Real estate: Pam Walkley

While the sector has been reformed since the GFC, dividends are still at risk

Is the Australian real estate investment trust (A-REIT) sector in for a severe downturn in the wake of Covid-19, such as it suffered after the GFC? Or does it now represent good buying after prices plummeted in the five months to April 30 – the S&P/ASX 300 A-REIT index fell 30% compared with a drop of about 20% in the S&P/ASX 300 index.

And with many investors relying on the sector for regular income, will A-REITs also cut their dividends? This is an especially important question given some banks and other high dividend payers are either slashing or deferring their dividends.

Undoubtedly the sector disappointed investors during the GFC. Far from delivering a steady income with less downside risk, it produced negative returns. In 2008, the S&P/ASX300 A-REIT accumulation index returned -55.3%.

The main reasons for the poor performance were high gearing levels, unsustainably high dividends, big fees paid to related companies and less-stable earnings sources – such as development, funds management and under-researched overseas property, rather than traditional Australian property rental.

Many in the industry point out it has totally reformed itself since the GFC. Gavin Peacock, co-portfolio manager of A-REITs for the UBS Property Securities Fund, says sector gearing levels are now about 29%, whereas they were around 40%, and in individual cases much higher, at the time of the GFC.

A-REIT sector debt is also lower, from more diversified sources and longer in tenure – the average debt term is almost six years, meaning it isn’t due to be repaid for many years, according to analysis from JP Morgan. These factors mean that REITs are far better placed than they were in the

GFC and that the chances of highly dilutive capital raisings are low. “We believe the liquidity picture is far superior than recent pricing suggests,” says JP Morgan.

The sector currently represents about a 30% discount to underlying values, says Peacock. And dividend yield for the sector is about 7.5%.

But some sub-sectors are expected to hold up better than others.

Peacock favours industrial, which is being driven by the rise of e-commerce, and convenience retail. No-go zones include funds that hold hotels, which are closed, discretionary retail, because of the huge drop-off in foot traffic in shopping centres, and some office funds, because of increased working from home and the impact of an economic downturn on office space take-up.

When considering future opportunities and risks, there are a few key themes to watch, says Grant Atchison, co-founder and managing director of Freehold Investment Management, a specialist property and infrastructure fund manage.

“Covid-19 has, in our view, fast-tracked a number of themes,” he says. These include the impact on the demand for offices over the medium term as employers embrace a more flexible work environment. This change has been coming for a number of years, but with some resistance. And data centres and related IT infrastructure are likely to become more mainstream, as businesses fully transition to the cloud.

But the security of A-REIT dividends is not certain in the short term. “If you’re investing in REITs this year, be aware dividends could be at risk,” says Morningstar analyst Alex Prineas, who believes a lot of REITs will cut dividends, particularly those exposed to retail or cyclical areas such as housing development.

Pam Walkley, founding editor of Money and former property editor with The Australian Financial Review, has hands-on experience of buying, building, renovating, subdividing and selling property.