It’s fair to say 2014 has been a disappointing year for the Australian stock market. After a year of ups and downs, the ASX 200 Index is now sitting on a 4.02% loss since January 2.
The market’s weakness was felt in some sectors more than others. If you invested in the mining sector, you know what I’m talking about.
Resource companies have found it especially tough going. Slowing Chinese growth and falling commodity prices have hit the sector hard. Resource stocks have been severely battered as iron ore and oil prices have sunk by more than 45% each, while the coal price is down 25% for the year. The lower Aussie dollar — at least against the US dollar — hasn’t been enough to offset these lower prices.
To get a positive return in 2014 you had to look elsewhere. But with interest rates at 50-year lows and returns on term deposits continuing to fall, investors struggled to find somewhere to earn a buck. You may have turned to dividend paying stocks — like the big four banks. But even these powerhouses have been underwhelming, dogged by questions of whether they have adequate capital reserves.
However, there was one sector that had a great year — Australian Real Estate Investment Trusts, or A-REITs.
A-REITs are popular with investors looking for high-yielding, relatively low risk, and conservatively managed stocks. The trusts are property owners that derive income from rental returns. They tend to have stable earnings and pay reliable distributions to shareholders. And unlike pre-GFC REITs, most of REITs’ total returns come from rent paid by tenants, which are generally signed to long term leases.
The S&P/ASX 200 A-REIT Index is up 19.8% since the start of the year— that puts it 24% ahead of the broader market. And it paid an average dividend yield of 5.5%.
The largest REIT on the ASX, Westfield Corp. [ASX:WDC], is up 41% so far this year. Diversified office, retail and industrial A-REIT, Charter Hall Group [ASX:CHC], is up 30%. Niche A-REITs have had a strong year too. Healthcare A-REIT Generation Healthcare REIT [ASX:GHC] is up 24.5%, and pub owner ALE Property Group [ASX:LEP], is up 19.4%.
Despite these recent gains, REITs aren’t looking all that expensive right now. Overall, they have strong balance sheets, appropriate payout ratios, solid earnings and sensible growth strategies. Of course, you need to question whether that performance can continue going forward.
The major risk is a rise in interest rates. REITs are sensitive to rate rises because it raises their cost of debt, and makes alternative investments more appealing. Just a rumour of raising interest rates can impact REIT share prices that very day. You may have noticed, then, when the US Fed mentioned ending its quantitative easing policies earlier this year.
Yet there’s no certainty around when rates will rise. In fact, Tactical Wealth editor, Kris Sayce, bets ‘that interest rates will stay low for at least another 20 years’. Even still, REITs are preparing for the chance that rates will rise. They’re refinancing debt incurred during the GFC at lower rates and extending the length of time needed to pay off debts.
There are a few ways that you can invest in the sector. You can simply buy one or more of the A-REITs on the ASX. But this will leave you open to company specific risk. That’s the risk that the company faces troubles not affecting the broader market. Things like poor management decisions, or problems with a major tenant, or with securing finance. If you choose to invest directly in A-REITs, you should have a thorough understanding of the company and be confident in its management.
You have a couple of other options that avoid company specific risk and are less volatile. The first is with an actively managed A-REIT fund. Active management involves the fund manager using their judgement to identify stocks that they think the market has mispriced. However, the higher fees charged by these funds often outweigh the active management benefits.
Another option is to invest in a passive index fund. These give you investment exposure to all those REITs within a certain index — say the S&P/ASX 200 A-REIT Index that’s up almost 20% this year, as mentioned above. You can invest in these on the ASX or through unlisted fund managers. The fees on exchange-traded funds (ETFs) are typically lower than for unlisted funds.
The global property investment I recommended to members of the Albert Park Investors Guild has returned 14.3% since August. With a diversified global strategy, my analysis suggests this is the best property investment to own as we enter 2015.
For The Daily Reckoning Australia