The real estate asset de jours delivering solid income streams
Real estate assets, including office towers, logistics/warehouses and healthcare centres – or, as I prefer to call them, Towers, Tin Roofs and Treatment Centres – are proving to be the asset de jour among investors seeking sustainable income streams in today’s COVID-19 inflicted climate.
For the past five consecutive months, Australia has experienced an historically low cash rate of 0.25 per cent. This record low rate is the Reserve Bank of Australia (RBA’s) attempt to caveat domestic and international market volatility, softening the blow of a global economic downturn.
While low rates are great for variable household mortgages, or any other loans, they are wanting for savings accounts, term deposits and any other cash-related investment vehicle. Across the four major Australian banks, interest rates paid on term deposits held for 12 months and payable on maturity, average 0.85%.1So those with these types of income-investments might seek alternative vehicles to generate revenue and, subsequently, pay regular, higher returns.
In times of uncertainty, it seems people reach for the tangible. What’s more tangible than bricks and mortar? There are two typical ways of investing in commercial property, outside of owning an asset outright – through listed and unlisted vehicles.
Property Funds listed on an exchange are referred to as Real Estate Investment Trusts (REITs) or Australian REITs (A-REITs). Investors can buy or sell their shares in these funds at any time. This gives the benefit of liquidity, that is, investors can take out their money whenever the Australian Securities Exchange (ASX) is open and the securities are trading.
Unlisted property funds are entities not available on a security exchange, such as the ASX. Basically, it’s the syndication of ownership of a single property or group of properties, to a group of investors.
Closed-ended, unlisted funds specify the period an asset(s) will be owned (usually for five to seven years) and typically provides monthly or quarterly returns (distributions) based on the net rental income received from the tenants. The fund’s asset(s) are typically divested at the end of the term (depending on unitholder votes) and funds are returned to investors, which potentially include the benefit of a capital gain. No additional units are issued or redeemed during the term of the fund. This type of fund generally has lower volatility than a listed fund as the assets are usually valued once or twice a year and the unit price is updated at the time of valuation. Centuria’s distribution yields for the March 2020 quarter for close-ended funds averaged 6.64%2.
Open-ended funds are similar, except investors can enter or leave the fund during the duration of the fund, when there is a liquidity facility in place. These funds provide more liquidity for investors with the flexibility of withdrawing their investment at designated intervals, usually monthly or quarterly periods. Centuria’s distribution yield for the March 2020 quarter for its open-ended fund was 5.28% (annualised).
When deciding which property fund is best to invest in, attention should be paid to a few key metrics –the drivers that can deliver stable rental income and, therefore, increase the likelihood of attractive returns. Key metrics include:
- Weighted Average Lease Expiry (WALE).
The average number of years a property has secured a tenant(s). The more years, the better as it provides greater assurance of rent revenue, which better translates into certainty of returns.
- Tenant Profile
The type of tenant renting underlines how effectively it can pay its rent. Tenants whose businesses are resilient against any economic or political uncertainly are highly desired. That is, those whose products and services are in constant demand and therefore more likely to have a strong cashflow. For example, Government agencies, ASX-listed entities, multinational corporations, large grocery store chains and large medical operators.
- Asset Quality and Location
This is very important, especially if you are investing in a single asset fund. An asset’s location and quality determines its desirability and demand from tenants, which can translate in to stable income and potential for rental growth.
- Trusted Manager
It’s important to choose funds that have a reputable fund manager – the entity responsible for overseeing the operation and financial management of the properties. Ideally you want a manager that is experienced, who has operated throughout several property cycles and has a strong track record of delivering returns to investors.
Types of Property
There are no pure residential A-REITs on the ASX. The most common form of ownership is by direct investment. In comparison to commercial properties, residential investments typically have shorter leases (usually six to 12 months), ambiguous and inconsistent quality of tenants, higher overheads and lower income returns. According to Domain Group’s June 2020 Rent Report1, median rental yields for houses across Australia’s capital cities were 3.75% and for units were 4.22%.
Due to COVID-19’s impact, furloughed employees, fewer international tertiary students, and a rise in unemployment, which stands at 7.1%2, has lowered demand for residential rental property throughout March to June 2020.
