A-REIT property trusts in a sweet spot for investors

Property trusts, especially those focused on Sydney office market, remain investors’ favourites.

A-REITs with a concentration in Sydney are the favourites among yield hunters. Picture: Craig Greenhill

In the hunt for yield the gravy train is no longer bank stocks, but property trusts, and inside that train the dining carriage is reserved for commercial property funds with a concentration in Sydney.

That’s because the Sydney ­office sector is now moving towards a vacancy rate of less than 5 per cent — and this comes just as the city planners in Sydney have unleashed a major new plan for the city centre which will reduce residential towers in favour of commercial developments.

Better still, broker Credit Suisse now suggests that developers in Sydney CBD can build new office blocks for about $16,000 per square metre, while the average values for that sort of existing space in the city is about $22,000 per square metre. In other words, it’s a sweet spot.

And though broker estimates for replacement building costs are always open to challenge — not to mention the reality the banks must provide financing for new projects — commercial property trusts, also known as A-REITs, are finding themselves the favourites among yield hunters.

What’s more the attraction is not solely for their yield — but crucially for their ability to grow those yields year on year.

A-REITs still have their faults: underlying properties invariably get overpriced in every property cycle while the funds themselves also have a history of taking on excessive gearing and outbidding each other to ultimately create a bubble.

The recent scare that swept the international property market after unlisted funds representing half of London’s institutional property market were briefly frozen shows how quickly liquidity troubles can place the sector out of favour.

Nonetheless, the vast bulk of the local CBD office market represented by listed funds and some of the underlying variables are looking very attractive relative to the sluggish picture offered by alternative choices in the local economy.

Indeed, A-REITs look set to continue to be the favourites in the endless search for income triggered by rock-bottom cash rates.

Can it get any better?

The issue for investors looking for the first time at this sector — and anyone who has rode the wave of a swing towards A-REITs in recent years — is whether this sweet spot for the sector can be extended?

The headline numbers are certainly impressive:

• On average stocks in the sector return a dividend yield of 4.4 per cent and that’s before franking — against cash rates of 1.75 per cent.

• Better still, rental growth which underpins dividend growth in the sector continues to grow at more than 4 per cent per annum among the best-known funds.

• The total returns — price appreciation and dividend income combined — among A-REITs in the 12 months to June 30 was 22 per cent.

• Overall earnings growth in the sector is running at about four times the average of 8 per cent for the ASX 200.

So the short answer to whether it can get any better for A-REITs is: unlikely. It will be very hard for this sector to do 20 per cent again in a full year — the big lift came as retail investors bid up the price of the stocks that paid those solid yields.

The same thing happened to bank stocks in an earlier part of the cycle. Nonetheless, the ­momentum behind the shift from bank stocks to A-REITs, combined with a better outlook for property, remains a key driver.

Which A-REITs are passing the sizzle test?

No single A-REIT perfectly matches the formula for perfect exposure to Sydney commercial real estate, but there are a number of funds which continually emerge as favourites among the leadings brokers and analysts. They offer exposure to Sydney and Melbourne, the best centres for office real estate growth now.

Investa Office certainly fits the bill and the stock has been nominated as a buy by Credit Suisse. Mirvac Group, which offers industrial and retail besides its better known portfolio of residential property, is another.

Morgan Stanley says the other top choices in the sector are Stockland and Lend Lease.

Brokers are also watching for the potential of improved forecasts from Goodman and Dexus in the weeks ahead as the reporting season for FY16 is due to begin in the coming days.

Outside of the office sector but still snugly within the area of A-REITs are the growing list of specialist A-REITs that concentrate on a single area of activity such as storage or childcare.

Favourites here are stocks such as Arena (childcare) and ­National Storage.

Why Sydney’s commercial market is the hotspot

1. Low vacancy rate in the city.The percentage of empty office space is about to fall below 5 per cent for some property grades — half that of Brisbane or Perth — creating a healthy demand in the city for new offices, which are regarded by industry experts as ‘‘commodity assets’’ because they are easily replaceable.

2. Useful new planning laws. The City Of Sydney recently released its biggest planning changes in years. Under new rules commercial projects will be encouraged where there is a perceived oversupply of residential towers. The changes create an unusual situation in city planning where commercial developments may have a favoured position.

3. Attractive replacement costs. Developers in central Sydney can build offices for substantially less than the going rate for office space per square metre. New research on prices within the city suggests that developers will find the market exceptionally attractive in the coming years.

4. Development zones clearly identified.
The Sydney areas most likely to see intense activity are Haymarket, Circular Quay and the new commercial zone at Barangaroo. Existing developments such as Chifley Square, Philip Street and Bligh Street have already seen a very strong lift in valuations over the past three years.