AREIT RISKS AND REWARDS: 2019 GUIDE

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.

Source: JPMorgan

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.