After years of delivering stellar total returns, the tide would appear to be turning against Australia’s listed property sector. The Australian Real Estate Investment Trusts (AREIT) sector delivered a disappointing -9.8% over the past 12 months, comparing unfavourably to the 6.0% return achieved by the broader Australian market.
We believe there are two factors behind recent underperformance; one macro and one more micro in nature. Let’s start with the macro: bond yields.
Given their role in the pricing of assets, it is useful to review trends in global bond yields and interest rates. Recent commentary emanating from the US has reaffirmed that the long-term trajectory of interest rates is heading one way – and that’s up. With long bonds (10-year government bonds) hitting all time low yields in mid-2016, the long road back to ‘normality’ appears to have begun.
With the above noted, we believe it is equally important to remind investors that rates remain at historically low levels. As previously discussed, we continue to view this as a protracted and grinding cycle: one that provides a degree of support for good quality, high yielding assets.
Figure 1: US 10 Year Treasuries 1962 – Present.
Source: Macro Trends
The second more micro factor to highlight is the headwinds facing the retail sector. Whether it be fears relating to the imminent entrance of Amazon or simply consumer related concerns, retail has been on the nose and the retail focused REITs have not escaped unscathed. As illustrated below, three of Australia’s largest listed retail focused REITs have delivered returns of -13.35% (VCX), -14.6% (SCG) and -22.89% (WFD). Notably, while WFD’s asset base is focused on offshore markets, all are ASX50 constituents.
Figure 2: 1 Year Performance VCX, WFD & SCG.
Source: Google Finance.
In contrast, we have seen several smaller, nimbler REITs navigate a tougher period in solid fashion. Each small cap REIT presents with sound portfolio metrics while offering an attractive average distribution yield of 7.2%. The four we highlight include:
- Centuria Metropolitan REIT (ASX: CMA)
- Convenience Retail REIT (ASX: CRR)
- Elanor Retail Property Fund (ASX: ERF)
- Industria REIT (ASX: IDR)
Figure 3: Key Metrics.
Source: Clime, Stocksinvalue.
Centuria Metropolitan REIT (ASX: CMA)
It has been a busy period for CMA, a small cap REIT that invests in office and industrial assets in metropolitan markets across Australia. In June 2017, CMA merged with the ASX listed Centuria Urban REIT (CUA). In addition to being accretive to FY18 distributable earnings, the benefits of the acquisition included a material increase in CMA’s investment portfolio of 54% to over $600m.
Post balance date (30 June 2017), CMA also announced the acquisition of three further assets that, in aggregate, acted to further improve key portfolio metrics. Concurrent with the release of the FY17 results, management reaffirmed guidance for FY18 distributable earnings per security of 18.6cps, while also commenting:
“CMA’s FY18 forecast distribution is 18.1 cps, an increase of 3.4% on the previous financial year’s distribution generating a strong FY18 distribution yield of 7.6%. Distributions will be paid in equal quarterly installments of 4.525 cps.”
Convenience Retail REIT (ASX: CRR)
The genesis of CRR actually dates back to 2002, when manager APN Property Group launched its Property Plus Portfolio (PPP). This unlisted trust invested in a small portfolio of service stations and has delivered an average annual total return of 14.6 per cent since inception.
With the $90m asset base of PPP being rolled into the new enlarged CRR vehicle, whose asset base now exceeds $300m, investors can gain access to a high-quality ASX listed portfolio offering an attractive quarterly income stream.
CRR was established to invest in Australian convenience retail commercial property, leased to leading national and international businesses which operate petrol stations, fast food outlets and related convenience based consumer offerings. Ultimately, CRR is designed to deliver a high, reliable and growing cash income stream, as well as the potential for incremental capital growth over time.
Key portfolio metrics look sound. Occupancy is high at 99.4 per cent while the weighted average lease expiry (WALE) of 13.6 years is amongst the best on the ASX. At 30 per cent, gearing is in the lower half of management’s target range of 25 to 40 per cent, and provides some scope to grow the vehicle further in coming years.
CRR may appear marginally expensive if one were to superficially review the pricing premium to its net tangible asset (NTA) backing of $2.73 per security. However, on deeper inspection, the capitalisation rate (of 7.2 per cent) used to calculate this asset valuation looks conservative to us.
The reality is that many comparable long WALE assets are transacting on much tighter yields in the private market. In addition, the capitalisation rate used to value the assets of listed peer Viva Energy REIT (VVR) is at an approximate 20 per cent premium to CRR. Concurrent with the attractive 6.8 per cent yield on offer, this view drives our valuation of about $3.10 per security.
With an attractive and defensive yield backed by long term leases to a high-quality tenant base that includes Puma Energy Australia, Woolworths, 7-Eleven and Viva Energy Australia, we believe CRR is worthy of consideration for relatively risk averse, income focused investors.
Elanor Retail Property Fund (ASX: ERF)
Australia’s grinding economic environment has translated to tougher conditions for many of the nation’s discretionary retailers in recent times. By extension, many retail focused real estate investment trusts (REITs) have concurrently been discounted by the market, perhaps with good reason. As a result, we continue to believe that those REITs leveraged to non-discretionary retail may represent a pool of underappreciated opportunity.
In our view, one such opportunity is the Elanor Retail Property Fund (ASX: ERF). Despite a heavy focus on non-discretionary retail and a sector leading yield of 7.8 per cent, ERF continues to fly under the radar.
While ERF continues to add breadth to its portfolio and tenancy mix, its portfolio remains anchored by high quality national tenants including Woolworths, Wesfarmers and Metcash (IGA). The majors occupy 63 per cent of lettable area and contribute nearly 40 per cent of base rental income.
ERF also exhibits sound portfolio metrics. The portfolio has a high level of occupancy at 99.1 per cent while its weighted average lease expiry (WALE) profile is a solid 4.8 years.
We believe an interesting dynamic currently at play represents a further avenue of opportunity for the nimble ERF in the near term. Larger listed peers are seeking to focus their efforts more exclusively on their largest trophy assets.
As a result, we are starting to see a number of good quality (yet relatively small) assets deemed non-core being offered by larger REITs at reasonable prices. A good recent example is ERF’s accretive acquisition of Gladstone Square. Anchored by Woolworths on a 20-year lease, the asset comes with a rental guarantee, is 100 per cent occupied and has a WALE of 8.6 years.
Industria REIT (ASX: IDR)
We believe an interesting few months lie in wait for IDR, an ASX300 AREIT which owns a portfolio of office and industrial properties across Brisbane, Sydney, Melbourne, Adelaide and Newcastle.
Of particular interest is that the $2bn REIT, Growthpoint Properties Australia (ASX: GOZ), has taken an 18.2% position in IDR at $2.30 per security. While not central to the investment case, we therefore believe there may be some corporate appeal in IDR.
Corporate activity aside, we believe our investment in IDR, which was built out at a reasonable discount to net tangible asset backing, is well supported by fundamentals. Occupancy is sound at 95%, the weighted average lease expiry is sound at 7.6 years and gearing is comfortable at around 31%.
Despite rallying solidly in recent months, IDR continues to trade at a reasonable discount to our valuation. Management would appear to agree with this view, recently announcing an on-market buyback of up to 5% of securities on issue. Concurrently, investors receive an attractive distribution yield of about 6.7%, paid quarterly.
*Note: As IDR, CRR and CMA all pay quarterly distributions, all will trade ex-distribution on either the 28th or 29th of September 2017.
Clime holds CMA, CRR, ENN, IDR, SCG, VCX and WFD in some of its (primarily income focused) mandates.