Today’s A-REITs – slimmed down, more stable, but not without headwinds
It’s no secret that A-REITs were one of the hardest-hit asset classes during the GFC, and while A-REITs have taken the lessons from the GFC to heart, investor confidence has been slow to recover – and to reward the sector for its prospectively more stable business models and income streams.
While there is still need for investor caution, evidence is mounting that there are opportunities in the sector for those seeking income opportunities.
Today’s A-REITs are markedly more conservative than their pre-GFC incarnations. Pre-GFC, many A-REITs added leverage, increased their offshore investments, branched out into areas associated with less stable income streams, such as funds management and development, and became more aggressive in their earnings-to-dividends payout ratios.
Since this time, gearing ratios have returned to pre-GFC levels of about 30%, due to a combination of rebounding asset valuations and equity recapitalisations (rights issues). Several A-REITs have announced plans to wind down their overseas exposures and reduced or abandoned their efforts to pursue non-core fee streams. A-REITs are making allowances for capital expenditure and other expenditures while reducing earning payout ratios from nearly 100% during the market peak to the more sustainable level of 80%.
Australian property fundamentals are fairly strong with occupancy levels for core, major property types (office, retail and industrial) generally in excess of 90%, positive if modest pressure on leasing rates, and low overall levels of new supply. These fundamentals indicate a stable valuation outlook at the asset level, with future valuation gains to be driven by higher occupancies and slowly rising rents in the near- to mid-term.
Despite this, A-REITs underperformed their global peers during the GFC and have continued to do so during the global rebound. In fairness, US REITs have benefitted during the rebound from capital markets’ search for yield in the low-interest environment in the US, whereas A-REIT dividend yields in Australia are similar to those offered by term deposits.
That said, Blackstone’s bid for Valad Property Group at a greater than 50% premium to share price in late April may be interpreted as a sign international investors believe that in certain cases, the A-REIT share price discounts to net tangible assets (NTA) are exaggerated, and some represent buying opportunities.
Given the high degree of correlation between A-REIT and Australian equities performance, the major headwinds facing A-REITs are similar to those facing the Australian equity markets as a whole. These include: the drag of a high currency, modest though to positive non-mining related domestic growth, and uncertainty regarding the contagion effects of the European debt situation, sluggish US growth and a China slowdown.
In spite of these wider macro headwinds, there are a number of factors working in favour of A-REITs: the structural changes to A-REITs post-GFC, the stable outlook for Australian property fundamentals, the historical high component of income to overall return, and the current on-average modest discount of share prices from NTA. The combination of these elements means A-REIT shares now appear to offer a reasonable risk-return trade-off.
Martin Lamb is head of property, Asia-Pacific, for Russell Investments.
