When boring is good – A-REITs in focus

Financial journalist
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This is a boring article, about a boring sector. But boring is good.

Boring is just fine in the context of the Australian real estate investment trusts (A-REITs).

The A-REITs simply collect rent from their tenants, and pass most of it on to their unit holders. With their distribution yields running at about 6.5%, the trusts are finding plenty of favour in a low-interest rate environment, from global as well as Australian investors.

For a while there – pre-GFC – the REIT sector wasn’t boring. Many of the trusts had branched out into other income streams, for example, property development and syndication; they had used the cheap debt on offer to quadruple their average gearing level, to close to 45%; they were using some of that debt to offer investors payouts more than they generated in income; and they were expanding overseas.

It was heady times, but the reckoning on the market when the debt bubble exploded was savage.

Cleaning up

Australia’s REIT managers have cleaned up their act. Asset sales and capital raisings have pulled the average gearing level down from 43% in 2007 to 27%. At the same time, the average overseas exposure has fallen from 38% to 18%. Payouts are also firmly back in conservative territory, at just over 80% on average, as managers look to put away a bit of money to work on their businesses.

Given the yields on offer, the cleaning-up of the sector resulted in strong investor support. Over the year to 31 March 2013, the A-REIT category returned 30.7% in total returns, nearly one-third better than the overall share market return. From large discounts to their net tangible assets (NTA) valuation, the A-REIT sector moved in many cases to premiums.

That is OK – many investors are prepared to pay a price premium for the yields offered, both in terms of absolute and relative level of yield, plus the reliability of the income. But there was little room for the sector to improve – until now.

The REIT sector fell by about 7% in May, and is down about 10% from its recent peaks, offering just a touch more value. In terms of trading close to NTA valuation, the A-REIT sector looks fairly valued at present. With some of the 2012-13 froth having come out of the sector’s pricing, it looks just that touch more sustainable.

Given where interest rates are now, forecast FY14 distribution yields at around the 6.5% mark still look fairly attractive. Combined with a generally more stable fundamental structure, investors are right to look at the sector with renewed interest.

Arguably, as they cleaned up their act, the trusts became too conservative. There is some room for them to re-gear the balance sheet: they are paying about 5.5% now for debt, which they can use to buy an asset yielding 7%. Right away, that gap is working for unit holders.

Plenty of competition

Having largely pulled back from overseas, there is plenty of competition for the A-REITs from foreign investors and Australian super funds for high-quality assets – but even with that, they will not be looking to move back to Europe or the US.

The major exception is Westfield Group, which has largely become the REIT of choice for Australian investors seeking international exposure, while the Westfield Retail Trust manages the group’s Australian and New Zealand assets. Goodman Group is the REIT with the biggest international exposure behind Westfield Group.

But generally speaking, the A-REITs have changed their focus post-GFC from over-geared overseas-income assets to much lower-risk, Australian-based assets.

Non-rental income streams are still available for those investors that want them – for example, in Stockland Group, Australand, Charter Hall Group and Mirvac Group – but they are less common than they were several years ago.

The REITs are looking at a lower-growth environment and weighing up their strategies. For example, Charter Hall has been raising institutional equity and buying assets, while stablemates Commonwealth Property Office Fund and CFS Retail Property Trust are more focused on value-adding strategies such as re-leasing.

There is a wide range of REITs and different investment drivers for each. For example, broker Citi’s best A-REIT picks include Australand (pending its major Singaporean investor selling out), turnaround story Federation Centres, industrial developer and manager Goodman Group, and Stockland. Citi predicts Stockland can generate a total return of 28% over the next year as it benefits from a low-interest-rate driven recovery in new housing markets across Australia.

Citi also likes Westfield Retail Trust and Investa Office Fund. Fellow broker Bank of America Merrill Lynch says CFS Retail, Mirvac, Dexus Property Group, Westfield Retail and Lend Lease are all buys. Goldman Sachs likes the Woolworths spin-off, Shopping Centres Australia.

Macquarie favours Dexus Property, Investa Office, GPT Group and Charter Hall. JP Morgan also likes Dexus, GPT and Mirvac Group in the office sector. Mirvac is particularly strong in the Sydney office market, and recently bought a $584 million portfolio from GE Real Estate Investments Australia.

When looking at the yields on offer for A-REITs, investors have to remember the need for a quality overlay. For example, there are higher forecast FY14 distribution yields on offer than Westfield Retail’s 6.9%, but for the quality and defensive nature of the portfolio, that is about as good as it gets for a yield-oriented investor.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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