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Why I’ve gone cold on ASX REITs

ASX real estate investment trusts (REITs) have had a tough year in 2020 so far. Formerly favoured for their income potential, REITs were among the hardest hit sector in the coronavirus-induced market crash in March.

Take the Vanguard Australian Property Index ETF (ASX: VAP) – an exchange-traded fund that tracks the REIT sector on the ASX. VAP units fell almost 50% in value between 31 February and 23 March this year. That compares very unfavourably against the broader S&P/ASX 200 Index (ASX: XJO), which fell by 36.3% over the same period. The ‘recovery’ period hasn’t been kind to REITs either. Today, the ASX 200 is down around 8.7% year to date, whereas VAP units are still down around 22% since 1 January.

So are REITs a bargain buy at these prices? The economy, although still very much compromised as a result of the pandemic today, will no doubt recover in the months and years ahead, right? That means REITs should follow suit… right?

Well, perhaps not. As you’ve probably gathered from the headline, I’m not too wild about REITs today or for future investment. Here’s why.

What does an ASX REIT offer investors?

A REIT is a company that makes its profit from the rental of property and land assets — think retirement villages, apartments, warehouses, offices, shopping centres, and business parks. A REIT benefits from a special tax structure, in which company tax isn’t paid on earnings. In return, a REIT is normally required to pay out 90% or more of its profits as shareholder distributions. Because this money is untaxed, these yields will typically offer a higher yield compared to other ASX dividend-paying shares (albeit without the benefits of franking credits).

As such, I used to believe REITs were a useful income area to explore and useful shares for dividend investors to own as part of a diversified, income-focused portfolio.

What’s changed for REITs in 2020?

So why have I gone cold on REITs as an avenue for dividend investors to explore? Well, (as you might have guessed) it’s all to do with the coronavirus pandemic.

REITs have been among the worst hit sectors of the economy as a result of the pandemic. Lockdowns (both past and ongoing) have resulted in shopping centres closing, businesses shuttering and rental payments being deferred. All of this is terrible news for REITs. Consider Scentre Group (ASX: SCG), a REIT and owner of the Westfield-branded centres in Australia and New Zealand. It has already cancelled its dividend payment this year, and I’m not convinced they’ll be coming back this year or perhaps even in 2021.

Even if the economy returns to some state of normalcy in the next few years, I think the outlook for most property assets has irrevocably changed.

Think about the trends that the pandemic has accelerated. Online shopping – through the roof. Working from home – a new normal today. Sure, some of these trends might recede once the pandemic is over. But I don’t think it will be anything like it was in 2019.

I believe we have seen a decisive shift in economic behaviours that is set to become permanent. And what does more online shopping and working from home mean? It means fewer people going to the shops less often. It means fewer people going to the office less often.

And that, in turn, means the land that houses shops and offices is less valuable. That is a great big problem for the companies that own these assets.

Foolish takeaway

REITs have been smashed in this pandemic, and I think the changes in consumer behaviour that have accompanied it have permanently damaged the investment prospects of REITs. As such, I’ve gone cold on REITs as viable, income-producing assets. It’s a shame, but one must never invest on sentiment alone! Thus, I’ll probably be avoiding the REIT sector from now on.

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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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