Patrick Noble suggests investors should stop overlooking property and reap the rewards from the renaissance.
The Australian Real Estate Investment Trust (AREIT) market has experienced quite a renaissance over the past four years, but despite undergoing a much needed rehabilitation the sector still remains overlooked by many.
Laying the foundation for a revival
In 2008/2009 the sector saw the substantial de-risking of balance sheets through a combination of equity raisings, reduced gearing and improved portfolio quality.
These necessary actions laid the foundation for the sector’s revival and ensuing performance. Deep discounts to net tangible assets (NTA) at the time didn’t hurt either.
Property valuations have since stabilised and distributions have also been rebased to more sustainable levels. So AREITs are now in very good shape and the extent of this progress can be seen in Charts 1 and 2.
Chart 1 shows the heavy equity raisings conducted over 2008 and 2009, shoring up balance sheets. Coupled with non-core asset sales, Chart 2 highlights the commensurate decrease in gearing – all the more striking considering falling asset values at the time.
A favourable outlook for willing investors
For investors willing to look at the sector now, the outlook remains favourable.
The primary driver behind the investment proposition is that once again, the sector exhibits its traditional hallmarks – a lower risk profile than equities and an attractive yield.
Furthermore, a number of AREITs are still trading at discounts, and recovering sub-sectors, such as residential, also offer interesting opportunities. The prospect of some ‘cap rate compression’ (valuation upside) could also be another positive factor over the next 12 months.
Adding value through active management
While the opportunities are there, they are not universal across the sector, creating a vexing issue regarding the use of passive investing in the index.
While one can focus on cost, the fact is that over the past five years to June 2013, the index has been a third quartile performer, while the top quartile managers have delivered strong excess returns.
Neither is it a debate on the dominance of Westfield Group or sector concentration. Rather, it is the diversity of trusts; by strategy, property type and location, and the dispersion of returns (and risks) that create opportunities for active management.
While the index returned just under 24 per cent for the year end to June, Chart 3 shows a range of returns across some select REITs over the financial year.
The opportunities are there for active managers to exploit and remain in place across key sectors and specialist REITs, such as pubs and childcare centres, over the coming year.
Retail versus residential investment outlook
Retail is facing a number of headwinds that may be problematic for the sector. Retail sales growth has been weak and “over-renting” has manifested in negative re-leasing spreads. Some may also argue the sector faces structural headwinds, though some cyclical influences are starting to abate.
Conversely, the residential market is showing signs of improvement. Affordability has improved through a number of mechanisms including lower prices and interest rate cuts.
Finance numbers for home loans and investment approvals have also seen modest upticks of late.
There is also structural support for medium density housing due to demographic demand and state subsidies aimed at new construction.
With NSW expected to lead the broader housing recovery – Mirvac’s higher exposure to apartments and its presence in key urban areas such as Chatswood and Harold Park in Sydney – are likely to be a key driver of returns over the next couple of years.
At its May 2013 update, Mirvac reported continued momentum in pre-sales of the Harold Park development, a highly sought-after area near Sydney’s CBD.
A simple Google search of Harold Park will show the extent of the wealth creation, with the old paceway transforming into an up-market residential precinct. Like the pub across the road, Mirvac shareholders could also be beneficiaries when the project marks its completion.
For investors looking for attractive yield and a lower risk profile, AREITs can fill the vacancy. It’s time to stop overlooking AREITs and start reaping the benefits of the renaissance.
Patrick Noble is a senior investment strategist at Zurich.
