Looking to invest in ASX real estate shares? Read this first

With interest rates effectively zero, investors are seeking income from ASX shares. Here we look at outlook for office and industrial shares.

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When hunting for a reliable income stream and capital growth, ASX commercial property shares have historically ranked highly on investors' wish lists.

As well they should.

With no end in sight for today's record low interest rates, which may edge even closer to zero when the Reserve Bank of Australia meets on 3 November, investors today are more desperate than ever to put their money to work for them.

As Ross Lees, the head of funds management for Centuria Capital, told the Motley Fool last week:

People are buying real estate because they want income. Interest rates have gone down. If you can get the right real estate with good quality tenants, I think you're really well positioned into the next couple of years.

Lees is spot on there.

But the question facing ASX investors today is, just what is the right real estate?

When COVID-19 snuck onto Australia's shores in late January, it quickly set off a series of events that drastically changed the face of commercial real estate markets. Fast forward to October and no one knows when – or even if – Australia's property markets will ever look like they did in 2019.

view looking up to tall office building

Image source: Getty Images

A stark divergence in real estate fortunes

According to Colliers International, as reported by Commercial Real Estate, the first 3 quarters of 2020 (through to 30 September) saw a 58% decline in commercial real estate transactions in Australia. And remember, those 9 months include January and February, when the coronavirus had yet to have an impact.

Retail deals over the 9 months dropped by 29% while office deals fell a dramatic 75%.

But it's not all bad news for commercial property. Industrial transactions recorded by Colliers were up 5.6% over the first 9 months of 2019.

While the viral shift of people working and shopping from home has dragged on the office and retail markets, it's seen a big boost for e-commerce. And in turn ushered in growing in demand for warehouse and logistics facilities to support that.

According to Ross Lees:

We've seen a huge acceleration in e-commerce. The industrial sector already had a big tailwind behind it, and that's just really pushed it along. In the last 2 months, we've been the largest acquirer of industrial real estate in Australia…

The opportunity in industrial is the revolution in e-commerce, how companies respond to it, what they do in their supply chains and how that can drive industrial demand.

Colliers believes the 5.6% growth in industrial deals would have been significantly higher if not for a shortage of prime assets for sale. The firm estimates there's some $26 billion of capital, primarily from institutional investors, interested in the industrial sector.

Gavin Bishop, head of industrial capital markets at Colliers International, says:

Given that just $3.57 billion has traded so far in 2020 [in industrial transactions], it highlights the significant mismatch between supply and demand and the significant volume of unsatisfied capital looking to be placed. As a result of this, we expect that additional assets will be brought to market in 2021 as groups look to capitalise on the continued strength of the industrial and logistics market.

Will ASX office shares bounce back?

It's far too early to sound the death knell for the office market.

While the coronavirus has hyper-accelerated the pace of changes that were already taking place when it comes to CBD office space, many workers – and their bosses – are eager to see a return to shared work spaces.

Cushman & Wakefield's NSW managing director of commercial real estate, Simon Fenn remains bullish on the office market outlook.

As Commercial Real Estate notes, Fenn expects "office sales volumes to increase in the final quarter of the year and to be higher again in the first half of 2021 – provided the COVID-19 virus is contained".

Containing the virus is, of course, the big and highly unknown caveat here.

Nonetheless, Ross Lees also remains optimistic on the future of the office market, though he believes it will likely be less centralised with solid public transport connections and close to amenities. And the buildings themselves will likely need some amending.

As Ross states:

We've focused on making sure that the buildings are in a situation where tenants feel comfortable returning to work. Priorities have been making safe work plans, places where people want to come.

How have these ASX office and industrial shares performed?

We'll tie this off with a quick look at the performance of some leading industrial and office funds.

First up for the office sector is Centuria's real estate investment trust, the Centuria Office REIT (ASX: COF). At the current share price, the REIT pays an annual dividend yield of 8.3%. Year-to-date the share price is down 29%.

Next up is the Australian Unity Office Fund (ASX: AOF). The fund pays an annual dividend yield of 6.2%. Year-to-date the share price is down 24% since 2 January.

Turning to the industrial sector, the Centuria Industrial REIT (ASX: CIP) pays an annual dividend yield of 5.6%. The share price is down 2.5% in 2020.

Then there's the APN Industrial REIT (ASX: ADI). It pays an annual dividend yield of 4.5%. Year-to-date the share price is 8.6%.

For some comparison, the S&P/ASX 200 Index (ASX: XJO) is down 7.0% in 2020.

With the share prices of the office funds having fallen further, their current yields are certainly more attractive.

The question every investor needs to ask themselves before investing for income though, is what's the long-term outlook for capital gains?

Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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