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There is a lot of water – not to mention an election – to pass under the bridge before Labor’s proposal to stop excess franking credits from dividends being refundable to low-tax-rate holders, but it has certainly caused yield-oriented investors to lift their focus from high-yielding fully franked dividend payers (see Paul Rickard’s article today to assess how it might affect you).
One of the places that investors are re-examining is the A-REIT (real estate investment trust) sector, which is once again a strong candidate for a yield portfolio.
The caveat there is that the REIT distributions are typically untaxed in the trusts’ hands and do not come with franking credits attached. Some of the REITs are stapled securities – where a unit in a property trust trades indissolubly with a share in a property company, and the latter may be active in property development, syndication, management and property services – thus giving rise to a small franking component. And there is often a small tax-advantaged component, arising from tax concessions, such as depreciation allowances and tax-deferred income, but this is not as effective in reducing an investor’s tax liability as fully franked dividends from shares – and in the self-managed super fund (SMSF) context, does not augment the yield to the SMSF in accumulation or pension mode.
But as yield-conscious investors start to re-examine REITs, they should look past the headline yields for strong and sustainable income flows that might have a role to play in a re-jigged yield portfolio.
Here are my top three candidates for REITs that offer attractive cash yields that allow investors to sleep soundly at night, and offer them some prospects for distribution growth – with the added bonus of some capital growth thrown in, to boost the total return.
Formed last year from the merger of Centuria Capital’s two listed property trusts, Centuria Metropolitan REIT and Centuria Urban REIT, CMA specialises in suburban (non-CBD) office markets. It knows this market exceptionally well and is a very hands-on manager. CMA holds 19 properties in five states and the ACT, with 84% of the portfolio on the eastern seaboard. About 43% of rental income comes from the trust’s top ten tenants, which are a mix of high-calibre businesses – the listed Insurance Australia Group (IAG) and Wesfarmers’ Target department store chain are the two largest tenants – and government departments.
The portfolio has 97.8 % occupancy, with a weighted average lease expiry (WALE) of 4.3 years, which is a touch on the low side, but the trust’s forward expiry profile can give investors a fair degree of confidence, with less than 1.2% of income expiring in the remainder of this financial year, and 50% of its income expiring in FY22 and beyond.
The balance sheet is very strong, with gearing below 30%, and a debt maturity of about three years. The distribution is underpinned by 96% of CMA’s rental income having fixed annual increases of 3.6%. The trust has reaffirmed its full-year distributable earnings guidance of 18.6 cents per security and distribution guidance for 18.1 cents per security, which would give a payout ratio of 97.3%. As a potential bonus, the relative value of the suburban office markets compared to CBD markets sees analysts holding a consensus target price of $2.57 on CMA, or 12% above the current security price.
The diversified nature of the Stockland portfolio – across retail centres, business parks, logistics centres, office buildings, residential communities and retirement living villages – gives rise to a highly sustainable yield, with solid prospects for long-term growth and value creation. Stockland has a conservative payout ratio – under 80% – but very good prospects for upside, with funds from operations (FFO) surging by 16.9% in the first half, and company guidance projecting FFO per security growth for the full year in the range of 5%–6.5%, which should enable distribution growth of about 5%, and an FY18 distribution yield of 6.4%.
Stockland has come down in unit price on the back of concerns about the retail environment – the bulk of the portfolio is invested in retail – but that opens up scope for capital growth and a boost to the total return for holders of the stock: but for investors interested primarily in sustainable and above-market distributions (and growth therein) Stockland is an attractive proposition.
Again, that word, “retail,” which some investors might view with concern, but Charter Hall Retail REIT is heavily focused on “convenience-based” shopping: 93% of its rental income comes from convenience-based non-discretionary retailers. About 76% of major tenant rental income is generated by supermarkets, with Wesfarmers and Woolworths businesses representing almost half (48%) of rental income.
While there is definitely intense competition among supermarket operators, supermarket sales maintain steady and consistent sales growth, without the volatility attached to clothing and department stores. And the supermarket wars actually benefit CQR, because disrupter Aldi is becoming a bigger tenant – it is now the seventh-largest tenant by rental income – and the trust says more Aldi stores will be added to the portfolio.
CQR projects a FY18 payout ratio of 92.4% of earnings, and expects the payout ratio to stay in the 90%–95% range. CQR has been working on a strategy of enhancing the REIT’s portfolio quality by “recycling” out of lower-growth properties and into higher-growth properties, and analysts say this re-positioning is almost complete.
The portfolio has a WALE of 6.7 years, and the tenant mix makes CQR a relatively predictable yield generator. With forecast yields in the 7.3%–7.4% range, CQR offers a high-quality income stream.