What is an AREIT?
For a long time, AREITs were known as listed property trusts (LPT’s), a specific kind of commercial property investment structure that allowed ordinary investors to own a portion of a commercial property portfolio without being a millionaire. Examples include Dexus, GPT, and Scentre Group.
In 2008, Australia fell into line with other countries that use the term REIT, or Real Estate Investment Trust. We put ‘Australian’ in front of it, which is why property trusts are now known as Australian Real Estate Investment Trusts (AREITs, sometimes written as A-REITs).
This is a change in name but not in purpose. An AREIT allows you to invest in commercial property through the purchase of a part of its commercial property portfolio, bought and sold on the Australian Stock Exchange (ASX) like any other share.
AREIT ownership entitles you to an equivalent portion of the dividends it pays, called distributions, and the capital growth it delivers. This comes without the risk, expense or capital outlay of purchasing and owning an entire commercial property yourself. Of course, there are pros and cons, but for income investors, they can be an attractive option.
What is the key difference between residential and commercial property investing?
For decades, residential property investing has been the dinner party topic of choice. Buy a place (assuming you can afford the deposit) and negatively gear it on the basis that the capital growth will exceed the relatively low rental yields.
Commercial property isn’t like that. The AREIT sector’s focus is on delivering an attractive, stable yield, primarily from the rent collected from tenants. AREITs are therefore seen as more defensive investments where capital growth is secondary to yield.
Whilst the foundations of residential and commercial real estate are bricks and mortar, commercial property investing tends to attract investors primarily focused on income whilst residential investing emphasises capital growth.
There are other differences, including ease of access to markets and liquidity, but buyer motivation and the source of future returns are seen as the key difference between investing in commercial versus residential property.
How do AREITs work?
Before the advent of AREITs, the only way to invest in commercial property without buying a building outright was via a property syndicate, an illiquid fund that used to be the preserve of specialist investors. It was not possible to purchase a part of a shopping centre, warehouse or hospital in a way that made buying and selling easy and low cost without much capital outlay.
The advent of the listed property trust sector in the 1970s changed all that. Now anyone can access commercial property indirectly, buying and selling small parcels of real estate much as one does an ordinary share, with minimal upfront capital commitment.
An AREIT is a publicly-listed company that pools investor funds much like a managed fund. But instead of buying shares, an AREIT purchases and manages a portfolio of commercial properties, which might include office buildings, shopping centres and warehouses.
AREIT managers are responsible for the upkeep of their buildings, leasing the space and collecting the rent from tenants, charging a fee for their services. In return, AREIT investors avoid the hassles of owning and managing commercial property. They are also responsible for maximising and distributing the income the AREIT receives, primarily from rents, to their investors.
In Australia, some trusts operate as stapled securities, where a development or funds management company is attached to the trust. This enables the AREIT to potentially deliver to investors higher growth as it has a broader range of earnings sources. However, these earnings are more volatile than collecting steadily growing rent from a tenant over the term of a secured lease.
Stapled securities with large components of corporate earnings should be considered differently as they are more akin to the real estate operating companies seen in offshore markets than a traditional REIT.
No matter their structure, it is the rental income stream, asset values and the value that the market places on those things that typically determine an AREIT’s value over time.
What type of AREITs can I invest in?
In addition to the usual categories of office, retail and industrial, AREITs also offer access to other kinds of commercial real estate including healthcare property, childcare centres, convenience stores and data centres. Despite the growing variety, commercial property investing is usually categorised into three areas:
- Investing in retail real estate – This includes buildings like shopping centres – your local Westfield for example – retail shopping strips, restaurants, service stations and convenience outlets.
- Investing in office real estate – These are the towers that mark the skyline of Australia’s major cities and the office parks that dot suburban areas. They tend to be occupied by larger local and multinational businesses.
- Investing in industrial real estate – From simple warehouses and distribution centres to highly specialised facilities, these are the places where things are made, stored, distributed and where new products are developed.
There are over 30 AREITs listed on the ASX, offering exposure to the three core commercial property sectors (office, retail and industrial) along with those that specialise in owning non-core assets such as aged/childcare, hotels, service stations, storage assets.
