AREITS: THE 2019 ESSENTIAL GUIDE

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.

WHY CHOOSE AUSTRALIAN REAL ESTATE INVESTMENT TRUSTS (AREITS)?

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.

KEY TAKEAWAYS:

  • 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.