The property and A-REIT market is sitting on the launchpad as domestic players re-renter it and investors prepare for demand to rocket.
The Australian real estate investment trust (A-REIT) and property markets have been subdued following the turmoil of the global financial crisis (GFC) as players concentrate on keeping their heads above water and businesses in profit.
The drivers that saw Australian businesses step back from the market and make room for international players to enter have begun to fizzle out. The industry is now on the cusp of change and the role of advisers will be instrumental in shaping the next step.
Outdated theories that property is not a practical area of investment need to be squashed, while advisers need to coax their clients into understanding the benefits that property and REITs can play in a diversified portfolio.
Direct property trumps
While both direct and listed property are viable areas for investment as part of a portfolio, direct property continues to outperform listed due to its low volatility and strong returns.
The Property Fund Association’s (PFA’s) most recent research, conducted by Atchison Consultants, shows that direct property has lower volatility for total returns than listed property and produces higher cumulative returns over all measured periods.
“What we say to advisers is: look, a balanced portfolio should have some listed property in it but it should also have some direct property. The reason is it behaves very differently,” Centuria Property Funds’ chief executive and PFA vice president Jason Huljich tells ifa.
“The main [trend] – and this is what the planners are catching onto – is the correlation with the equity market. We’ve seen a few planning groups put their listed property allocation into equities and their direct property allocations into alternatives allocation because those listed have behaved almost identically to equities over the long term.”
Mr Huljich explains that there has definitely been a pickup of interest in property investment in the past few months as the yield equation strengthens.
“A lot of sophisticated planning groups are seeing that it is a very good time to buy,” he says. “There is limited downside risk but fantastic opportunities where they can get a pretty strong yield, as well as some really good potential for capital gain as well.”
New funds with a yield of 8 per cent or 8.5 per cent are looking incredibly attractive compared to term deposit rates, which are dropping down to 4.5 per cent.
PFA president Robert Olde explains that investors should remember property also has a tax advantage.
“Investors are certainly starting to see that and are now looking for something more than just a net three or four per cent,” Mr Olde tells ifa. “They are looking to get back into those yields more around seven to eight per cent.”
Australian Unity Investments (AUI) has also noted increased demand for property, particularly direct property, as clients in self-managed funds with a lot of cash start to look for yield elsewhere.
“We basically cater for retail investors and they’re all in cash, which has got to be the worst investment they’re ever going to have. They really ought to be moving out, either into Australian equities or these international equities or domestic property, or they’re going to miss the boat,” AUI’s head of property, Martin Hession, tells ifa.
“Property prices are on the move so people should be coming out of cash; they should be coming into property. Is that happening? In some cases. It is starting to come back, just not back to the heady heights that it was at.
“Now is the time – well, you’re a bit late really, but better late than never,” he says.
REITs come back
Since the global financial crisis (GFC), A-REITs have stopped chasing risky development-type deals and gone back to the property basics to look for safe secure assets with good tenants and yields.
The REIT market split into two distinct segments: the ‘big eight’ (Westfield, GPT, Goodman, Stockland, Mirvac, Dexus, Charter Hall, and CPA & CFX), which were able to tap the markets and recapitalise during the GFC, and the smaller REITs, which struggled and were bought out.
Now yields are back up at eight to 10 per cent and rates have dropped, the cash flow from REITs is much greater than the interest.
“There is not as much pressure on capital growth in these REITs, so I think that combined with cash deposits and with rates dropping down to pretty low levels – almost GFC levels – that’s drawing people out of cash and chasing the high yield that these REITs are offering now,” Blue Sky Alternative Investments’ property division managing director, David Laverty, tells ifa.
“They’re moving from cash into safer style property investment,” he says. “They’re picking the eyes out of the REITs that they think are offering a good rate for yield. It’s very much a flight to quality property assets that is the trend that we see.”
Andrew Cannane, The Trust Company’s general manger of corporate clients, agrees there has been a turnaround in investor demand for REITs in Australia because investors are starting to see value again.
“We’re getting closer to that tipping point – if [we’re] not already [there] – where the A-REITs are now starting to trade at their net tangible asset (NTA) [level],” Mr Cannane tells ifa.
“I guess ... that’s the analyst and investor market, probably for the first time in a long time, saying ‘we think the underlying assets as well as the development pipeline of these REITs is now worth NTA’.”
Investor demand for A-REITs was lacking previously because they were trading below their NTA but in the past few years the focus has been getting that back to zero.
“They’re pretty much there now,” Mr Hession says. “Most A-REITs prices are only two per cent below their NTA, so I’m thinking they’re about ready to enter the market.”
Over the past 10 years, REITs have experienced returns of around 16 or 17 per cent each year. “So there has been a strong performance, a strong pickup in the sector,” BT Investment Management portfolio manager Julia Forrest tells ifa.
“Basically, REITs have gone onwards and upwards. I think [inflows are] starting now. People really need to start thinking about what they do with their money.
“If you can get three per cent growth and six per cent yield, so you’ve got nine per cent total returns, that is what people should be expecting from REITs – and that is what they have delivered,” she says.
