Meet the REITs that are cleaning up and paying out
Since General Property Trust became Australia's first ASX-listed real estate investment trust 50 years ago, the pitch has barely changed.
Australian real estate investment trusts (AREITs) are still all about income.
What has changed is the environment in which they operate. The pandemic has accelerated the shift to online while working from home has made flexible working here to stay.
And with retail shops shuttered during lockdowns, we’ve seen online purchasing exploding to unprecedented levels, providing a heady boost to industrial assets.
The uncertainty of these structural forces is the source of the opportunity.
The income streams from Australian property trusts are more reliable than many investors think. In our view, the fear remains overdone and not sustained by the evidence.
In this wire, I discuss what we're seeing in the sector and why we remain confident of its place in the investment market.
That's a good-looking yield
At a time of record low-interest rates and disappointing bond returns, AREITs offer a yield unobtainable from almost any type of listed security with a similar risk profile – 5.15% in the case of the APN AREIT Fund as of mid-September 2021.
The relatively high yield can be explained by the fear that AREITs might not be the reliable investments they once were.
Backed by the APN Real Estate Securities team’s knowledge, experience and the data we’ve collected over the past year or so, I can say unequivocally that they are, albeit with a few caveats, which we’ll get to.
Landlords take the long view
The Federal Government’s National Leasing Code of Conduct is back in play in Sydney and Melbourne, but landlords have enough capital to get them through should tenants be eligible for rental support.
If the next few months are tough, the impacts will be less significant than last year and again, it will only be temporary.
Meanwhile, there are very encouraging signs around vaccination rates, which are a boost to consumer and business sentiment.
The recent 2020-21 reporting season proved the stability of AREIT income streams.
Earnings growth is forecast to increase across the sector by 10% on average in 2021-22, making the relatively high yields currently on offer even more attractive.
Nevertheless, this has been a challenging period that will produce lasting changes within the sector, with clear winners and losers.
Who's cleaning up
On the winners podium stand industrial REITs. The boom in online sales has led to incredible growth in this sector, which we expect to continue.
Alternative REITs also profited. Having proved their resilience and importance in providing essential services to the wider society, they’re now in high demand.
There are also winners amongst the retail REITs. With the major malls largely closed and people confined to their homes, there has been a boom in neighbourhood and convenience – which these days often means the nearest servo.
So too did large-format retail centres, which were less impacted by lockdowns and benefitted from the residential upgrade (working-from-home fitout and home improvement) and the house price boom.
Cities are bouncing back
In the office sector, CBD offices were hardest hit, along with inner-city shopping precincts. Nevertheless, thanks to near 100% cash rent collection and stable asset values, office landlords reported satisfying results which were ahead of 2019-20.
Occupancy rates are declining, with landlords offering greater incentives to secure new tenancies, but this is not surprising considering the pandemic ended one of the longest office cycles seen in Australia.
While the future of the office has a way to play out, given the full impact of working from home yet to be determined, tenants will require quality flexible office space that meets their evolving needs. Most of this is located in Australia’s CBDs.
The rebound over the 18 months has not come as a complete surprise, considering the level of overreaction, but opportunities still abound.
How we've responded
When the full impact of the pandemic hit in March last year, we set about repositioning the APN AREIT Fund to reflect trends we were seeing offshore (through managing our Asian and Global REIT funds), where the outbreak was further advanced.
We reduced our exposure to offices and shopping malls and added to our holdings in convenience retail, industrial and alternative REITs.
The rebound over the 18 months has not come as a complete surprise, considering the level of over reaction, but opportunities still abound.
Four compelling yield opportunities
My first pick might look odd given previous comments, but Scentre (SCG) still looks attractive. In the period between lockdowns, foot traffic and retail turnover rebounded, showing shoppers’ strong desire to return to shopping malls.
We expect that effect to resume once lockdowns are lifted. Scentre's current share price – still 25% or more below pre-pandemic highs – appears not to reflect this view, with investors receiving a 5% distribution yield that will grow while they wait.
Another retail landlord which is yet to regain favour with investors is Charter Hall Retail (CQR).
Last year’s discounted capital raising has seen the stock in the doghouse, yet the company primarily owns high-performing neighbourhood shopping centres.
Due to strong investor demand for their defensive cash flows, which currently provide a 6% distribution yield, asset values have been rising strongly.
A number of alternative asset owners offer compelling yields. Waypoint REIT (WPR), Australia’s largest listed service-station owner, currently yields 5.7%, while the APN Convenience REIT (AQR) offers an even better 6.3%.
These assets are in high demand as they broaden their cashflows into convenience retail. Last year we saw a record number of transactions in the market.
Lockdowns had no impact on service-station earnings. They remained open as an essential service, so rent was paid by excellent tenant covenants with the likes of BP, Chevron and Shell
Uncertainty still threatens
The AREIT sector still faces some headwinds. The impact of Covid is unlikely to be fully felt for some time and the threat of new variants and shutdowns remains. As for the structural shifts to working from home and online retail, they’re still unfolding.
Against this, we must factor in the changing approach to the pandemic from governments around the world and here in Australia, where the strategy of living with the virus has prevailed over eradication.
This offers a little more confidence to commercial property tenants.
The return of students and tourists, and eventual return to more typical levels of immigration, will further boost demand and underpin economic growth.
Learning from the GFC
Whilst the winners and losers in the sector are clear, there’s a more important point to consider: after the global financial crisis, AREITs returned to their knitting.
Ambitious expansion plans were wound back, leverage was reduced and management attention returned to the reliability and stability of the income streams.
The pandemic has proved the value of these changes. The sector hasn’t just survived but, in most cases, has prospered. Few expected that 18 months ago.
Reporting season revealed that net tangible assets per share rose almost 10%, the best performance in years.
Debt levels are at historic lows and occupancy, at 95% across the sector, hasn’t fallen anywhere near as many feared it might.
At the beginning of the pandemic, REITs became priced for oblivion. Subsequent experience has proved their enduring qualities which, even now, are not yet fully appreciated.
My reading list
Income-oriented investors who want to learn more about how to assess opportunities in commercial real estate may find APN’s Little Book of Big Property helpful.
If you like the sound of a 5%-plus yield, supported by secure, sustainably growing income streams, I highly recommend taking 30 minutes or so to read it.
Investing with APN Real Estate Securities
APN Real Estate Securities (RES) is a specialist investment manager that actively manages portfolios of listed property securities. Since inception in 1998, our deep understanding of real estate and “property for income” philosophy, together with a highly disciplined investment approach has been the backbone of our performance.
Our team of investment professionals possess real estate experience spanning several property cycles. Our investment decisions are supported by extensive research and valuation processes that have been developed over more than two decades.
RES became part of Dexus (ASX: DXS) in August 2021. Dexus is one of Australia’s leading fully integrated real estate groups, with over 35 years of expertise in property investment, funds management, asset management and development. (VIEW LINK)
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Pete joined APN in 2006 and in January 2019 transitioned into his new role, becoming responsible for management of APN’s suite of real estate securities funds. Pete is now also the dedicated Fund Manager of the APN AREIT Fund