Australian Retail Estate Investment Trusts (A-REITs) have long been an integral part of a diversified investment portfolio. Alongside shares and bonds, investors often turn to A-REITs for their income streams and diversification benefits.
A-REITs allow investors to own an interest in a professionally managed portfolio of commercial real estate without the operating issues of owning the properties directly.
Most A-REITs own a diversified portfolio of properties, spread across various geographic regions, lease lengths, and tenant types. A-REITs provide exposure to both the capital value of the underlying properties and the rental income they generate.
The two fundamental characteristics of commercial property are the income received from tenants and the value of land and buildings. These form the income and capital components of returns.
Commercial property investors can choose to focus on capital growth, income, or a combination of the two. Certain types of commercial property may be acquired for their potential capital appreciation, while others may be acquired for their ability to generate cashflow (rent).
For example, a shopping centre with long leases might deliver an attractive cashflow but only moderate growth. Conversely, the development of a commercial office building during a boom in the office market may deliver little cashflow, but significant capital growth.
In the context of the A-REIT sector, investment is mostly centred on delivering sustainable levels of income over time from long leases to high-quality tenants. These cashflows are enhanced by the widespread use of typically moderate levels of borrowings by A-REITs on their balance sheet.
Historically, A-REITs have generally offered higher dividend yields than equities with similar risk profiles, resulting from their cash-flow-oriented businesses and their requirement to distribute all their taxable income given their trust structure.
[Editor’s note: Do not read the following commentary as a recommendation on the A-REIT sector. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article].
In addition to relatively higher income levels, A-REITs potentially provide the following benefits:
A-REITs have a track record of delivering solid total returns over the long term, in Charter Hall’s view. This is due to several factors including: solid performance in the underlying commercial property sector; the low-interest rate environment; the generally high-quality real estate owned by A-REITs; and the consistent and growing demand for income-focused investments given Australia’s ageing population.
For example, the Charter Hall Maxim Property Securities Fund has delivered a 14.6% annualised return over the last 10-year period. (As at 31 August 2021, after fees but before tax. Past performance is not a reliable indicator of future performance.)
A-REITs provide a liquid vehicle for investing in commercial real estate, an inherently illiquid asset class. Whereas physical properties may take months to market and sell, real estate securities are traded daily on ASX. The liquidity of A-REITs makes it easy to access investment capital.
A-REITs provide diversification in several ways. They can provide diversification at the broad investment portfolio level and the sector itself is diversified across sectors including shopping centres, office buildings, industrial and logistics property, self-storage facilities, childcare centres, service stations and hospitality. Within individual A-REITs, it is common to find a diversity of location and tenant.
Commercial property and A-REITs offer a hedge against inflation as tenant leases have annual reviews which are either linked to inflation or have fixed increases, often greater than inflation.
A-REITs are subject to oversight by government regulatory agencies, which require strict standards of corporate governance, financial reporting, and information disclosure.
Since the underlying assets of A-REITs are land and buildings, there is an intrinsic value that is often best depicted by their NTA (net tangible asset per unit). This contrasts with many listed companies which may only have intangibles on their balance sheet making valuation more difficult and uncertain.
Most A-REIT distributions deliver to investors some type of tax benefit which comes from building allowances and building depreciation, which is passed through the trust to investors.
[Editor’s note: Like any investment, A-REITs also have risks. Investing in A-REITs on the ASX website has more information features, benefits and risks of listed property funds.]
The A-REIT sector has delivered strong total returns to investors over the past 12 months, while still delivering attractive levels of income. For the 12 months ending August 2021, the A-REIT sector (S&P/ASX 300 A-REIT Accumulation Index) delivered a total return of 31.8%.
Presently, the A-REIT sector is also offering a sector distribution yield of 4.0%, which is 2.8% above the Australian 10-year bond rate of 1.2% and significantly above the official cash rate of 0.10%. Investors should note that these asset classes have different risk profiles.
These A-REIT yields increase to 5.0% if one looks at the sector on an equal-weighted basis rather than based on market capitalisation, owing to the large weighting of Goodman Group (ASX: GMG) in the A-REIT index.
This fact supports the case for active management in the A-REIT sector by specialised property securities managers, who can position their portfolios to focus on either higher levels of income or index outperformance.
The outlook for A-REITs over the next 12 months looks positive, in Charter Hall’s view. With continued Covid-19 vaccine rollouts, we expect that the easing of government lockdown restrictions and a return to more normal economic conditions will be supportive for owners/landlords including listed A-REITs.
We also expect interest rates to stay lower for longer which will be supportive for both commercial property and A-REITs returns.