The long game: Are REITs worth the wait?

Despite some robust performances in 2017, investors should adopt a measured approach to Australian real estate investment trusts (A-REITs) in 2018.

Experts advise exercising caution when choosing to invest in REITs/A-REITs in the current economic climate.

Quay Global Investors’ principal and portfolio manager, Chris Beddingfield, said that of their 25-stock REITs portfolio, they are only comfortable with the performance of one at this point in the property cycle. He noted though, that REITs still have a role to play in every balanced portfolio, and investors should look at the property market from a long-term perspective. 

“It’s a long duration, long term asset. Investors should just focus on the fundamentals of real estate,” Beddingfield said. 

REITs portfolio manager and head of research property at Australian Unity Investments, Damian Diamantopoulos, said REIT performance hasn’t been unusual. 

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“If you look at the last three-year returns cumulatively, the sector has put on something like 27 per cent. So, average that out to about eight to nine per cent compounding per year, which is what you can normally expect out of REITs and property, and that is a seven to 10 per cent total return per annum,” he said. 

BOND YIELDS

Consensus within the industry is that rising bond yields are one of the major issues facing the REITs sector.

Rising long-term interest rates have caused some aggressive selling of REITs over the last two to three months.

“A lot of investors tend to bucket-list real estate as this interest rate-sensitive sector, so when bond yields rise, investors tend to sell out of REITs and buy growth equities,” said Beddingfield.

AMP Capital’s head of Australian real estate securities, Mark Ferguson, agreed, but noted that the real estate investment sector is a long game.

“With rising bond yields, the sector is definitely challenged in terms of any capital growth this year. But you must stop looking at daily share prices and the short term. Step back from the day-to-day noise you often read about."

The big question is: just how high will bond yields go?

“At the moment they’re around the 2.8 to 2.9 per cent mark, and they’ve been going up as US bonds have been going up,” Ferguson said.

“In the US you’ve got expectations of higher inflation and stronger growth coming through, and that’s driving higher bond yields. Here it’s a little bit different economically, but our bonds are following the US up. When that happens, it puts pressure on Australian REITs.”

Experts stress, however, that REITs require disciplined investors.

“There is this perceived benefit that direct real estate has lower volatility, but you don’t mark-to-market physical real estate every day as you do listed real estate. It takes a different type of discipline to be a listed investor – you have to wait the long game,” said Beddingfield.

Diamantopoulos said active managers can benefit from the volatility of the sector as they’re able to reposition and take advantage of movements and mispricings.

“As an active manager, you can either take advantage of those opportunities or you can take the rollercoaster ride that the index gives you and wear the ups and downs. The fact is you will have a smoother ride via active management,” he said.

“You shouldn’t be expecting ridiculous earnings per share growth or ridiculous uplifts in valuation. At the end of the day, property should be based on the underlying property fundamentals – occupancy, rental reversion and quality of asset."

ONLINE SHOPPING

One of the ongoing issues facing the worth of A-REITs as an asset class is the rise in online shopping and the introduction of major online retailers, such as Amazon, into the A-REIT index.

“A large portion of the A-REITs market is retail, and so again over the medium-longer term there is this ongoing erosion of bricks and mortar retail sales as more consumers transition to online shopping,” said Beddingfield.

There could be some winners, however, with industrial property looking to benefit from the surge in online retail penetration.

“That’s been reflected in share prices, but there could also be some winners in the shopping centre sector as well,” said Beddingfield.

Beddingfield explained that the results coming from the US showcased that the better mall operators are still performing well and generating good growth and high levels of occupancy, whereas the other end of the spectrum saw poorer quality shopping centre owners suffering.

“We think that will play out the same way here,” he said.

“High quality assets of high quality retailers will still continue to do better than those who own property in poorer quality shopping centres,” added Ferguson.

Diamantopoulos agreed in that it’s not all doom and gloom in the retail property sector.

“There are structural and cyclical challenges affecting retail but, if you look at the current results that have started to come through, retail is still holding up. Occupancies are still pretty full,” he said.

He said convenience-based retail, for example supermarket-based shopping centres, will continue to do well as these hold consumer needs.

“The big fortress malls, for example Chadstone and Bondi Junction, will continue to do well as they attract the international retailers. It’s centres that are in between – so too big to be convenience and too small or inefficient to attract the national and international retailers – that will see issues.”

WESTFIELD EXIT

The sale of Westfield to French property giants, Unibail-Rodamco, could also see some shifts in the A-REITs index. 

“The index will be more diversified by having less retail, and it’s a good thing that more diversified exposure is available for A-REIT investors,” said Ferguson.

Diamantopoulos said that, should the deal come to fruition, the Westfield weight in the A-REIT index could be reduced by six to seven per cent.

“The by-product of that is that there will be a potential mini-tsunami effect of potential capital that may still need a home within the REIT space. So the other stocks within the index may benefit at that point in time as investors need to place those funds,” he said.

Head of real estate and funds management at Centuria, Jason Huljich, agreed that the Westfield deal could mean good things for investors in the A-REIT sector.

“I think it’s quite good that it will be watered down with Westfield going offshore, meaning that there’s diversity in the Australian index,” he said.

The deal will see approximately $7 billion come back into the Australian market, with $1.5 billion of that to be reinvested in the Australian market.

“When that much capital comes back into the market, it usually bodes very well for REIT prices. Presuming it proceeds, somewhere around May/June that $1.5 billion will be coming back into the market looking for a home. So, you will see a pretty good REIT market about that time.”

UNLISTED PROPERTY SECTOR

Huljich said the unlisted sector is looking up.

“If you go down to the property metrics in Australia the results are quite positive. Looking at the commercial and industrial side, you’ve got New South Wales and Victoria performing very well, with very low vacancy rates in the office space,” he said.

“We’ve seen a large rental growth – somewhere between 10 and 11 per cent – in Sydney and Melbourne, meaning those markets are very strong. NSW has huge infrastructure spends in both rail and road, and obviously new airports, so that bodes well for all sectors of property.”

In terms of the rest of the east coast, the Brisbane and Perth markets have struggled in the last five years, but vacancy rates are decreasing.

“Brisbane and Perth are definitely coming right. We bought some commercial assets in Perth a year ago and that market has gone from a very high vacancy rate to having dropped to under 20 per cent,” said Huljich.

OUTLOOK

Experts are cautious about entering the A-REIT sector given the current economic climate, but don’t discount its worth.

“We feel the macroeconomic backdrop today is a little bit challenging for real estate in Australia, at least in the interim,” Beddingfield said.

Ferguson agreed, noting that if the past three months are any indication, this year will be a difficult environment for A-REIT investors.

“We’ve been so accustomed to falling bond yields and rising property values. Now we’ve hit the point of inflection where bond yields are on the rise, putting pricing pressure on A-REITs and REITs in general where bond yields are rising around the world,” he said.

Diamantopoulos remains optimistic, noting that these are the moments where investors should perhaps take advantage of REITs selling below book value.

“If you weren’t holding REITs you’d be looking at it as a re-entry opportunity,” he said.

“You’ve got very good markets in Australia, especially in NSW and Victoria and improving markets in Perth and Brisbane, which bodes very well for the underlying assets in the portfolios,” added Huljich.

Investors may want to look at investing globally where the sector is performing better.

“The UK performed extremely well post-Brexit, as did Europe, Singapore and Hong Kong,” Beddingfield said.

“Some of the best opportunities have been in Australia in the past, but there are some tremendous opportunities overseas run by some of the most outstanding and experienced real estate companies in the world, for instance student accommodation, manufactured housing, healthcare and hospitals,” Beddingfield added.