Opportunities in Australian listed real estate
Mark Ferguson explores the opportunities in Australian real estate investment trusts, and outlines the sector outlook in different segments.
You only need to look at the continued interest in Australian property from international investors to see the attractiveness of the sector.
Many large global pension funds hold investments in Australia via direct property, property funds or as holdings in Australian real estate investment trusts (A-REITs).
Australian listed property is an asset class within the property universe that is something of a quiet achiever. What many investors don't recognise is that it can provide good direct-property-like returns over the long term due to A-REITs' sustainable underlying rental income streams.
Investors in A-REITs are also able to own some of the highest quality Australian commercial property available, similar to the Australian property portfolios of Australian wholesale property funds, global pension funds and the largest Australian institutional property funds.
A-REITs hold more than $93 billion in assets domiciled in Australia. Foreign demand for Australian property helps to underwrite property values and also provides an increasingly deeper, more liquid property market, which allows for more efficient price discovery and improved cross-border investment capital flows. A-REITs have been very successful partnering with global pension funds and sovereign funds either at an asset level or at a wholesale fund level.
In an investment world of low returns with zero or even negative real interest rates, A-REITs offer a sustainable distribution yield plus an element of growth. Distributions are rental income derived from contractual rental agreements often based on rental terms of five years or more in some cases. Quality often marks an A-REITs portfolio: prime grade commercial property assets, a healthy rental term of five years plus, and a tenant list that includes ASX-listed companies with high credit ratings and many government departments at both the federal and state levels.
In the A-REIT market, the investment opportunities are predominantly spread across the major property asset classes of retail (52 per cent of assets), office (19 per cent), industrial (10 per cent), offshore retail (12 per cent), and offshore industrial (four per cent).
More than 90 per cent of A-REIT property exposure is on the east coast. These property exposures are located in the conurbations of Sydney, Melbourne, and Brisbane, and will continue to benefit from the east coast industry economic growth drivers in construction, infrastructure, retail, education, healthcare, technology, financial services, and professional services.
The property investment trend we see continuing is property investors being more discerning in owning high quality commercial property portfolios that are situated in greater Sydney, Melbourne, and Brisbane, which will be the major focus for Australia's economic growth during the next few decades.
Hence, quality property in these locations will provide superior rental growth and greater long-term capital growth. A good example of this is in Sydney where the major A-REIT office landlords have attracted quality tenants in the technology space such as Atlassian, LinkedIn, Apple, and Twitter. The same phenomenon has played out in the retail property market with A-REIT retail landlords at the forefront of attracting the immense wave of international retail tenants such as Zara, H&M, Marks and Spencer, Sephora, Uniqlo, and many others.
The A-REIT sector also offers diversity within each of the property sub classes of retail, office, industrial, and residential. For example, the retail property market includes regional centres, sub-regional, neighbourhood, supermarket-based centres, direct factory outlets, and large format retail centres.
Office assets are predominantly prime quality, that is, premium or A-grade, which are located in the major CBDs of Australia as well as suburban office and business parks.
The industrial sector is better known for its logistics centres but also includes warehouses, light manufacturing and some industrial/office assets.
Residential development activities encompass land lot sub division, housing and apartments. Other evolving property asset classes to emerge have been healthcare, retirement living, childcare, self-storage, data centres, hotels, and manufactured housing estates.
These property asset classes are embryonic in nature and we expect some of these to grow at a much faster level than the overall A-REIT sector.
Sector outlook
Retail
We favour the retail landlords with the highest quality regional shopping centres that are redeveloping their centres to cater for the changing consumer needs of experiential shopping: entertainment, casual dining, and a full range of international retailers.
At the other end of the spectrum, we are positive on the outlook of well-located neighbourhood centres anchored by strong supermarkets that provide consumers with convenience-based shopping.
Office
Across the capital cities, the outlook is very divergent. Our preference, however, is toward the employment growth markets of Sydney and Melbourne.
The Sydney and Melbourne CBD office markets are expected to be the greatest beneficiaries of employment growth generated by technology firms, financial services, education, healthcare, and professional services.
The Sydney market is expected to see good rental growth during the next three years as the level of landlord incentives paid to tenants is reducing and the supply outlook for 2017 to 2019 is much more muted.
The level of foreign demand for quality office buildings in Sydney and Melbourne is expected to remain at elevated levels and hence with expected rental growth this will also underpin capital values.
Industrial
The industrial sector has seen a dramatic rise in values in part due to soaring land values in properties located in close proximity to major urban centres as residential developers have acquired sites for future apartment developments.
Due to the easily replicable nature of industrial property, quality of location (near ports, infrastructure nodes) and facilities, tenant type, and duration of leases have become very important investment attributes at this point in the cycle.
Mark Ferguson is the head of Australian listed real estate at AMP Capital.
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