What is the average return on AREITs?
Over the last decade to 30 June 2019, the S&P/ASX 300 AREIT Accumulation Index has returned 14.03% p.a.
The APN AREIT Fund (the red line), an actively managed portfolio of AREITs, has delivered an average yield of 8.27%1 over the same ten year period.
Investing in AREITs is not risk-free, although it is generally assumed to be lower risk than investing in ordinary shares. An ordinary listed company pays dividends from the profit it makes, which can change rapidly from year to year. Because an AREIT typically pays dividends (called ’distributions’) from rents collected rather than profits, the income stream is generally more predictable and reliable.
Are AREITs a good investment in 2019?
As of 30 June 2019, the 10-year bond yield was 1.32% while the S&P/ASX 300 AREIT Accumulation Index offered a yield of 4.46% and the APN AREIT Fund offered a yield of 5.90%2. Of course, different risks are attached to each. Bonds are government-guaranteed in a way that every other investment is not.
Judging a return should, therefore, be assessed in light of the risks taken to achieve it. Whether this amounts to a sound case for investment depends on your circumstances, tolerance for risk and investment objectives, plus a number of external factors, including the state of the economy and the level of interest rates.
If you’re in search of regular, reliable income and have an investment time frame of 5-7 years, AREITs are worthy of your consideration.
How do I choose an AREIT?
In our view there are six factors to consider;
- Quality of management – Factors like the ability to achieve rental increases, sensibly manage properties, negotiate with tenants, provide reliable dividends and manage debt will help you build an overall picture of management quality and skill.
- Portfolio diversification – No investment should be made in isolation. If your AREIT portfolio is overexposed to one particular sector your diversification risk increases. Consider each investment in light of how it will affect your overall portfolio.
- Earnings, dividends and growth – Whilst past performance is no guarantee of future returns, examining an AREIT’s financial history and how it has translated to investor returns will give you a better feel for the company and its assets.
- Debt levels – Debt is an important factor in every business and AREITs are no different. Prior to the global financial crisis, the AREIT sector had a debt binge that was followed by an unprecedented liquidity crisis. Since then the sector has returned to its knitting with debt levels near post-1999 laws. Debt levels are a major driver of AREIT returns and they should always be watched carefully.
- Exposure to non-rental sources of income – Australian Real Estate Investment Trusts are unusual in that regulations permit them to generate a large component of their earnings from non-rental sources such as development and funds management. In Asian REIT markets these riskier earnings are either prohibited (Japan) or limited to maximum levels (10% in Hong Kong; Singapore 25%). Income from funds management and property development – the typical sources of non-rental income for AREITs – is generally more volatile. Check each AREIT to determine the extent of non-rental related income and read The Goodman effect for a real-life example.
- Use other valuation metrics – Here, you have a smorgasbord of options. Take your pick from net asset value (NAV), price-to-funds-from-operations (P/FFO), net tangible assets (NTA) and capitalisation rate.
I don’t want to build my own AREIT portfolio. What options do I have?
If you don’t have the time, skills or inclination to build your own AREIT portfolio but still want to access the benefits and income stream of AREIT investments you have two choices.
The first is to invest in a property securities fund like the APN AREIT Fund. This gives you immediate access to a team of expert commercial property analysts. They determine which investments to buy, hold and sell, with the aim of maximising your returns and income stream.
For a fee of less than 1%, you get immediate diversification, simple administration and a monthly distribution paid into your bank account, leaving you free to get on with your life.
If this doesn’t sound like your thing, you might want to consider an unlisted property trust, sometimes known as a syndicate like the APN Regional Property Fund. When you invest in this structure, you’re only one step removed from direct ownership, which gives you a higher degree of visibility and financial involvement in the properties themselves, but also a higher degree of risk.
