AREITs continue to suffer from a lack of investor demand four years after the onset of the GFC, but there appears to be an increasing trend for investors turning their attention towards stocks with exposure to riskier sectors of housing and retail in order to boost returns.
For example, small listed real estate investment trusts (REIT) have managed to stabilise and are starting to attract more institutional support.
Now that property trusts are gingerly getting themselves back on their feet, whatever their strategy, they are starting to reconfigure in the wake of the GFC.
"Property trusts have really been trying to reinvent or redefine what they are," Australian Unity chief executive David Bryant says.
"I think one of the challenges for everyone when they look at the sector is, 'is this just an industrial trading company and instead of shampoo its product is property or is it property ownership?' At a retail level, investors have always seen listed property trusts predominantly as owners of property and collectors of rent. That is what they understand to be the dominant component of what they're investing in."
Bryant explains that property trusts are likely to go one of two ways: a company will either pick a sector and create a clear strategy, such as Stockland with its three R (residential, retirement living and retail) strategy; or revert to the older generation listed property owner type of trust such as Centro and its plans to merge its businesses.
"Most people are getting away from the 'be all things to all people' space, which is where a lot of the debt came from. Getting back to a more specialised and more clearly defined portfolio [is key]," he says.
Morningstar senior research analyst Adrian Atkins agrees, saying: "They're trying to just get back to the old days of being just a low-growth income investment. So they're reducing gearing and selling foreign assets and portfolio and just going back to basics. That's the trend right now, going back to basics.
"It might be pretty difficult to sell so it could take years [until they are back to basics], but given gearing is okay, it's not a massive concern."
What does this mean for advisers?
The challenge for investors and advisers is to try to weigh up returns relative to equities. The shift in the market is a tricky one and there is a question over whether the AREIT sector is a sensible move for investors.
"I definitely think [AREITs are a good idea for advisers]," Atkins says.
"It's good for conservative investors looking for yield for extra income. That's what they offer and that has got to appeal to retirees and other investors who want lower risk investments with more yield [but who] aren't really searching for growth."
Resolution Capital managing director Andrew Parsons agrees that relative to fixed income alternatives, REITs are starting to look reasonable. But Parsons urges investors to look at REITs on a global basis, citing the fundamental problem in Australia is the lack of choice.
"I think [advisers] have got to start getting comfortable with looking at global REITs. It takes a little bit of work to get familiar and comfortable with the names, but global REITs contain some truly great real estate platforms and real estate management and if you look at the performance of global REITs versus global equities over the last 10 to 20 years, global REITs have actually performed extremely well," he says.
"Everyone has been concerned with volatility and, of course, short-term volatility is very disappointing, but I think investors really need to take a longer-term view and look at the long-term results, and long-term results suggest that a global REIT exposure produces very competitive returns."
He notes that it is important advisers take the time to look into the fundamentals of global real estate vehicles to better appreciate what they are buying, which is sensibly leveraged vehicles with high-quality real estate in an environment where new construction is low, making the outlook for global real estate quite strong.
"The focus on AREITs is flawed. There are some competitive stocks, but there's just not enough depth and breadth of stock to get comfortable, with a few exceptions."
Company shifts
Several corporate movements have highlighted increased interest in the Australian listed property sector.
Firstly, and probably most timely, is Centro and its efforts to merge and refinance its Centro Property and Centro Retail businesses.
On 22 November, investors voted on the refinancing and reformation of Centro Property and Centro Retail to become Centro Retail Australia. On 24 November, the group had a second court date to approve relevant members' and creditors' schemes.
The restructure would mean the new company would be debt-free and the second largest property manager in Australia.
With that in mind, and with ownership of 43 shopping centres nationally and a market value of $4.4 billion, Centro Retail Australia would be a target for potential takeovers.
Charter Hall Office REIT announced earlier this year that it would exit the United States market and sell its entire US portfolio to Beacon Capital Partners for a gross sale price of US$1.71 billion, or US$1.57 billion after estimated costs and adjustments.
After successfully repositioning Charter Hall as an Australia-only REIT, Macquarie Group led a consortium bidding for Charter Hall's remaining stake.
But in October, Macquarie opted out of the privatisation bid after Singapore wealth fund GIC and Canada's Public Sector Pension Investments Fund upped their bid.
GIC and the Public Sector Pension Investments Fund agreed to buy out Charter Hall Office REIT's remaining stake for $400 million each, an extra $100 million each than the initial commitment.
In August, Australian Unity Investments (AUI) started to prioritise boosting the Investa Diversified Office Fund's liquidity, following the financial services group's agreement to purchase Investa's retail property funds business for an undisclosed amount.
"Our intention is to open the fund for applications and to develop liquidity options for investors over the coming months after we become the responsible entity," AUI general manager for property, mortgages and capital markets Mark Pratt said in August.
The acquisition, when finalised, would mean AUI's property funds business would have almost $2 billion in FUM.
"The acquisition is the latest step in our long-term strategy to grow our property funds business," Pratt said.
