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Australian real estate investment trusts (AREITs) have performed well in recent years thanks to a number of tailwinds, but investors now need to once again focus on the fundamentals, said Grant Berry, portfolio manager of AREITs at SG Hiscock & Company.

“Falling interest rates have prompted an increase in investments in higher yielding assets, and listed property companies have benefited from this.

“However, we are now in the late stage of the property cycle and some of the drivers of returns will start to recede.

“Investors should be aware of some of the risks likely to play out as the cycle further matures and consider opportunities to add a defensive element to their portfolios,” Mr Berry said.

Speaking at an investor briefing event in Melbourne earlier today, Mr Berry said the heightened valuations in some areas such as office and industrial sectors is cause for concern.

“A significant warning sign for us is the valuation dispersion in the AREIT market – that is, the gap between the lowest and highest valued REITs. It is currently at its widest level since the global financial crisis, signalling deep-seated variations between companies and how they are valued, which has significant implications for investors.

“For example, with the office and industrial sectors, values are extending well beyond rents which we believe is unsustainable in the medium to long term.

“Our positioning is therefore focusing on identifying high quality assets with less cyclical exposure, seeking to achieve higher, more stable income yield supported by tangible assets.”

Mr Berry said that, contrary to popular opinion, the retail sector is a good place to look for opportunities.

“There is a view in the market that the retail sector is in recession and that people are only shopping online, meaning bricks-and-mortar retailers – and the retail property sector – are in terminal decline.

“We take a different view. History has shown that retail is the least volatile sector of the property market, even during times of recession, and our research shows that retail is the most superior form of real estate exposure over the long-term.

“Much was made of the entry of Amazon into Australia but this was overplayed. There is no doubt that online retail is taking some market share, but the key issue facing the sector at the moment is weak wages growth and benign consumer sentiment. And we are seeing signs of improvement in these areas.”

He believes retail continues to offer a strong long-term story due to factors such as:

  • very high barriers to entry
  • developments are typically demand-led rather than speculative (as is the case with office or industrial property)
  • a highly diversified income base with 99 per cent occupancy over time
  • significantly lower maintenance capital expenditure and lease incentives compared to office property
  • the opportunity to further develop the property, such as building hotels or office blocks over existing malls.

“At this late stage of the cycle, we would prefer to have exposure to high quality assets that are less vulnerable to cyclical factors, which are trading at discounts and that are out of favour.

“Should the cycle turn or momentum change, we believe this approach will deliver good outperformance,” Mr Berry said.