Will Rising Bond Yields Destroy A-REITs?

Real estate market - a-reits

Regardless of your financial situation, every Aussie can own a piece of this beautiful country. With just a few dollars, you can claim your stake to some of the best commercial real estate in Australia. I am, of course, talking about A-REITs.

The whole reason US president Dwight D. Eisenhower signed legislation in September 1960 to create REITs was to benefit the individual. These trusts allow investors like you and I to invest in diversified commercial real estate.

Over the past five years, A-REITs have been a great investments for Aussies. The ASX 200 A-REIT Index is up 44.5% over the period. Including dividends, total returns are close to 80%.

But could that five-year run soon come to an end?

Citi calls the end of A-REITs?

Interest rates have a big impact on A-REITs. They determine the cost of borrowing, property values, and affect the future cash flows of these reliable dividend payers.

So now with interest rates on the rise, and rising bond yields also, should you avoid A-REITs altogether? Citigroup Inc. [NYSE:C] believes so. As reported by The Australian Financial Review:

In the note titled Australian Property: Are we going back to normal? analysts Adrian Dark, David Lloyd and Suraj Nebhani say higher US rates, rising yields on US and Australian 10-year bonds and REITs that have underperformed the flat local market since their last research note in May suggest a tougher time to come for Australia’s large listed landlords.

In this environment, stocks already trading below the multiple on earnings at which they typically trade, such as Vicinity Centres, Scentre Group and Stockland were likely to do better than others that had further to fall, such as Mirvac, or those trading higher as a result of the current cycle, such as Goodman group and Dexus Property Group, they said.

Year-to-date, the ASX 200 A-REIT Index has fallen more than 8%. But I think Citi has over-exaggerated the situation.

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Buy the business, not macro trends

While the US is set on rising interest rates, we Aussies likely won’t see higher rates in the near future.

In his most recent monetary policy statement, Philip Lowe, head of the Reserve Bank of Australia, told the press:

The outlook continues to be supported by the low level of interest rates. The depreciation of the exchange rate since 2013 has also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment.

The AFR condensed Lowe’s speech to the following: ‘…the Australian economy is plodding along, inflationary pressures remain feeble, so there’s absolutely no reason to lift Australian interest rates any time soon.

Instead of worry about macro trends, take a leaf out of Warren Buffett’s book. He recently bought two REITs, even while the US Federal Reserve is determined to raise rates higher. The first REIT was Store Capital Corp [NYSE:STOR], which has a unique way of leasing its property.

As reported by MarketWatch:

‘…The company [Store Capital] distinguishes itself by focusing on tenants that provide rent payments directly from their business operations, which includes gaining access to the businesses’ financial statements. Through this business model, Store reduces the number of tenants vacating unprofitable units if they become insolvent. Store collects additional payments like other REITs from two other sources, tenant credit quality and underlying real estate value.

The second REIT Buffett purchased was Seritage Growth Properties [NYSE:SRG]. The company, which was formed from the real estate of Sears Holdings Corp [NASDAQ:SHLD], avoids investing in indoor-mall-type stores. Instead, it leases out its property to grocery stores like Whole Foods, spin-class fitness centres, and entertainment venues.

Now, when I say ‘take a leaf out of Buffett’s book’, I don’t mean by buying A-REITs. Instead, you should base every investment on the underlying business. That’s why I suggest you shouldn’t throw A-REITs out of your potential investment pool. If you find one you like, don’t let Citi or other analysts scare you out of it.

Regards,

Härje Ronngard,

Junior Analyst, Markets & Money

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