The property allocation demands reconsideration
The rationale for an allocation to international property for investors is compelling. As interest rates hover at historic low levels, with another rate cut from the central bank in October making three Australian rate cuts this year, investors are being starved of income from traditional sources such as bonds or savings accounts. Investors are having to take on more risk and are moving to real estate investment trusts (REITs) because they provide a reliable income stream.
Savvy investors are also looking beyond Australian shores and starting to include international REITs as a way to diversify their portfolios and achieve superior risk-adjusted returns.
BENEFITS OF INTERNATIONAL REITS
The global economy, in the aftermath of the GFC, has been characterised by periods of low economic growth and low interest rates. By mid-2019, 10-year government bond yields around the world had fallen to historical low levels. In Australia these fell below 1% for the first time and have stayed low. In other developed nations they went to zero. Cash investments returns were barely sitting above 0%.
This has raised significant challenges for investors seeking to generate income from their portfolios while also preserving capital value. Some are seeking income by taking extra risk. REITs have been a target. A key benefit of REITs is the defensive income streams they can provide. Property assets typically earn reliable income from rent, which provides a regular income stream to investors, even during an economic downturn.
Additionally, rents can be linked to inflation, which is important because it means income increases with the costs of living.
DIVERSIFICATION – SECTORS AND EXPOSURES BEYOND AUSTRALIA
Australia was one of the pioneers of listed real estate investing. General Property Trust was the first Australian listed property trust (LPT) in 1971. Other world-leading names included Westfield, General Property Trust and Multiplex. But the market has diminished. Since the beginning of this century, the proportion of the S&P/ASX 200 represented by Australian REITs (AREITs) has fallen to just 8%, down from a peak of 25% in 2006 as illustrated in Chart 1. One of the major reasons for this has been corporate actions and mergers and acquisitions. In 2006 there were a record 71 listed AREITs, today there are 44.
For example, Westfield and its various entities have experienced several corporate actions consolidating, spinning off and finally being taken over by Unibail Rodamco for $32 billion. The Australian shopping centres branded as Westfield were not acquired by Unibail and are now held by Scentre.
Chart 1: AREIT’s diminishing importance on ASX
Source: Factset, ASX, VanEck 2000 to 2019.
For those investors still holding AREITs, the Australian market is dominated by a few big trusts, where the top 10 AREITs accounted for over 90% of the S&P/ASX 200 AREIT Index as at June 2019. That contrasts with listed property assets offshore which are better diversified and include some sectors that are not readily available in Australia such as healthcare property trusts, hotel and resorts, and specialised REITs such as data centres. Investing offshore can broaden investors’ property opportunities and increase their diversification significantly.
DIVERSIFICATION – LOW CORRELATION WITH OTHER ASSET CLASSES
REITs have been used by investors for their defensive qualities as they achieve a high proportion of their returns from income rather than capital. In addition, listed property has a low correlation of returns with those of other equities and fixed income investments.
In Chart 2, we compare the two standard market benchmarks for international property and equities. For international equities, the MSCI World ex Australia Index is used. For international property, as most investors seek a hedged exposure to the asset class to limit currency volatility eroding income, the International REIT Index is used.
International REITs show a downward-sloping term structure of correlations with the broad international equities market. As their underlying return drivers are fundamentally different, REITs have a powerful diversification role in investment portfolios.
Chart 2: Correlations between International REIT Index and MSCI World ex Australia Index Portfolio
SUPERIOR RISK-ADJUSTED RETURNS
A new VanEck research paper, The Proper(ty) Allocation, also reveals that a portfolio including international REITs delivers superior risk-adjusted returns compared to a portfolio without international property over five years.
We constructed a hypotheical balanced fund with and without an allocation to international listed REITs. This is based on ASIC’s MoneySmart balanced investment option which “invests around 70% in shares or property and the rest in fixed interest and cash”.
Our analysis reveals that a portfolio including international REITs produces a historically higher annualised portfolio return than a portfolio without international REITs, and without incurring significant incremental risk as measured by standard deviation.
Stronger balance sheets than in the past
The long-term fundamentals for selecting real estate investments are robust. Restricted funding in the current environment has limited supply and with improving demand, strong rental growth has emerged in the latter half of 2019. We expect this trend to continue in many markets and sectors around the world, particularly in developed markets.
Once a concern for investors, REIT balance sheets have been de-risked over the last 10 years and are in stronger shape. Since the GFC, the REIT industry has reduced leverage and extended maturities of debt instruments to lock-in low interest rates for many years ahead. Collectively, REITs have reduced their overall leverage ratios to the lowest in at least two decades.
ACCESS THE PROPER ALLOCATION
Traditionally the domain of large institutions, investors of all sizes can now access international REITs via managed funds or ASX-listed exchange traded funds (ETFs).
Arian Neiron is managing director and head of Asia Pacific at VanEck.
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