AREITs benefit from volatile equity markets but investors should understand risks

From

Grant Berry

The volatility in equity markets has led to investors seeking more defensive investment options with Australian real estate investment trusts (AREITs) regarded as a useful alternative, says SG Hiscock & Company’s director and portfolio manager, Grant Berry.  

“REITS, or listed real estate, has the attraction of more predictable income streams than many mainstream equities, thanks to lease agreements that include annual fixed increases, CPI inflation increases and, in some cases, inflation plus increases.

“As an investment option, AREITs reflect the real, tangible nature of real estate. If gearing is low there is the appeal of knowing that there are real assets supporting value. As a result, AREITS have been an attractive option for investors who are seeking stable income as well as capital growth,” he said.

However, Mr Berry said investors need to understand the sources of income for REITs, as well as the assets and balance that support the investment, particularly as the property cycle reaches its later stages.

“While balance sheets are overall very healthy in the current low interest rate environment, given the stage we’re at in the property cycle, some of the drivers of recent growth within AREITs may start to taper off. 

“Investors should be aware that many AREITs undertake other activities such as development and third-party management, which create additional sources of income, but which may be vulnerable in the late stage of the cycle. 

“At the moment, there is considerable pricing dispersion within AREITs and, on our analysis, this is at the widest level since the global financial crisis. Investors therefore need to ensure they fully understand the current risks as well as the opportunities within the sector,” he said.

Mr Berry said the market is ascribing a considerable premium for what are considered higher growth groups, with earnings from development and funds management in particular. 

“This is late cycle behaviour, and warrants caution.

“Across the property sector, some trusts have had more investment support than others – in particular, industrial and office-focused REITs; however, the rental growth is more short-term than long-term, as pricing is very conducive for development, which will lead to increased supply.  

“At the other end of the spectrum, we are also observing high quality and lower risk groups trading at discounts to their asset backing, which we believe provides a real opportunity,” Mr Berry said.

He added that an unprecedented low interest rate environment, low capitalisation rates, e-commerce and the flow of capital are collectively driving the performance of the AREIT sector.

“Looking ahead, improved consumer sentiment, a bottoming-out in residential and the implementation of anticipated tax offsets will serve to improve confidence in retail and residential-exposed AREITs.”

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