"The Investa funds add a substantial office portfolio to our sizeable retail, commercial and healthcare property funds, as well as augmenting our existing industrial property funds."
Other AREIT companies are following suit and looking for potential mergers. For example, Challenger Diversified Property Group, GPT Group and Investa Office Fund are also looking into acquisitions in order to strengthen their position in the market.
Caution ahead?
According to Huntleys' Your Money Weekly AREITs report in October, confidence in the sector is fragile and volatility is expected to continue.
"A continued stock market rally could see beaten down stocks rebound strongly but long-term investors are encouraged to focus on good quality," the report says.
Atkins says investors have to continue the strategy of selling offshore assets.
"Vacancies increased during the GFC so office trusts and industrial trusts need to focus on leasing up vacant space," he says.
"Confidence will gradually build. If they keep delivering, then it will build."
The GFC has meant that a lot of entities have disappeared in the AREIT market and bigger players are focusing much more on their strategy and having clearer capital management and debt. For the long term, this could generate quite attractive returns, but for now the market seems to be adopting a wait-and-see sentiment.
"The next couple of years will be a period of really proving that they have their game plans sorted out and they can deliver on them," Bryant says.
Now seems an opportune time for people to begin thinking about the sector, to look at the returns they are getting and ensuring they are seeing continued evidence that their strategy and business plan are stable.
"From a distance [the AREIT industry] looks to be much more settled, but I think that for a period of time, investors are going to want to see continued evidence of that confidence to come back," Bryant says.
"[Moving forward] I think it's going to be quite cautious. I think it will take some time to come back."
Despite concern over the future of AREITs, leading to a weak outlook for the sector by some people, Macquarie has a more optimistic outlook for the future.
"At Macquarie Private Portfolio Management we view the AREIT sector as attractively valued on a long-term view, and in the near term we like the sector's defensive earnings stream, with high income certainty," Macquarie portfolio manager Michael Frearson says.
"The sector is currently trading on a forward yield of 6.6 per cent, which is looking increasingly attractive given the recent fall in domestic interest rates."
Frearson explains the 78 per cent payout ratio is a more conservative and sustainable distribution policy than AREITs had prior to the GFC.
Macquarie expects the sector to continue to perform relatively well in the near term owing to a recent fall in domestic interest rates providing support to it.
"We expect underlying asset values to be stable in the near term with some moderate growth, driven by income growth likely to occur for higher-quality assets. The two-tiered market is expected to continue, with higher-quality assets likely to outperform lower-quality sub-sectors," Frearson says.
The risk of the AREIT sector being overtaken by developing markets in Asia and elsewhere that are able to offer a broader range of products and higher returns also fuels uncertainty in the future of the sector, but Macquarie is not put off.
"While the AREITs' index weighting in global REIT indices has fallen, it still remains one of the largest REIT markets in the world by market capitalisation, although not by the number of securities listed. Additionally, the AREIT sector generally has a higher percentage of passive REIT structures, rather than development exposure, which is common in Asian markets," Frearson says.
"Given the growth in developing economies from Asia and Europe, we do expect the sector's weighting in global benchmarks to continue to fall given the current outlook.
"However, it is important to note that this view can change quickly, because if and when the sector resumes trading at a premium, a number of additional AREITs could be listed, which will boost sector diversification and reduce sector concentration risks."
History of AREITs
When AREITs began, the concept was simple - property trusts were an ownership vehicle that owned properties, had tenants and paid rents with the benefit of liquidity.
Over the past 20 years, property trusts realised they could be much more than just ownership vehicles and, in time, owning properties became a much smaller part of their business. The trend for property development increased and property trusts and their business became more diverse, essentially becoming industrial companies, with property as the product, rather than simply just property trusts.
When the global financial crisis (GFC) arrived, it had a huge impact on the property sector and property trusts, as they had become, got themselves into a circular situation. Being aware that the more they owned, the more they could charge, their priority became owning more property, regardless of its value and the deal made.
The best way to buy more property was to borrow money, and the best way to borrow money was to increase the value of existing properties.
Soon enough, the valuations rose while yields continued to fall, trapping companies in debt. They were aware that the only way to increase yield was to sell some of their properties and pay off debt, but they were faced with the problem that, with such high valuations mid-GFC, no-one would buy, and they couldn't lower the values because it would breach their debt governance.
Benefits of investing in AREITs:
* Income and capital growth: Distribution yields are either quarterly or six-monthly, allowing investors to regulate their cash flow. They also offer opportunity for capital growth.
* Low-cost exposure to real estate: Access to the property market at a relatively low transaction and management cost.
* Liquidity: Can be bought and sold via any stockbroker on the Australian Securities Exchange.
* Taxation advantages: Access to tax concessions.
Key risks of investing in AREITs:
* Market risk: Risk of investing in an asset class that may decline in value owing to market sentiment following asset devaluations, et cetera.
* Income risk: Past distributions cannot be guaranteed for the future.
* Gearing risk: Some may borrow funds to increase potential returns, a technique that can magnify both returns and losses.
Source: Australian Securities Exchange
