A-REITs: what will the market hold in 2014?

Australian real estate investment trusts (A-REITs) give everyday investors exposure to the capital growth and rental income of big ticket property assets.

Yet despite a stellar year in the Australian share market and a firm performance from commercial property, the average total A-REIT return of 7.1% in 2013 looks decidedly pedestrian compared with 19.6% return for the ASX.

So what is the outlook for this investment sector in 2014? Much depends on what happens with interest rates, as REITs tend to be favoured over bonds when rates are low.

“We’ve seen growth in the 20%-30% bracket in recent years, but I don’t expect 2014 to be one of these,” Winston Sammut, Managing Director of Maxim Asset Management, told me.

“What I expect from A-REITS is a 6% to 6.5% yield and some improvement in asset pricing, say in the 2% -2.5% range. That adds up to a 9%-10% overall return, which is quite adequate when the cash rate is at 2.5%.”

The REIT sector around the world saw a major shakeout following the GFC, resulting in a focus on paying down debt and selling assets to improve balance sheet strength.

With Australian commercial real estate seen as prime, offshore investors have been especially active, attracted by relatively strong economy and transparent market with good governance practices.  As one industry stalwart pointed out, the Canadian Pension Fund wrote its biggest acquisition cheque to participate in Sydney’s $6 billion Barangaroo project, along with locals First State Super and Telstra Super.

That offshore interest has been diluted somewhat recently by a falling dollar and a flurry of new issues in late 2013.

Those foreign investors may be drawn back in if the dollar bottoms, to join forces with domestic high net worth individuals and institutions attracted by the spread over official interest rates.

But as Sammut points out, investor interest also hinges on a no-surprises reporting season, which is just about to start.

“The issue is whether the sector and individual A-REITS report steady-as-she-goes performance. We’ll be watching the office and retail parts of the market as there is a lot of sub-lease space out on the market which is likely to put a lid on any rampant growth in rents.”

Another talking point is the Westfield proposal to split its domestic and international businesses, which while not universally popular among major investors, is likely to be concluded.

Many in the market will also be taking a keen look at managers. With the big restructures in debt and gearing mostly out of the way, A-REITs will be under pressure to demonstrate they can keep on taking internal opportunities to enhance returns.

The other focus will be A-REITs in the residential development space to see whether the rebound in optimism translates into returns.

“This is where the potential sparkle is in 2014,” Sammut tells me. “Industrial A-REITs will probably keep chugging away with investors likely to see returns in the 8%-8.5% range.

“But will land developers like Stockland and apartment-focused players like Mirvac be able to make the most of the continuing signs that the housing market is improving, albeit at a slightly slower pace than 2013?”

“A-REITs are returning to what they previously were, which is rent collectors. With global markets still wary of volatility, A-REITs potential for a reasonable spread may not sound overly enticing, but it makes for a quite adequate risk-adjusted return.”