Isolation and social distancing restrictions throughout March to June 2020 limited shoppers from physically buying instore. Consequently, with shops receiving limited sales incomes they have been less likely to meet rental commitments to their landlords. The COVID period has escalated the growing decline of footfall in retail precincts and according to KPMG there has been an 8.1% cumulative decline throughout three years to March 20203; and a predicated further fall to 11.7% throughout 2020. Additionally, JLL research showed mall vacancies have reached a 20-year high, rising 5.1% in June 2020 from 3.8% in December 2019.
However, online shopping has steadily increased year-on-year, creating a positive impact on logistics and warehouse property. The graph below illustrates the strength of online shopping. Online retail sales grow on average $2 billion year-on-year and as at 2019 Year End, reached $30 billion.6
Source: JLL Research, NAB
These large centres, characterised by tin roofs and large open spaces, are typically between 5,000sqm and 20,000sqm. They are generally located along key transport corridors, such as road arterials, rail freight lines, shipping ports and airports. They are usually let on five to seven-year leases though purpose-built facilities attract longer terms. Demand for this asset class has been significantly growing in recent years due to the growth in ecommerce and its need for well-located warehouses to service customers.
According to JLL research1, the average vacancy rate across Australia’s Eastern seaboard states was 3.8% at 2019 year end. Throughout 2019, retail accounted for 22% of industrial take-up, behind transport, postal and warehousing.
In terms of income returns, Australia’s largest pure-play industrial listed fund, Centuria Industrial REIT (ASX: CIP) delivered a 5.9% dividend per share (DPS) yield on 30 June 20202.
Offices, particularly large office towers, have benefited from strong investor appetite throughout the past couple of decades. As towers attract multiple tenants, they are well diversified as the ability to generate income usually isn’t reliant on one company. Lease terms are generally between three and 10 years.
In recent weeks, workers have started to return to their offices in most cities. There has been recent negative press coverage regarding future demand, however, we believe offices have a mid to long-term positive outlook. We don’t believe the recent working from home thematic will significantly affect demand for office space.
Regarding income returns, Australia’s largest pure play office listed fund, Centuria Office REIT (ASX:COF) delivered an 8.8% DPS yield on 30 June 20203.
Healthcare property encompasses medical facilities – from primary care, such as GPs and medical centres; secondary health, such as day hospitals; tertiary health including private hospitals; allied health such as dentists and physiotherapists; and ancillary health, such as pharmacies and childcare provisions. These assets are typically held in unlisted funds.
According to MSCI’s research for the December 2019 Year End, Hospital market yields were 6.11% and Medical Centres, 5.97%. Healthcare assets can attract 10 to 30-year lease lengths, depending on the nature of the asset.
Due to an ageing population’s reliance on medical facilities, as well as rising chronic diseases, such as diabetes, this asset class’ demand looks very likely to continue growing.
Different Property Types in Perspective
Comparing current income returns, shows a convincing argument for investing in real estate property funds, especially when compared with term deposits.
Source: *Average across Australia’s four major banks as at 20 July 2020. ** Moelis Research based on Factset, Bloomberg, company disclosures as at 17 July 2020
In summary, while different real estate asset classes attract varying levels of income, in the current to long-term period, offices, warehouses and healthcare facilities continue to retain strong demand. More specifically, they offer a significant premium to term deposits, albeit with higher risks of capital loss. Whether an investor wishes to invest in unlisted fixed term funds, unlisted open-ended funds or a REIT, depends on his or her risk appetite and desire for liquidity.
- NAB Term Deposit interest rate for investments of $5,000 – $499,999 held for 12 months is 0.95%; CBA Term Deposits interest rate for investments of from $50,000 to $1,999,999 held for 12 months is 0.85%; Westpac Term Deposit interest rate for investments of between $5,000 and $2,000,000 held for 12 months is 0.85%; ANZ Advanced Notice Term Deposit interest rate for investments of $5,000 to $99,999 held for 12 months is 0.75%
- Annualised, based on 31 December 2019 net asset backings
- ABS – 6202.0 – Labour Force, Australia, May 2020
- KPMG Beyond COVID-19 June 2020
- JLL Research Report: Australian Industrial Investment Review & Outlook 2020
- CIP FY20 DPU of 18.7 cents per unit. CIP closing price of $3.17 on 30 June 2020
- COF FY20 DPU of 17.8 cents per unit. COF closing price of $2.02 on 30 June 2020