Property Securities: the forgotten yield play

Listed Property Trusts (LPTs), as we used to call them, were in portfolios because of their low correlation with growth assets. While we expected growth assets to go up in the long term we were aware that the short term could be very volatile. These property assets were expected to stay in a narrower range while delivering a stable stream of income.

The income wasn’t just regular. It went up with inflation. The assets were bricks, mortar, steel, and glass and businesses paid rent to use them. When businesses failed, as they often do, the manager just got new tenants. New tenants or old, the leases had regular rental reviews to keep up with inflation. If you were diversified across enough properties, the risk was low and the reward was good.

In those days allocations to cash were just for liquidity. The returns from cash were considered poor.

Then the world went global and LPTs became A-REITs (Australian Real Estate Investment Trusts) so that they could be marketed offshore. Debt and financial engineering took over as income assets tried to turn themselves into growth assets. Like the rest of the super-fuelled financial markets, this came to an unpleasant end.

During the Global Financial Crisis (GFC), with credit markets in a state of disarray, there was a flurry of capital out of the sector as investors feared the highly leveraged and at times opaque structures would lead to a complete loss of their capital — just ask any Centro Properties investor.

Investors parked their money in bank deposits but the idea wasn’t just to keep it safe. As the tide of the bull market went out, what was exposed was how many investors focus on yield. People were chasing the highest term deposit rates they could find sometimes jumping from bank to bank every three months to get the latest honeymoon rate.

A number of years have passed with investors slowly moving back into property securities as the gearing ratios improved. It is the right time to revisit the opportunities that they offer. 

With many economists predicting week economic growth, we are expecting the current RBA cash rate of 2.5% to remain at this level for some time. This bodes well for the property securities sector and in this type of environment we believe that valuations will at least remain at current levels or we may even see a slight increase.

October saw the Market Vectors Australia A-REITs Index rise with the main news in September being the U.S. Federal Reserve's decision not to taper Quantitative Easing and the potential U.S. Government shutdown. In Australia, all housing indicators beat expectations including housing finance and building approvals as well as the continued increase in national house price growth and auction clearance rates.

Although general economic forces move the overall sector in a particular direction, individual property securities are affected by their broad sector (Office, Retail, Industrial or Diversified), together with specific security factors — this leads to the fundamental question on every investor's mind, 'Which property security should I invest in?' This isn't an easy decision as they are all in different sub-sectors of property and have their own nuances, be it cost of debt, sub-sector exposure or quality of assets.

There is no doubt that Australians have a love affair with property. Many retirees are leveraging up their Self-Managed Superannuation Fund (SMSF) to invest in property directly with the aim of improving their retirement income.  However, this investment comes with many other costs such as stamp duty, agent fees, and so forth, in what is generally considered an illiquid asset.

On the other hand, the liquid alternative, Property Securities, continue to provide good relative value when compared to risk-free investments such as term deposits. The Market Vectors Australia A-REITs Index  (MVMVATRG) is currently yielding 5.5% substantially above one-year term deposit rates which have fallen below the 4% per annum level. As can be seen in the chart below the spread differential between the Market Vectors Australia A-REITs Index and the 1 year AUD Swap rate is 2.70% representing an enticing risk premium.

Source: Bloomberg, FactSet 

One way to access a diversified property security investment is the Market Vectors Australian Property ETF (ASX code: MVA). MVA is a purpose-built, efficient and cost effective way to invest in Australia’s property securities sector. The ETF currently has 17 holdings with capping factors applied to the larger property securities. What this means is that individual holdings are capped at 10% so that the likes of Westfield Group which is typically around 24% of a traditional market capitalisation index is only 10% of the overall portfolio, thereby limiting security concentration risks.

In the search for yield, property securities can offer both inflation-linked income and modest capital growth. They may also have a more defensive risk/return profile than other yield-oriented areas of the market.

Returns on term deposits are no longer satisfactory. People have been turning to dividends to provide yield but are nervous about capital losses in the short term. Diversified investors are bringing property securities back to their natural position in their portfolio and some are going even further. Those who have discovered their taste for a good yield with low volatility are taking an even bigger allocation to a well-diversified portfolio of property securities.

For more information on the Market Vectors Australian Property ETF issued by Market Vectors Investments Limited, including a copy of the product disclosure statement click here: http://www.marketvectors-australia.com/Funds/MVA/Snapshot/