3 niche a-reits still offering value

It is hard to get excited about large Australian Real Estate Investment Trusts (A-REITs) with signs of weakening tenant demand and expectations of higher bond yields. But beneath the tough outlook are some good performances from niche A-REITs.

The S&P/ASX 200 A-REIT index has a total return of 1% (including distributions) over one year. With the ASX 200 index up 10%, A-REITs have underperformed. The gap would widen as ‘bond proxies’, such as A-REITs, utilities and infrastructure stocks are sold.

A pullback was overdue. The A-REIT sector strongly outperformed the broader sharemarket over three and five years and income investors flocked to listed property trusts with attractive, reliable distributions as global bond yields fell.

The 12-month underperformance of A-REITs relative to the broader market might be a buying signal, especially given the rout in Australian equities this week, which almost wiped out calendar-year gains.

Readers will recall I suggested in April for the Switzer Super Report to take some profits. I wrote: “The investment adage, ‘sell in May and go away’, looks particularly apt this year.”

On A-REITs, headwinds are unlikely to abate soon as a sluggish economy compresses capitalisation rates on properties and Amazon’s expansion in Australia creates uncertainty for retail landlords.

The A-REIT sector looks like it is in an advanced stage in the property cycle; that probably means weaker returns for the next few years. Of course, there’s always opportunity at an individual A-REIT level and some niche players have excellent prospects.

I nominated several niche A-REITS for the Switzer Super Report in late 2015 in “5 awesome A-REITs for your portfolio” and identified how Australia was following United States trends with growth in niche A-REITs through the Initial Public Offering market.

They included: National Storage Group (NSR), Asia Pacific Data Centre Group (AJD), Arena REIT (ARF), Galileo Japan Trust (GJT) and the US Masters Residential Property Fund (URF). Rural Funds Group (RFF), Aventus Retail Property Fund (AVN) and Folkestone Education Trust (FET) were reviewed favourably in 2016.

Storage-centre operator National Storage rallied from $1.49 in September 2015 (when the column was published) to $1.85, before easing to $1.46. I like National Storage’s leverage of the urbanisation theme and greater demand for self-storage space, but its earnings growth lacks sufficient visibility for now.

Data-centre owner Asia Pacific Data Centre Group, a column favourite, zoomed from $1.25 in September 2015 to $1.78 and looks like a takeover target.

Arena REIT, covered several times in this column, rallied from $1.61 in September 2015 to $2.22. Arena looks like a lower-risk way to play the childcare growth theme compared to owning more volatile childcare-centre operators.

Galileo Japan Trust soared from $1.77 in September 2015 to $2.65 (the price unit holders received in the A-REIT’s portfolio sale and subsequent ASX delisting) in early 2016. At the time, Galileo traded at a significant discount to its Net Tangible Assets (NTA), despite offering exposure to an improving Japanese property market.

The US Masters Residential Property Fund, the first Australia-listed property trust established to invest directly in US residential property, eased from $2.12 in September 2015 to $1.98, although a 5% distribution was of some comfort.

Farm investor Rural Funds Group stood out, soaring from $1.36 in March 2016 (in my column on attractive income stocks) to $1.77.

I like Rural Funds’ strategy to buy, consolidate and rent farms – a model that has worked well in the United States and is well timed given strong demand for Australian agriculture in Asia – and its potential to lift distributions. Rural Funds sought $79 million this week in a capital raising.

Bulk-goods operator Aventus has risen from $2.37 in September 2016 (when I last wrote about the A-REIT for this report) to $2.49. I like Aventus’ exposure to big-box retailing, which is a much more common form of REIT in the United States than here.

Folkestone Education Trust has barely changed in price since I wrote about it in August 2016 for this report in a column on education-related stocks. Like Arena, Folkestone has good exposure to childcare centres and growth in that market.

This performance update on niche A-REITs excludes distributions, so investors who have backed selected A-REIT newcomers have mostly done well in an otherwise underperforming listed property market.

Here are three A-REITs that still offer value:

1. Aventus Retail Property Fund (AVN)

Aventus still looks interesting despite its rally from $2.10 in late 2016. The owner of “super centre” properties acquired two large retail formats in Sydney in late May for $436 million. Although neither acquisition greatly affects Aventus’ earnings in the near term, they reinforce the trust’s potential to consolidate Australia’s fragmented super-centre property market.

The US experience has shown that large-format retailers attract more customers as household-name homeware, electrical and other speciality retailers are grouped. That, in turn, creates higher property occupancies and better performance than privately owned centres.

Aventus has a first-mover advantage, as a listed trust, in this market. A strong pipeline of potential acquisitions should underpin earnings growth over the next five years.

Bulk-goods retailers should be less affected by Amazon’s expansion in Australia, although electrical stores in super centres might feel the pinch from greater online competition.

Aventus is achieving good growth in property values. Its portfolio valuation has increased 14.9% since December 31, 2017. This was partly because of the rooftop expansion of the A-REIT’s Belrose Super Centre in Sydney and the repositioning of its Sunshine Coast property.

Don’t expect Aventus to shoot the lights out, but it can steadily grow earnings and distributions through organic growth and acquisitions in a fragmented, underrepresented sector on the ASX.

^{Source: ASX (www.asx.com.au)}

2. Arena REIT (ARF)

The childcare operator delivered a strong half-year result in February. Net profit rose 13% on the same half a year ago to $14.2 million; distributions per security rose 9%; and the net asset value (NAV) per security rose 13% to $1.74.

Key performance metrics, such as Arena’s Weighted Average Lease Expiry, average rent-review increase and lease-renewal rate, continue to deliver solid growth. Arena is well run and has a history of consistent distribution increases.

Upgraded distribution guidance of 12 cents per security for FY17 suggests distribution yield of about 5.5% at the current price. Add to that the prospect for low double-digit capital growth this financial year and Arena should deliver a handy total return.

Arena has come a long way from the A-REIT that listed in June 2013 after raising $75 million at $1.01 a unit through an IPO. It’s one of the best small-cap A-REIT floats in years.

Now $2.22, Arena trades at a significant premium to its latest stated NAV of $1.74. It deserves a premium given its exposure to the attractive childcare and healthcare sectors, and because of its consistently strong performance.

The A-REIT still offers value for long-term income investors seeking a mix of yield and capital growth. Active investors might wait for lower prices if the market sell-off continues.

^{Source: ASX (www.asx.com.au)}

3. Folkestone Education Trust (FET)

The owner of more than 330 externally managed childcare centres in Australia and over 50 in New Zealand delivered a solid first-half result for FY17.

Profit rose 16% to $69 million, the distribution increased 6% to 7.1 cents per unit and NTA rose almost 10% to 2.35 per unit.

Folkestone trades at a decent premium to NTA. But, like Arena, the A-REIT is well-run and offers exposure to the childcare sector, which has attractive prospects. The progression of the Government’s Jobs for Families Child Care Package bill through the Senate should boost the industry, underpinning tenant demand and profitability in childcare centres.

Morningstar’s $3.10 valuation for Folkestone looks about right. An estimated 5% yield, and Folkestone’s exposure to Arena (it has a 4.4% stake), are other attractions.

^{Source: ASX (www.asx.com.au)}