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Why ASX investors are stampeding into REITs

According to the AFR this morning, over $16 billion has flooded into ASX A-REITs over the past eight months. It’s no surprise then that the S&P/ASX 200 A-REIT Index (Index:^AXPJ) (ASX: XPJ) has risen a massive 21.5% in the corresponding period. A-REITS (or Australian Real Estate Investment Trusts) are clearly the flavour of the month (or the last eight). So what is behind this surge?

Why REITs are raising the roof

REITs are investment vehicles that are traded on the ASX but are actually trust structures rather than companies. This means they are governed by different laws that investors should be aware of. The REIT owns a portfolio of properties on which it collects rental income. As a trust, they are required to pass on at least 90% of profits as distributions every year to its shareholders. This makes REITs a popular option for income investors, as you are almost always promised a fat income stream (although this does not come with franking credits attached).

Income assets have an informal relationship with the ‘risk-free rate’ of return. This refers to the interest you can expect to see from a government-issued bond, which has almost zero-risk of default. When the risk-free rate is lowered, it pushes up the attractiveness of other riskier assets (like property) as it forces investors out of the comfort zone of risk-free bonds if they want a decent income stream.

With the Reserve Bank of Australia cutting interest rates to a record low last week (and with it the risk-free rate), REITs are now looking more attractive than ever. Although the RBA only moved last week, the markets had been pricing in a rate cut for some months now, which explains the steady rise of funds flowing into A-REITs.

Who are the big movers?

Although most A-REITs are benefiting from the low-rate environment, there have been some big movers. ASX favourite Goodman Group (ASX: GMG) is up over 46% since October, while industrial property manager Dexus Property Group (ASX: DXS) is up over 39% and Mirvac Group (ASX: MGR) up 43% (none including distributions). Interestingly, former favourite Scentre Group (ASX: SCG) has been relatively flat during this period – possibly reflecting ongoing concerns about the future of the retail mall space that Scentre operates in.

Foolish Takeaway

If I were an income investor, I would be very wary about jumping on this bandwagon. REITs can be a very useful part of one’s portfolio due to their ownership of physical real estate. However, the massive rises in these REIT’s prices feel somewhat unsustainable and may be driven more by emotion and yield-hunger rather than rises in underlying value. I personally won’t be following the crowd on this one.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Scentre Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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