I. Sector landscape and outlook
Australian Real Estate Investment Trust (A-REIT) is a portfolio of property assets. These are listed on the Australian Stock Exchange. REITs are generally close-ended investment trusts, where one can become a member by acquiring units from the stocks exchange. Rental income on the properties owned is the primary source of revenues for such REITs, and by virtue of the regulatory provision, they are required to distribute at least 90% of their net income among the unitholders.
A REIT is a diversified and professionally managed portfolio of real estate assets that enables investors to access a property portfolio which would not otherwise be available to the individual investor. REITs own real estate such as office, apartment buildings, warehouses, hospitals, shopping centers, hotels, etc. It provides portfolio diversification into the property with the potential to receive a regular and consistent income stream. Investors can gain the benefit of any increase in value in the underlying asset and from the regular rental income generated from the properties owned. Before March 2008, REITs were called Listed Property Trusts (LPT) and came into existence in 1970. REITs are viewed as low-risk and stable investments as they rely on rents to provide stable income.
Fig 1: Operating Model of REITs
Source: RBSA Advisors
Types of REITs
Retail REITs: Retail REITs are a type of REIT that own and manage retail properties and lease the retail space to tenants looking to set up grocery stores, shopping malls, boutiques, etc.
Residential REITs: Residential REITs own and manage rental apartment buildings which are used by families for residential purpose.
Office REITs: Office REITs own and manage office buildings and receive rental income via long term lease.
Self-storage REITs: Self-storage REITs develop storage spaces of various shapes and sizes and then rent them out to collect an income. These are used by people to store possessions and valuables, and by small businesses to store goods.
Industrial REITs: These types of REITs own and manage production plants, distribution centres and factories.
Australian REIT Sector
Australian REITs sector is not new, the first REIT in Australia was the General Property Trust, which got listed in 1971. However, REITs started gaining popularity only in the mid-90s, by when the market capitalisation of all REITs was already at A$7 billion. The size of REITs continues to grow since then, and in 2002 the market capitalisation of REITs swelled to A$ 47 billion, and by 2012 it crossed A$90 billion. At present, the market capitalisation of REITs stood at A$122 billion.
Fig 2: A-REITs at a glance
Source: Kalkine, Refinitiv (Thomson Reuters)
Advantages of REITs
- REITs are generally a friend of an income-seeking investor as they tend to pay a stable dividend. The dividend is driven by their revenue streams, which is rental income. Rental income is generally more stable than the revenue of a traditional business.
- REITs generally structure their leases to include mandatory rent increase each year. This is either a fixed rate or CPI inflation + a certain percentage. This offers higher certainty around future earnings and income for the REIT and the investors.
- REITs are relatively low effort investments. There are not many changes in operations from year to year, so there is generally less to worry about than shares in a typical business.
Fig 3: Advantage of REITs
Source: Kalkine
Australian REITs index have consistently outperformed the ASX 200
Though REITs have significantly underperformed post the outbreak of COVID pandemic but have gained some ground post hitting lows in March 2020. REITs are long-term investment assets and can give healthy returns if adequately selected and bought at a reasonable valuation. Over the last ten years, REITs index in Australia has outperformed the ASX 200 Index despite the recent correction.
Fig 4: 10 Year Performance (ASX REIT index vs ASX 200)
A-REITs are offering a solid dividend yield
At the current trading level, A-REITs are offering a lucrative average dividend yield of ~6.9%, which is approximately 1.3x of the ASX 200 index average dividend yield of 5.3%. Further, the average yield offered by A-REITs is ~7.4x of ten-year government bond yield. A-REITs are offering a lucrative dividend yield amid times when the interest rates are falling globally, and opportunity costs of fixed income securities investing are fading. Further, REITs offer access to the real estate market typically with low correlation with other stocks and bonds. As an income alternative to cash, term deposits and bonds, REITs are valued for their consistent distributions which are predominantly derived from the rental income earned on the trust’s properties. With the income coming from fixed, generally long-term rental contracts, the distributions are generally more predictable and stable than dividends payable from a listed company.
