Potential benefits of Investing in A-REITs

1. Income Generation: The net income generated by A-REITs can potentially be consistent and predictable. It includes rental income from the properties held, less interest costs from borrowings. To qualify for tax exemptions, A-REITs typically distribute the majority of their income to shareholders as dividends. This makes A-REITs a potential option for income-focused investors as A-REITs have historically provided more income than shares, as Figure 1 below shows.

Figure 1: Historical Income from A-REITs and Shares 

Source: Bloomberg Finance L.P., State Street Global Advisors as of 30 June 2024. Past performance is not a reliable indicator of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss as applicable. A-REITs = S&P/ ASX 200 A-REIT Index, Shares = S&P/ASX 200 Index.

2. Diversification: Investing in A-REITs potentially allows investors to diversify their portfolios beyond traditional asset classes like equities and bonds. This can help reduce overall portfolio risk due to lower correlations with A-REITs and other asset classes. In addition, investing in A-REITs can give investors exposure to a portfolio of premium property for a relatively small outlay.
 

3. Liquidity and transparency: Unlike physical real estate, which can take significant time to buy or sell, A-REITs are traded on the ASX, providing greater liquidity and transparency. Investors can quickly buy or sell A-REITs as market conditions change with a high degree of confidence about the market price.
 

4. Tax efficiency: A-REITs can have attractive tax features, including the pass-through of income without corporate tax at the A-REIT level, and tax deferred distribution components. However, individual income tax is still payable at the investor’s marginal rate. 
 

5. Inflation hedge: The value of real estate has historically appreciated with inflation, making A-REITs a potential hedge against rising prices during period of higher inflation, in State Street’s view.
 

6. Professional management: A-REITs are managed by experienced professionals who handle property acquisition, management, and leasing, relieving investors of these responsibilities.

Potential risks of Investing in A-REITs

1. Property market risk: The performance of A-REITs is closely tied to the real estate market. Factors such as economic downturns, oversupply of properties, or declining rental rates can negatively impact A-REITs. Some A-REITs are concentrated in a specific sector (e.g., retail) which can potentially pose a diversification risk for investors.  

Figure 2: A-REITs Performance and Economic Growth

Source: Bloomberg Finance L.P., State Street Global Advisors as of 30 June 2024. Past performance is not a reliable indicator of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. A-REITs = S&P/ ASX 200 A-REIT Index.

2. Equity market risk: Like all stocks, A-REIT prices can be volatile and influenced by broader equity market movements not specific to the property market. 
 

3. Interest rate risk: A-REITs use gearing to invest in property assets and can have moderate to high gearing ratios, which makes them sensitive to interest rate changes. Rising interest rates can increase borrowing costs and make yield-focused investments like A-REITs less attractive, potentially reducing their unit prices.
 

4. Less potential for capital appreciation: A-REITs typically distribute the majority of their net rental income, leaving less for reinvestment especially into new properties. This, therefore, reduces the potential for capital growth except in the case of property market upturns.
 

5. Management risk: While professional management of A-REITs can be a benefit for investors, the quality of an A-REIT’s management team can significantly affect its performance. Poor management decisions can lead to sub-optimal property purchases and leasing strategies in a competitive market.
 

Historical Performance of A-REITs

The performance of A-REITs over various time periods is shown below to illustrate their historical returns and volatility. Historical data over the last 20 years illustrates the perceived resilience of A-REIT income generation through multiple economic cycles. However, as seen in the different periods, capital appreciation has generally been weak.

Figure 3: S&P/ASX 200 A-REIT Index Historical Returns (% p.a.)

Source: Bloomberg Finance L.P., State Street Global Advisors as of 30 June 2024. Past performance is not a reliable indicator of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. 

Macro factors that could impact future performance 

The current macroeconomic environment in Australia is characterised by high inflation. In State Street’s view, this is an environment in which real estate, and A-REITs, could improve given that rental income can often be adjusted higher in inflationary periods. 

However, as shown in the table above, performance of A-REITs has been lacklustre in the last three years of elevated inflation. This is mainly due to the higher interest rates that central banks have been using to bring inflation under control as well the resultant weak economic growth and property market. 

Inflation is falling, albeit slowly. In State Street’s view, this could allow the Reserve Bank of Australia to begin cutting rates in the next several months. Lower rates and the support for growth they provide could potentially benefit A-REITs in the medium term. This may be one possible reason why A-REITs prices have lifted this year. 

In State Street’s view, the outlook is, clouded by several other macro trends that may negatively impact A-REIT performance. These factors include the sluggish return to office post-Covid, the continued growth of online retail and the slowdown of inward migration, which had supported residential rental inflation.   
 

Why ETFs for A-REIT Exposure?

With 41 A-REITs listed on the ASX, it can be difficult to pick individual ones or property sub-sectors that are likely to perform best. To overcome this challenge, an alternative for investors to consider is A-REIT Exchange Traded Funds (ETFs). ETFs allow investors to gain a diversified exposure to property through a single vehicle that tracks the performance of the A-REIT sector. 

It is important to note that just like any other investment, A-REITs, and A-REIT ETFs have similar potential risks, such as the possibility of delivering a negative return, or currency risk for global REITs.

Alternatives to A-REITs

A-REITs only offer exposure to the Australian property market and therefore might not offer enough diversification. In contrast, global REITs offer exposure to multiple international property markets, led by the United States. Global REITs also offer a more diverse range of sectors which include healthcare, and data centres which could benefit from the growth of AI and cloud computing. 
 

The Bottom Line

A-REITs offer investors an opportunity to invest in the commercial real estate market. In State Street’s view,  with careful consideration of the risks, A-REITs can be a component of a diversified investment strategy, providing exposure to the property market and the income it generates.

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[1] Source: ASX, as at 31 July 2024

DISCLAIMER

This article has been prepared by State Street Global Advisors, Australia Services Limited (AFSL Number 274900, ABN 16 108 671 441). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia · Telephone: 612 9240-7600 · Web: www.ssga.com. This material is for education purposes only and does not constitute financial advice. It has been prepared without taking into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you.

This material should not be considered a solicitation to buy or sell a security. Investing involves risk including the risk of loss of principal. Diversification does not ensure a profit or guarantee against loss. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).

6894541.1.1.ANZ.RTL Expiry Date: 31/08/2025