A different source of income
With Labor tipped to win the next election, and franking credits in their sights, here are eight reasons we believe conservative investors looking for sustainable income over the long term should consider AREITs for their portfolios.
1. Sustainable income
Whilst commercial property investing is primarily about income, over the last decade AREITs have done rather well in terms of capital growth. But their most attractive feature is the strong and stable distributions generated by recurring rental income from commercial property tenants.
The chart below makes the point, which plots the historical yield premium that AREITs have generated compared with bond yields.
Source: company data, Bloomberg
It shows a smooth dividend yield profile, but also a consistent premium against 10-year government bond yields since 2010. If you want sustainable income rather than roaring share prices or mediocre yields on a term deposit, commercial property is a good place to consider right now.
2. High-quality property exposure
In Australia, there are about 40 listed AREITs with a combined market capitalisation of about $128bn. These listed property trusts own some of the highest quality, best-performing assets in Australia, including Chadstone Shopping Centre in Melbourne, Westfield Bondi Junction and Deutsche Bank Place, one of Sydney’s leading commercial offices.
In addition, AREITs also offer exposure to storage and industrial parks, hospitals, aged care facilities and hotels. The calibre and range of tenants offers protection to investors and the attractive income benefits on which they rely.
3. Lower risk
The chart below shows the stability of income from commercial property compared to capital growth. Income returns (as shown by the blue bars) are far less volatile (and therefore less risky) than capital returns (the red bars).
That’s because rent must be paid whether a tenant makes a profit or not. The same cannot be said of ordinary dividends. Whether a company makes or loses money has no impact on its legal obligation to pay rent but may well impact its decision to pay dividends. Dividends can change rapidly: rents tend to rise slowly over the life of a rental contract. If you want stability of income at low risk, AREITs deliver it.
4. Built-in diversification
AREITs offer exposure to thousands of different properties and tenants in various locations such as shopping centres, office buildings, industrial property, childcare centres, service stations and more. This inbuilt diversification across businesses and sectors offers protection from normal business failures and economic cycles.
5. Lease terms boost defensiveness
The income from rents collected from commercial property is secured by long-term lease agreements that often last anywhere from 5 to 10 years.
Because rents increase over the lease period, either through changes in the Consumer Price Index, fixed annual increases or market-based reviews, rents generally cannot fall during the contract’s lifetime. This makes investors’ income streams safer and increases the defensive nature of their investment.
6. Buy and sell when you want
Property is an illiquid asset. But investing in commercial property through AREITs means you can buy and sell at any time. As with shares, AREITs are tradable on the Australian Securities Exchange.
In contrast, direct property ownership is an “all or nothing” proposition. You can’t sell a floor of an office building, a room in a house or one level of a shopping centre to release cash.
7. Tax-advantaged benefits
Most distributions paid by AREITs include a ‘tax-deferred’ component. This occurs when distributable income is higher than taxable income.
Because a trust can offset its taxable income through a range of deductions – including depreciation on plant and equipment, capital allowances on building structures, interest and costs – this is frequently the case.
Tax-deferred income reduces an investor’s initial cost base, increasing the potential capital gain when the investment is sold. Although this can mean more capital gains tax (CGT) at the point of sale, it is often offset by the reduced level of tax paid on income through the life of the investment.
This unique benefit is not widely known but has the potential to increase after-tax returns. For long-term investors, the benefits can be even more significant. If the units are held by a superannuation fund that realises the investments during the pension phase they have the potential to be tax-free.
To purchase a commercial property outright requires deep pockets, whereas AREITs are accessible to anyone and deliver exposure to a broad portfolio of high-quality properties that would otherwise be impossible to access as a private investor.
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Matthew is tasked with analysing and investing in Australian property trusts. He brings fundamental property knowledge, experience across a number of property sectors and a genuine interest in the AREIT sector.