Investing in real estate investment trusts (REITs) is a long-term exercise because they don't make products like a manufacturer, or provide services in the regular sense like a travel agency, so the majority of their income comes from rent and associated management services.
Some are property developers themselves, so they can create new "products" – the buildings and infrastructure – but large growth in assets comes from acquiring existing buildings. One other difference is that property can go up in value, so total asset value can be improved during a property boom. It can also go the other way, as we saw during the GFC, when many REITs had to mark their assets to then deflated valuations, and the red ink flowed.
Looking at three REITs, what do they have to offer amid an improving economy and residential housing boom? Residential and commercial property can move in different cycles, so you can't say that when one starts, the other will immediately go. However, both can be stimulated when interest rates are very low.
Federation Centres (ASX: FDC) is an owner and manager of shopping centres. It has reformed itself from Centro Retail Australia and relisted in January 2013. Dexus Property Group (ASX: DXS) owns, manages and develops industrial, office and retail properties. Investa Office Fund (ASX: IOF) concentrates on investing in office properties, mostly leased to government and blue chip tenants.
The share price of all three is about equal to their respective book values per share, so there is no great premium paid for any of them, apart from net shareholder equity. How can a REIT like these go up in value if that's the case?
Their values rise through more rental income, higher property valuations, higher returns on assets and reduction of debt. They can get more rent when leases are renegotiated and retail properties can also have higher rents based on increased sales of the tenant businesses.
At the beginning of a business cycle, consumer spending starts to rise, and shopping centre rents rise accordingly. So an investor would want to get involved in a retail-REIT like Federation Centres when the economy turns up and rental revenue increases.
Dexus predominantly gets its revenue from office and industrial property, so it wouldn't have this sales-related rent adjustment with its tenants. The same would be true for Investa. In their cases, getting the maximum market rental price and having high tenancy rates is the best way to maximise income.
All three benefit from a rising commercial and industrial property market. Returns on assets for the three are roughly the same, with Dexus Property edging out Federation Centres with 7.5% versus 5.93%, and Investa in third with 5.90%.
Foolish takeaway
Investors need to be well acquainted with commercial property cycles to judge the best time to get in. Just like buying a private property, more money is made buying in down times and letting the property cycle lift the value.
Federation Centres will be susceptible to potential flat or negative retail sales growth, but taking a position before the general economy improves too much will ensure better value.
Office and industrial properties will typically rise in rental value when companies see there is potential to expand the business but insufficient office space. So knowing the economic cycle means you can obtain better value.