- An Australian real estate investment trust (AREIT) is a company that owns and operates income-producing commercial properties;
- AREITs can be bought and sold just like ordinary shares;
- As most of their returns come from dividends, investors reliant on income tend to be attracted to AREITs;
- AREITs offer many different types of commercial property investment exposure, from shopping centres, offices and warehouses, to healthcare buildings and data centres;
- In the decade to 30 June 2019, the APN AREIT Fund has provided an average annual yield of 8.27%1 ;
- If you don’t have the time or skills, consider a property securities fund like the APN AREIT Fund or a property syndicate.
1. As at 30 June 2019.
2. As at 30 June 2019. Current running yield is calculated daily by dividing the annualised distribution rate by the latest entry unit price. Distributions may include a capital gains component. Distributions are not guaranteed and past performance is not an indicator of future returns.
There was a time when investing in commercial property was “all or nothing” affair. It was impossible to purchase a part of a shopping centre, warehouse or hospital in a format that made it easy to buy and sell. Everything was purchased and sold in its entirety, which is why to this day many investors think commercial property is beyond their means.
The advent of the listed property trust (AREIT) sector in the 1970s changed all that (read our AREITs: The 2019 Essential Guide). The first Australian AREIT – General Property Trust – was listed in 1971. At June 2019, there are 28 AREITS with a combined market capitalisation of $170bn in the AREIT 300 Index, with several other smaller AREITs owning high quality commercial real estate not included in the index.
Investors now have the option of investing directly in AREITs or using property securities funds, which have experienced management teams doing the leg work for investors.
Commercial real estate investing has also expanded to include unlisted property trusts, sometimes known as syndicates which are focused on secure income and, generally, a fixed term which removes daily volatility.
Therefore, investors have a range of options to access commercial property markets that provides income and sustainable growth benefits for which the asset class is renowned. In addition to this comes with minimal upfront capital commitment.
Why choose Australian Real Estate Investment Trusts (AREITs)?
You may not know of the term, but you will almost certainly know the names. Scentre Group (owner of Westfield Shopping Centres), Dexus and Mirvac are but three well-known AREITs. There are many more.
In fact, because many investors the world over want reliable, stable yield, each major global share market has its own ‘real estate investment trust’ (REIT) sector.
AREITs are trusts that own, manage and operate income-producing commercial real estate. Listed on the Australian Securities Exchange (ASX), AREITs can be traded just like ordinary shares, allowing investors to purchase an interest in a diversified, professionally managed portfolio of real estate in much the same way as you would purchase shares in a portfolio of companies.
There are seven major benefits of using AREITs to gain exposure to the commercial property sector:
1. Easy to build a diverse portfolio
The AREIT sector includes thousands of properties, from shopping centres, commercial office space and healthcare facilities to medical centres, data centres and warehouses. You can even access REITs in Asia, Europe and the US, making it easy to build a diverse portfolio of commercial property assets. Or you can invest in a property securities fund like APN’s AREIT Fund and Asian Fund, which, for a fee, delivers an instant, diversified portfolio with expert management.
2. Simple to buy and sell
Investing in AREITs is as easy as trading ordinary shares, and just as cost-effective. And because there’s a liquid market for most securities you can usually buy and sell when you want. Of course, you’ll need a broking account, but once you’ve got that you’re good to go.
3. Low entry costs
Compared to the large capital commitment required when directly purchasing a commercial property investment, buying AREITs requires only a small capital outlay – as little as the minimum parcel of securities required by your broker.
4. Relatively high yields
Due to their trust structure, AREITs generally pay out a higher percentage of earnings as distributions than ordinary shares. They also tend to offer a more dependable, higher yield than that usually available from residential property, or from dividend-orientated shares like the major banks or Woolworths, for example. Because income is typically sourced from rents rather than more volatile corporate earnings, the sector tends to attract investors reliant on a regular income.
5. Management expertise
Each AREIT is managed by a team of specialist property and investment experts focused on maximising rental returns and long-term capital growth for their investors. This also removes the need of investors to participate in rental negotiations, building maintenance and the like.
6. Tax effective
The regular income distributions from property trust investments originate in the rental income received from tenants. These distributions may contain a ‘tax-deferred’ component, which occurs if a property trust’s distributable income is higher than its taxable income.
