Property is attracting international and domestic capital, despite a relatively weak occupier market. Keith Power asks what this means for REITs.
Wikipedia defines a REIT as “a company that owns, and in most cases, operates income-producing real estate”. Manish Bhargava, a fund manager for APN’s Asian Real Estate Securities business, essentially agrees with this definition. The one key thing about REITs is they all lease pretty convincing properties, they collect a lot of rent every month or year and pay a very high ratio of that income back to the shareholders. So the dividend yields in a REIT are both high and attractive, he says.
According to Bryce Mitchelson, joint managing director at Arena Investment Management, most Australian REITs are now stapled entities as a company as well as a trust, for tax advantages. Arena itself is a boutique Australian REIT with exposure to office, industrial, retail as well as non-traditional types of property such as childcare and healthcare. Its investor base of approximately 16,000 is a mix of institutional and retail investors.
Mitchelson says the property market in Australia is currently in a sweet spot. Interest rates are very low, there have been plenty of overseas and domestic buyers in the market and, from a capital point of view, there is a shortage of property at the moment.
However, occupier demand is very weak, particularly for office space. Mitchelson attributes this to changes in technology and outsourcing overseas, especially in the case of call centres, and much more flexible work practices, with more people working outside of offices – for example, from home or while on the road.
So while there is much interest and investment flowing into property, driving prices up, this mismatch is not necessarily boosting income streams, which are generated by tenants. Consequently, incentives have been high with landlords chasing fewer tenants. Arena, for example, has been more of a seller of assets than a buyer in 2014, Mitchelson says.
Also, while property in Australia has had a good run, there will be an inevitable reversal at some point. Mitchelson predicts that in two or three years’ time, as both the domestic and global economies improve, the subsequent rise in interest rates will re-price property.
“As the property market improves – and we’re starting to see it now – the banks are starting to be a lot more free on their lending,” says Mitchelson. “As the market gets more liquid and free with capital, people will borrow more money, they’ll do quite well and all of a sudden will run the prices up to a point where [the market] is unsustainable and crashes again. There’s a cycle to it.
“We see opportunities in the more specialised space like childcare and healthcare, where the underlying demands are very strong and there has been a structural shortage of supply. If anything, since the GFC [global financial crisis] we’ve tried to refocus ourselves more in the non-traditional space.
“When we get old we need nursing assistance and it is very hard to find suitable accommodation. Most aged care accommodation is ‘four-bed wards’. We probably want our own rooms and facilities. When money started flowing back into property it went back into office buildings, retail, industrial. It hasn’t necessarily gone into the more specialised areas,” Mitchelson says.
In December 2013, Westfield Group (WDC) and Westfield Retail Trust (WRT) announced a proposal to merge WDC’s Australian/New Zealand business with WRT to form a new entity to be known as Scentre Group.
At the time, Frank Lowy, chairman of Westfield Group, said that the merger would create the largest REIT on the ASX (formerly the Australian Securities Exchange) and present a retail property investment opportunity that has not existed in Australia since the 1970s, before Westfield first expanded overseas. In June 2014, WRT security holders duly approved the proposed merger, although some players see it as Westfield semi-exiting the REIT market.
Nevertheless, Michael Doble, CEO of real estate securities at APN Property Group, is another who describes the Australian REIT market as in good shape. It is an ever evolving and changing sector, but not overcrowded and a market that is encouraging the participation of a broader range of investors, Doble says.
“It’s a market that yields around 5.5% of a distribution level and has a payout ratio of around 80%,” he says. “It’s a sector that’s been through the wringer through the GFC and had to recapitalise a number of stocks that destroyed a lot of value. The market fell very heavily, but a lot of that was really the fault of some inappropriate management strategies.
“I refer to excessive gearing and excessive investment in non-rental earnings. By that I mean REITs that bought funds-management businesses and had themselves exposed to risky, obscure earnings like property development. And they certainly paid the price,” says Doble.
However, after getting ahead of itself and the lessons it subsequently learnt, the sector is now again low-risk and very much focused on rent collection, he adds. After peaking at about 45%, gearing levels are back to around 29% and there have been significant changes within the senior management ranks of most Australian REITs, according to Doble.
“I always think the risks lie in complacency with management and not particularly in terms of their exposure to active earnings. It’s been a feature of the sector since the internal management model [that allows a corporation effectively to be stapled to a REIT] became more prevalent in the Australian market. In the US market, the internalised model has long been in existence, but a lot of Australian REITs were externally managed up until the last five or 10 years. That’s where the risks lie for the sector now and they always have.”