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REITs: victims of fashion

In Practice

A dedicated allocation to ASX listed REITs is largely an Australian idiosyncrasy as a legacy from the high weight and structural elements of the property trust sector in its heyday. The 2009 financial crisis should have put paid to the role REITs had in portfolios given their distribution cuts and capital raisings at the time. But as investor sought income and falling rates buoyed valuations, the comfort of the sector returned.
This year is another reminder that REITs are just equities, with correlated performance and as prone to disruption as any other sector. The ASX REIT sector is further compromised by the high weights of a few stocks with the top 5 totalling near 65% of the index. If one or two of these stocks are unattractive on valuation or fundamental grounds, the skew to others can become distorting simply to fill an allocation.
A carve-out to global REITs would be a better solution, with the top 10 stocks only 20% of the FTSE/EPRA Nareit index.  This index is also more diversified, naturally geographically, but also in the mix of property assets. Residential, communication or healthcare REITs are not locally listed, whereas they are relatively common elsewhere.
A broader option of an allocation to real assets rather than just property is an even better solution. Roads, rail or airports are property assets in practice even if their income stream is dissimilar and they can play a similar role in generating income and participating in the potential capital gain.
Current conditions, in any event, warrant a review of investment property. Retail is the obvious sector that has been cast into the fray. How many stores chose or are forced to shut doors permanently is yet ahead, adding to the risk that rents don’t hold up. Hospitality assets are similarly affected.
But the one that may be the most intriguing is the office sector. Big changes to work practices are a likely legacy of COVID.
Will work-from-home become an ingrained feature if businesses are comfortable with employee productivity? The potential cost-saving suggests many will give it a go. On the other side of the ledger is office amenity, anything from square meter per employee to building entry, lift wells, cleaning and meeting rooms. Buildings that can accommodate all the new aspects that are now becoming the norm should gain the edge in valuations. Will the CBD retain its advantage given constraints on public transport and general crowding?
It was only some 15 years ago that the tenancy of department and discount department stores was key to shopping complex valuations. Today they are a ball and chain. In all likelihood defenders of the current office sector will find comfort in the anticipated return to normal working conditions in coming months. But as has been the case for department store retail, the COVID experience starts a progressive pattern of change.
Even prior to this year, open offices with ever smaller space per employee were under debate. The irony is that just as people invested so much into making their homes a pleasant experience, in the office they were corralled into unimaginative small boxes where they spend most of the waking part of the day. Apply the same principle to an investment portfolio and consider Australian REITs as the box constraint relative to a host of alternatives.

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