Because a trust can offset its taxable income through a range of deductions – depreciation on plant and equipment, capital allowances on building structures, interest and costs during construction or refurbishment, and the costs of raising equity to name but a few – a trust’s distributable income is frequently higher than its taxable income. See the Hidden benefits of tax-deferred income for a more detailed explanation.
7. Capital growth
Growth is generally consistent with inflation over the medium to long term, adding to AREITs’ defensive qualities. Although there is an element of capital growth, AREITs tend to be income-driven investments, which is why they attract investors seeking a stable, sustainable income stream from commercial property, with little up-front investment.
What are the risks1?
As with ordinary shares, AREITs can sometimes be relatively cheap and at other periods over-priced. There’s a risk that you might buy and sell at the wrong time.
Then there’s the need for diversification, across various sectors and geographies. Building a sensible, high-performing portfolio of AREITs requires similar skills to building a portfolio of listed shares. You may not have the time or inclination to acquire those skills.
Finally, there’s the risk that every self-directed investor takes; whilst acquiring sophisticated analytical skills – assessing an AREIT’s debt levels, management capability and earnings capacity for example – is one thing, applying them successfully at a time of high emotion is quite another.
It’s for these reasons that some AREIT investors prefer to pay expert professionals to develop and manage a high-performing commercial property portfolio on their behalf.
How have AREITs performed?
AREITs generate most of their income (circa 55-70%) from the rent collected from the tenants of the retail, office and industrial properties they own. The chart below shows total returns over five and 20 years by sector.
The above chart shows the importance of income to total returns. Of course, the associated risk is greater than a term deposit but it’s typically lower than the kind of yield you might get from ordinary shares.
Over the last decade, AREITs have delivered an income stream, in the form of a distribution yield, consistently above the 10-year bond rate.
What is the outlook for 2019?
In the 2019 financial year, the S&P/ASX 300 AREIT Index returned 19.4%, the strongest result in three years and 8% higher than Australian equities.
Declining interest rates have played their part. In the short term at least, as interest rates decline, the stability of the income stream an AREIT delivers tends to be valued more highly. Whether this continues is impossible to say.
There are also some sector-specific issues at play. The out-of-favour retail sector returned -0.9% over the year to April 2019 while the office sector returned +35.8% and industrial a staggering +47.5%.
JPMorgan forecasts earnings per share (EPS) growth of 3.6% (up from 3.3%) in 2020, with FY19 distributions (DPS) expected to grow by 3.2% (down from 3.8%). Given the low growth environment and inflation below the Reserve Bank’s target rate, this would be no small achievement.
AREITs should be considered as a long-term investment. Over a five to seven-year period, we estimate investors can expect an 7-10%2 p.a. return from AREITs, most of it derived from income, plus growth that typically equates to the rate of inflation.
Recent returns have been greater, driven by lower interest rates and non-traditional investors seeking yield and capital insulation. An annual return of around 10% over the long term, however, remains a good rule of thumb.
1. General risks apply to an investment, refer to the APN AREIT Fund PDS to read a list of all the risks an investment carry: https://apngroup.com.au/wp-content/uploads/2019/07/AREIT-PDS_JUN2019_combined2.pdf
2. APN Estimation as at August 2019. This article contains “forward-looking” statements. Forward looking words such as, “expect”, “anticipate”, “should”, “could”, “may”, “predict”, “plan”, “will”, “believe”, “forecast”, “estimate”, “target” and other similar expressions are intended to identify forward-looking statements. Forward-looking statements, opinions and estimates provided in this article are based on estimates and assumptions, hence are inherently subject to significant uncertainties and contingencies. Many known and unknown factors could cause actual events or results to differ materially from estimated or anticipated events or results reflected in such forward-looking statements. Past performance is not necessarily an indication of future performance. The forward-looking statements only speak as at the date of this article and, other than as required by law, APN disclaims any duty to update forward looking statements to reflect new developments. To the fullest extent permitted by law, APN makes no representation and give no assurance, guarantee or warranty, express or implied, as to, and take no responsibility and assume no liability for, the authenticity, validity, accuracy, suitability or completeness of, or any errors in or omission, from any information, statement or opinion contained in this article.