By Greg Peel
Property has become the investment buzzword for 2013. Stock markets continue to rally on central bank stimulus yet the bulk of investors remain on the sidelines, still fearful of the volatility that has been a feature since the GFC. The assumed relative safety of "bricks and mortar" has become attractive to smaller investors in particular as falling interest rates render cash holdings unattractive.
In China, Beijing continues to apply measures to rein in that country's property boom. In the US, the housing market has already staged a solid recovery from its post-GFC depths. In Japan, cheap finance provided through Abenomics is reinvigorating property prices. In Europe, a crawl-back out of recession is refocusing attention on beaten-down property values. In Australia, the first signs of a post-GFC property recovery are appearing, with house prices rising on investor-driven demand.
Direct investment in residential or commercial property has regained favour in Australia, particularly as the RBA cash rate has fallen. Yet single-asset investment at the low end of the scale will always be risky. Diversification reduces risk, and quality properties and tenants improve return potential, but the average investor can only ever dream of owning a suite of CBD office blocks, for example, and outlays are even too steep for institutional investors.
The role is instead filled by real estate investment trusts (REIT). REITs seek to raise funds from the market to acquire a portfolio of property assets typically in one particular class ? retail, office or industrial for example ? and usually in one particular geography. Resultant property funds can be unlisted, thus trading off lower volatility with less ease of secondary market transfers, or listed, which aligns REITs with shares in terms of price transparency and ease of transfer but opens the funds up to general market volatility.
The Australian REIT (A-REIT) market began to collapse in late 2007, a year before the GFC, long before an ultimate credit freeze spelt the demise of Lehman. The lead-up "credit crunch" exposed over-extended gearing and low quality portfolios among many a listed A-REIT and for some death came swiftly. Others suffered near-death experiences and even those with lower gearing and higher quality properties were dumped on suspicion.
The A-REIT market has since rationalised, deleveraged, and divested of lower quality assets. The survivors have seen unit ("stock") prices recover and as rates on term deposits and other cash investments have fallen, yields offered by A-REITs have become ever more attractive to investors. Many funds fell to price levels inferring huge discounts to net asset values. As the property market has rationalised and the global economy has stabilised, asset valuations have become less fragile and those discount gaps have narrowed, providing for capital appreciation alongside yield.
The deleveraging of REIT balance sheets has reduced the risk of the funds themselves collapsing, irrespective of asset values and rental yields on offer. And this brings us to a very salient point.
Investment in a REIT is not simply an investment in property. Investment in a REIT is an investment in a company. In this instance, that company acquires and manages rental property. Property may offer "bricks and mortar" safety but just as any widget maker with a sought after product can mismanage the selling of that product, or just as any miner with high-grade deposits can mismanage the production of that resource, the management of properties can also be poorly executed.
A REIT investor does not buy property. A REIT investor buys shares in a company that buys and manages property. Resource Real Estate Global Property Securities believes the difference might be subtle but is fundamental, and overlooked by many a REIT investor.
Investors in A-REITs, and particularly smaller investors, are focused on comparing yield. If a term deposit is offering 4% and a REIT is offering 7% then the REIT looks like much better value. After all, it is backed by bricks and mortar. Banks, too, draw attention from investors on an almost exclusively yield basis. Yet bank analysts focus primarily on a bank's earnings trajectory ? that which is providing the cash to pay the dividends. Strong earnings growth means not only robust dividends but also capital appreciation. Analysts thus value banks on the basis of return on equity (ROE) ? a combination of earnings and yield ? rather than simply the yield itself. Strong earnings growth is indicative of successful management.
After having spent years in the property investment field, the fund managers behind Resource Real Estate have come to the conclusion that assessment of the value of a REIT based on yield alone is a shallow assessment, opening the investor up to mispriced risk. Even an investment in a REIT based on discount to net asset value is potentially an investment in a one-off opportunity as discount gaps close with an improving macroeconomic outlook. For the longer term investor, high yields and short term gains are not the goal. For the longer term investor, ROE is key.
Resource Real Estate has thus launched a fund with this alternative REIT investment objective in mind. REE notes there have been no real new entrants into the REIT market since the GFC and certainly none with a different approach, such as REE is adopting. The approach is to assemble a global portfolio of REITs based on assessment of management's capacity to improve ROE over time, rather than a portfolio based simply on buildings and tenants providing an attractive yield at current price levels.
REE invests in a REIT as a company. That is not to say the fund manager is ambivalent about what property is in the REIT portfolio. REE remains fundamentally an investor in property and portfolio selection is fundamentally driven by underlying property value assessment. But also of great importance is the fund managers' valuation of management itself.
REE is bullish global property. The following graph provides an explanation as to why.