While there are challenges and uncertainties facing A-REITs, the sector remains a relatively low-risk investment choice, writes Phoenix Portfolios’ Stuart Cartledge.
The S&P/ASX 200 A-REIT Accumulation Index and the S&P/ASX 300 A-REIT Accumulation Index both dropped over the quarter, giving up 3.4 per cent and 3.1 per cent respectively.
The broader equity market was also weaker in the June quarter, however it outperformed property indices, with the S&P/ASX 300 Accumulation Index down 1.6 per cent.
Much of the weakness came in the sector’s largest names.
In particular, large retail landlords were hit strongly as negative sentiment stirred by the ‘Amazon threat’ surrounding the Australian retail sector permeated through the market.
Westfield Corporation was the worst performer, off 9.6 per cent, whilst Scentre Group and Vicinity Centres lost 5.6 per cent and 6.2 per cent respectively.
The property fund managers were clear outperformers across large cap property stocks, with Goodman Group up 3.4 per cent and Charter Hall Group rising by 2.5 per cent.
Infrastructure was the strongest performing subsector in the June quarter, as both stock specific news and continued low interest rates were supportive.
Macquarie Atlas rallied 9.6 per cent, while Sydney Airport and Transurban were also strong, lifting by 7.2 per cent and 3.8 per cent respectively.
While residential property has faced much negative media coverage in recent times, those exposed to the sector outperformed the broader index over the quarter, buoyed by solid quarterly market updates.
Mirvac Group was mostly stable, down 0.2 per cent, while Stockland fell by 2.8 per cent, still outperforming the broader REIT sector.
In stock specific news, corporate activity remained a theme. The takeover of the Brookfield Prime Property Fund was announced and completed during the quarter.
Both Industria REIT and Asia Pacific Data Centre Group (AJD) were the subject of 360 Capital Group (TGP) takeover rumours, with TGP requisitioning a meeting to install itself as manager of AJD.
Elsewhere, a proposal to partially internalise the management of Investa Office Fund was rejected by unitholders.
As an interest rate sensitive sector, property will come under pressure to the extent that we see a long and protracted rise in bond yields.
However, we would argue that the capitalisation rates used by property valuers have not fully reflected the upside pressure from falling bond yields and, as a result, a modest increase in bond yields can be easily absorbed.
The February 2017 reporting season and revaluations announced in June have confirmed the ongoing upward pressure, with book values revised upwards across the board.
Earnings certainty is another key driver that investors find appealing with property.
There have been very few downgrades to forecast earnings and we expect a robust outlook will also make property stand out in what may well be a difficult broader equity market.
The sector now offers investors a current-year distribution yield of around 4.9 per cent. In comparison to bond yields trading around 2.6 per cent, the yield premium of the sector continues to reside above its long-term average of 1.9 per cent.
Furthermore, today’s distribution yield is more robust than historical yields because it is based on a more conservative payout policy that retains some earnings to support growth.
We expect the uncertainties in the sector caused by Amazon to not impact earnings in the short-term because it will take some time to build. However, the industrial REIT sector will see a positive impact.
Over the medium-term, A-REIT earnings streams are relatively secure given the contracted nature of rental income and long average lease terms.
Furthermore, financial leverage is low, with gearing across the sector of approximately 30 per cent (debt to total assets) keeping the sector a relatively low risk investment choice.
Stuart Cartledge is the managing director of Phoenix Portfolios.
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