The Australian Real Estate Investment Trust (A-REIT) market has long been viewed as a safe source of capital gains and regular income but the pandemic has changed that, and the recent volatility may not disappear soon. Among the clouds, however, there are new opportunities.

The assets of a typical A-REIT include such things as commercial office buildings, industrial properties, retail shopping centres, hotels and leisure venues or even residential property.

They have long been favoured by investors because they have the potential to provide good returns in the form of capital gains along with a regular distribution of income. They also enable investors to gain exposure to the commercial property market without the requirement to manage the properties themselves.

Covid shake-up

But over the past two years of the pandemic, many of the assumptions underpinning this sector suddenly changed.

In the office market, the shift to working from home hit city CBD offices hard. Inner-city shopping precincts suffered from the same issue though suburban demand for space increased. With retail shops shuttered during lockdowns, online purchasing exploded to unprecedented levels. Supply chain disruption also hit imports but gave a fill-up to local manufacturing.

As the pandemic eases, it is these changes in structural forces underpinning the A-REITs that some see as driving the new opportunities for investors, while background economic factors have begun to look more positive.

Growth outlook clouded

“Macroeconomic drivers remain strong for REITs with GDP growth of above 4% coupled with sound corporate balance sheets (average gearing for REITs at 27%) and household savings at an all-time high of 20%,” said Amy Pham, Fund Manager of the Pengana High Conviction Property Securities Fund, a part of the Pengana Capital Group.

“However, three obstacles challenge the outlook over the near term, including ongoing elevated levels of COVID-19 infections, production and supply chain bottlenecks and an elevated inflation rate,” she added.

“The big question is – will the RBA raise rates to curb inflation and, if so, how will REITs perform in this environment?”

Volatility a new reality

For the year to date the A-REIT sector, like many asset markets, has struggled a bit. The S&P/ASX 200 A-REIT (XPJ) index, the benchmark for A-REITs and mortgage REITs, was down around 12.5% by early March compared with the ASX 200 index which had fallen around 6% percent over the same period.

However, the A-REIT index is still up 11.8% from a year ago while the ASX 200 has only posted a 3.9% gain. The A-REIT index had lost around 20% immediately after Covid arrived in 2020, only to make that up and more in a bumper 2021 when A-REITs gained 27% and the sector was ranked the strongest performer on the ASX.

Looking ahead, experts see a return to more normal conditions in the office market, a recovery in retail and strong demand for industrial spaces, while the residential market has shown few signs of slowing. It remains the case, however, that these structural shifts toward working from home and online retail activity are still unfolding.

Support emerges

Sameer Chopra, Head of Research Pacific at global real estate services and investment firm CBRE, said given the economic outlook, commercial property in general will look attractive as an asset class because of its perceived role as a hedge against inflation.

In its latest market outlook CBRE said the listed property sector – retail, offices, and industrial properties – should also gain support from the return of high levels of migration, capital inflows and strength in residential prices and commercial rents.

Another key driver of future demand is likely to be the massive Australian superannuation industry which, according to CBRE, has seen its allocation to property slide below historic norms for the sector.

CBRE estimated the allocation to property, (both listed and unlisted) by the superannuation sector has dropped to 7.7%, well below its long- term average of 8.2%.

“Assuming similar levels of growth in the superannuation system in 2022 and a push to increase the allocation to property to the long-term average, CBRE Research estimates that an extra $68 billion worth of property would need to be owned,” Chopra said.

“Some of this might occur through capital value appreciation but significant capital will need to be deployed across the major sectors to make up the shortfall.”

Chopra said this also had the potential for new listed A-REITS to be created to cater for this wave of capital.

E-commerce impact

A big winner could also be industrial A-REITs where the boom in online sales, spurred by the pandemic, has led to robust growth in demand for properties which is expected to continue.

Australia’s e-commerce penetration rate has increased to 14% but still lags other major countries and is below the global average of 22%. CBRE estimate that every $1 billion of additional ecommerce sales requires an additional 70,000 square meters of logistics space.

Investment considerations

When investing in A-REITS there is a lot for an investor to bear in mind. Factors include property valuation metrics, balance sheet fundamentals, cash flow sustainability, tenant demand and supply fundamentals, gearing and interest cover ratios of the fund. Investors also need to understand the individual properties held by the fund and their characteristics.

The ASX provides access to a wide range of A-REITs across multiple property segments, some focusing exclusively on one sector like offices or industrial spaces and other holding a cross section of assets.

The three main Australian property ETFs are the Vanguard Australian Property Securities Index ETF (ASX:VAP), the SPDR S&P/ASX 200 Listed Property Fund (ASX:SLF) and the VanEck Vectors Australian Property ETF (ASX: MVA).

Each of the three ETFs invests in ASX-listed REITs and follow slightly different benchmarks: the S&P/ASX 300 A-REIT Index, S&P/ASX 200 A-REIT Index and the MVIS Australia A-REITs Index respectively.

In terms of individual stocks Pengana Capital’s Amy Pham recommends the REIT fund manager sector and highlights as good prospects Goodman Group (ASX: GMG), Charter Hall Group (ASX: CHC), and Centuria Group (ASX: CNI).

 “CHC is now trading on a ~16x earnings multiple, below the average for the AREIT sector,” Amy Pham said. GMG, with a development book of $12.7bn combined with very high and growing margins should see significant growth in development earnings as the projects are delivered. While the structural shift into alternative assets will benefit CNI.

AUSIEX investors take long view

Property stocks have enjoyed sustained interest by AUSIEX investors in recent years. According to recent trading data for January 2019 to March 2022, over $4b in property stocks (including AREITS) has been traded on the AUSIEX platform.

Investors have been net buyers of the sector from September 2019, preferring securities such as Vanguard’s Australian Property Securities Index ETF (ASX:VAP), Goodman (ASX:GMG), shopping centre owners Scentre Group (ASX:SCG) and Unibail-Rodamco-Westfield (ASX:URW) by number of customers, trades and traded value. Investors appeared to favour highly-diversified exposure to the sector with VAP traded by 7% more accounts than the second-ranked security by number of customers.

Looking at trader profiles, Boomers accounted for the lion’s share in terms of trades at or over 50% of total property sector trades in the basket of securities analyzed, but Gen Xs’ share increased over the period to now account for approximately 40% of total property sector trades.

Interestingly, whilst Millennial investors saw a long slow decline in shares following a spike from March to May 2020, Gen Z has very recently taken an interest in the sector and have overtaken Millennials, in a possible sign that the demographic feeling housing affordability most keenly are seeking exposure via equities markets.

Examining advised investors specifically, the data also showed a strong preference for the sector in Victoria, with NSW and WA investors ranked next by percentage of accounts dealing in the sector. Strong recent interest in the sector in WA has meant the state has leap-frogged QLD. There were also sizeable swings in adviser interest throughout 2021, with around one in five advised accounts trading property. This increased to more than one in three (35%) during the 2021 market bull run from April to July before retreating to one in eight as advised clients rotated back into ASX200 stocks.

The data also showed that SMSF accounts were very keen to gain exposure during the pull back in January 2022, with 74% of accounts buying a property stock.

At the beginning of the pandemic, REITs suffered heavily as investors fled all forms of property but since then the asset class has proved its worth, providing investors who are looking for a higher yielding asset with a compelling solution.