A-REITs are trading at a discount
From the LTM PE multiple standpoints, A-REITs are trading at a substantially discounted valuation against the broader ASX 200 index. The average LTM PE of the A-REITs stood at 15.04x, whereas average LTM PE multiple of ASX 200 stood at 23.6x.
Risk
- Commercial property tends to have much longer leases. Once the lease expires, there is a probability that the tenant might not renew the lease, which might leave the REIT with no income from that property.
- Due to COVID-19 pandemic, REITs might face a delay in rent collection, which may adversely affect their cash flow.
- REITs have a relatively higher contribution of debt in their balance sheet. Higher debt put balance sheet at risk in adverse times.
Outlook
COVID-19 presented unprecedented challenges to REITs where most of the business forced to shut shops. The government introduced the containment measures, which resulted in the closure of non-essential business, including offices, manufacturing units, shops etc. These containment measures resulted in short-term pain for both the tenants and the landlord.
In retail space, once the market stabilises, we believe that properties which are leased to the businesses that are focused on meeting the day to day requirements would continue to drive the solid returns. In-office space, there are chances that COVID-19 may change the way business operated traditionally, and employers might prefer the remote working concept. However, we believe most of the corporates would return to the office culture, and social distancing measures would require additional space, which would fill in the space vacated by the remote working staff. Industrial properties are likely to face minimal impact. In fact, we believe the boom of eCommerce would result in a higher demand for warehouses and logistics. Since consumers are preferring online shopping, most of the businesses are going online and increasing infrastructure spending with a focus on shoring up local supply chains, which is likely to drive industrial property (warehouses and storage spaces) demand.
II. Investment theme and stocks under discussion (MGR, CQE, AVN and SCG)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘EV/EBITDA’ method.
- ASX: MGR (MIRVAC GROUP)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 8.38 Billion)
Mirvac Group is an innovative property group, which is involved in delivering innovative and exceptional workplace precincts, high-quality homes, retail destinations, & connected communities for its clients.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~20% on 13 August 2020 closing price. We have considered Stockland Corporation Ltd (ASX: SGP), Scentre Group (ASX: SCG), and Charter Hall Retail REIT (ASX: CQR) etc., as a peer group for the comparison purpose. At the same price, the stock was offering a dividend yield of 4.23%.
- ASX: CQE (CHARTER HALL SOCIAL INFRASTRUCTURE REIT)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 900.9 Million)
Charter Hall Social Infrastructure REIT is in the business of property management. It has the ownership of established freehold early learning centres.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~18% on 13 August 2020 closing price. We have considered Arena REIT No 1 (ASX: ARF), Hotel Property Investments Ltd (ASX: HPI), and ALE Property Group (ASX: LEP) etc., as a peer group for the comparison purpose. At the same price, the stock was offering a dividend yield of 6.4%.
- ASX: AVN (AVENTUS GROUP)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 1.12 Billion)
Aventus Group is engaged in the investment and management of large retail property assets.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~17% on 13 August 2020 closing price. We have considered Centuria Office REIT (ASX: COF), Charter Hall Retail REIT (ASX: CQR), and Shopping Centres Australasia Property Group Re Ltd (ASX: SCP) etc., as a peer group for the comparison purpose. At the same price, the stock was offering a dividend yield of 5.9%.
- ASX: SCG (SCENTRE GROUP)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 11.0 Billion)
Scentre Group owns and operates Westfield in Australia and New Zealand with interests in 42 Westfield Living Centres.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~18% on 13 August 2020 closing price. We have considered Goodman Group (ASX: GMG), Mirvac Group (ASX: MGR), and GPT Group (ASX: GPT) etc., as a peer group for the comparison purpose. At the same price, the stock was offering a dividend yield of 10.7%.
Note: All the recommendations and the calculations are based on the closing price of 13 August 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
*Please be aware that dividends are variable and not guaranteed.
Disclaimer
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