer Australand, which is expected to boost its June half distribution by more than 20%, on the back of the recovery in the residential market.

The price factor

However, as is normal when a sector has had a strong run, most of the REITs appear fully priced. According to broking firm Morgans, there are only three REITs trading at a discount to their net tangible assets (NTA) figure

Top three discounts to net tangible assets (NTA)

Source: Morgans

Another way of looking at REIT prices is to check them against the consensus target prices of the analysts that cover them. On this statistic, more REITs are at discounts to consensus target price than at discounts to NTA (see accompanying table), with the best of them being Astro Japan Property Trust (AJA), a diversified REIT specialising in Japanese property, with 34 retail, office and residential properties, located mainly in Tokyo. To be comfortable investing in Astro Japan Property Trust you have to have a confident view on Japanese property: JP Morgan, for one, has such a view, placing a recent “overweight” recommendation on AJA.

Top five discounts to analysts’ consensus target price

Source: FN Arena, Stock Doctor

Also in the discount to consensus forecast table are Westfield Group (WDC), which is rated “buy” by Bank of America-Merrill Lynch and Deutsche Bank, “outperform” by Credit Suisse and “neutral” by Macquarie and UBS; office trust GDI Property Trust (GDI), also rated an “outperform” by Credit Suisse; specialist retirement living REIT Ingenia Communities (INA) and Sydney-Melbourne trust Australian Industrial REIT (ANI), which is rated “buy” by UBS.

New kids on the block

Ingenia is a good example of the newer breed of REITs, which have opened up niche opportunities away from the standard office/retail/industrial/residential menu that the sector has traditionally hosted.

In the last couple of years the REIT sector has been augmented by:

Generation Healthcare REIT (GHC), the only listed REIT that invests solely in healthcare assets. The portfolio of seven properties includes hospitals, medical centres, laboratories and other purpose-built healthcare facilities.
Arena REIT (ARF), a REIT consisting of two sub-trusts stapled together, one investing in healthcare property, the other in childcare property.
APDC Group (AJD), the only listed REIT that owns data centre assets. AJD has a portfolio of two operational data centres in Melbourne (M1) and Sydney (S1), and another under construction in Perth (P1). AJD has one tenant, listed data system operator NEXT DC Limited (NXT), under long-term leases.
National Storage REIT (NSR), a specialist self-storage REIT that is the third-largest self-storage provider in the Australian market, with 62 centres in six states storing goods for 23,000 residential and commercial customers.
Folkestone Education Trust (FET), a childcare property trust that owns a portfolio of 351 early learning centres.

These have all added the ability to target in a REIT portfolio investment “themes” outside the main property sectors.

The broker view

Broker Morgans reckons the way to play the REIT market at present is to look for office REITs with exposure to office with long-weighted average lease expiries – for example GPT Group (GPT) and Cromwell Property Group (CMW) – given soft tenant demand and increasing supply in some markets.

Morgans also likes 360 Capital Office Fund (TOF), which it says is one of the few pure-play office REITs in the market, offering investors a simple business model focused on suburban office markets;

Also on its list of favourites are good-quality industrial property REITs – namely BWP Trust (BWP) and Industria REIT (IDR) – which have a favourable near-term outlook, with ongoing tenant demand driven by internet retailers and businesses looking to upgrade their logistics infrastructure; and

Morgans rounds its picks off with its preferred residential play, which is Stockland Group (SGP).

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