With increasing opportunity for investment in the property sector, the role of the adviser has become even more significant.
There is a clear view that advisers need to keep up to speed with property market shifts and ensure their clients are well placed to take advantage of opportunities as they arise.
“[Advisers should] definitely come back to looking at the sector – there are some fantastic opportunities around and it’s a great time to be buying these assets,” Mr Huljich says. “There are not a lot of buyers around and they can put their clients into these products with very limited downside risk. There are some very good opportunities for capital gain.”
Mr Olde agrees, adding that there have been fundamental changes in how some products work compared with five or six years ago, but with which advisers are not up to speed.
“Before the GFC these products were geared at 60 to 65 per cent, [while] a lot of the new funds are down around 45 to 50 per cent. I don’t think a lot of advisers have looked at that,” he says.
As well as realising the potential of property investment within a diversified portfolio, advisers also need to engage with their clients to ensure their portfolio is apportioned effectively.
“You have to be in growth investment,” Mr Hession says. “If you’re investing for retirement, which is where advisers are probably working most, cash is the worst investment you can have. They need to get into growth investment.
“My adviser would say to me, two to three times the amount you can live on should be in cash, the rest in growth investments. Then if it all hits the fan, pardon the expression, you don’t have to sell any of your assets, [and] it doesn’t matter if you’re locked in some fund you can’t get your money out of because you’ve got three years of cash to keep you going and hopefully markets will change in that time,” he says.
Mr Hession warns, however, that investors and advisers shouldn’t get too overconfident and put all their money into property because it is still an illiquid investment.
“No more than 10 per cent, maybe 15 per cent, but no more than that,” he says, “and make sure you have sufficient cash put away so you can add to that if things turn bad because you don’t want to have to be selling your assets in down markets. You have to be able to ride it out.”
Ms Forrest agrees that around 10 per cent to 15 per cent of a client’s assets should be in a growth security such as property.
“I think it would be remiss of an adviser to keep people in cash,” she says. “Even though it is an easy option and the downside obviously levers in terms of capital, you need to preserve people’s wealth.”
But when it comes to ‘de-risking’ a portfolio, advisers have done pretty much everything they can, she explains. Although they can spend time supporting the way in which a client wants to divide their portfolio, ultimately it is all about the objective of the client.
So, if their objective is to have a well-diversified property portfolio up to a specific dollar amount, an A-REIT would certainly form a part of that. But if the client’s objective is, for example, to drive down bad debt, maybe A-REITs would form a much smaller part.
“It is really important for advisers during difficult markets – and [with] the Australian dollar fluctuating and gearing levels within these funds varying; also with clients being a little sceptical of what has happened in the past – the best thing for them to do at this point is to find out their objectives and realign themselves with their strategy,” MyAdviser’s managing director, Philippa Sheehan, tells ifa.
She explains, however, that clients should still be encouraged to have a diversified portfolio that includes property, either direct property or an A-REIT.
“I think sometimes advisers were caught up in the fact previously that clients wanted property [but] couldn’t necessarily afford or didn’t want to go into the direct property market but didn’t understand necessarily how A-REITs worked,” Ms Sheehan says.
“Therefore, they didn’t look at the level of gearing within some of those A-REITs.
“What we are seeing now is that both advisers and clients are a lot smarter in the investment game and that those advisers who are using REITs are looking for the criteria (valuation, returns, growth prospects and level of gearing),” she says.
The property and A-REIT market looks set to take off, and supported by consistently steady performances over the past 12 months, many more investors have been attracted to it.
“This time last year, we were sitting at about 740 and the index is now at 940, so we’ve had a very strong return,” Forrest says. “Basically, REITs have really gone onwards and upwards since then.
“I think what you can expect is three per cent yield, six per cent growth and maybe sector trades that are modest to NTA. So in terms of total returns, personally that ticks all my boxes.”
Along with increased investor interest, there are investment managers who have weathered the GFC confidently and have continued to stay in the market, managing assets.
“I think there is a bit of a theme of quality or assets and quality or cash flow in property at the moment, so if you’ve got a solid manager who has been through the GFC, who has an asset which is secure, doesn’t have a lot of leverage, has good tenants etc. I think you’ll see a flight to quality there,” Mr Laverty says.
Mr Olde adds that the property market has moved through a period of nervousness but the core fundamentals of property are now starting to shine through again.
“Yields are predictable as we go into commercial type property with longer leases, and I think investors do realise that property is a longer-term asset,” he says.
While Mr Huljich agrees, he also expects to see more demand, particularly for the unlisted property sector.
“It looks like term deposit rates are going to stay low for a while, so investors and advisers should be looking for other assets to invest in that can provide some more attractive returns,” he says.
Australian superannuation funds and A-REITs are also beginning to become net buyers of property again, causing foreign investors to back out of the market.
“A-REITs are closing the gap. You’re starting to see that a lot more as a result of their capital partnering model,” Mr Cannane says. “So I think you’ll see foreign investors interested, but they’re not going to buy as well as they did.”
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