Real estate investment trusts (REITs) are popular on the ASX amongst many investors. Some investors love the property exposure that a REIT can provide. Others enjoy those outsized dividend distributions that often offer some of the highest dividend cash flow available on the ASX.
I am not one of those investors, though. In fact, I have only ever owned one ASX REIT, and that was long ago and for a very brief time. I don't see any scenario that will have me rethinking that position anytime soon.
So why don't I find this popular asset class on the ASX appealing? Well, there are a couple of reasons I never buy ASX REITs.
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ASX REITs don't pay franking credits
Firstly, ASX REITs don't typically attach franking credits to their dividend distributions, at least at a significant level. This is due to their unique structure. Most REITs are exempt from paying corporate tax. Whilst this has some upsides, such as allowing the trusts to pay out higher dividend distributions to their investors, it has the downside of not allowing those payments to come with franking credits attached. Remember, franking credits are generated when a company pays corporate tax on its profits.
This is not a delbreaker in itself. I am fine with an unfranked dividend if it is an above-average payout. But many investors might find this aspect of REIT investing unappealing.
The returns of ASX REITs are not good
I can deal with the unfranked dividends that REITs usually pay their investors. But what I really struggle with is the tendency of the typical ASX REIT to be a substandard investment.
REITs often employ leverage, or borrowed money, to construct their investment portfolios. That is understandable, given that REITs invest in real estate. However, this has the unfortunate consequence of tying the valuation of those REITs to interest rates. If you look at the long-term unit price of any REIT, it often rises and falls alongside movements in the cash rate. This dynamic seems to limit the ability of an ASX REIT to compound over time.
Take the price of popular ASX REIT and Westfield operator Scentre Group (ASX: SCG). Today, Scentre units are going for $4.21 each at the time of writing. That's almost exactly the same price as you could have bought this REIT for ten years ago today.
It's a similar story for many others, including Charter Hall Long WALE REIT (ASX: CLW), HomeCo Daily Needs REIT (ASX: HDN), Mirvac Group (ASX: MGR), and Vicinity Centres (ASX: VCX).
Stockland Corporation Ltd (ASX: SGP) has yet to even get close to its last record high, which was clocked way back in late 2007.
Of course, not all ASX REITs are tread-water investments. For example, Goodman Group (ASX: GMG) has been a notable performer in recent years. However, most ASX REITs tend to fall into this valuation stagnation, and it doesn't give the sector a good name.
Foolish Takeaway
The tendency of most ASX REITs to stagnate and fail to deliver compounding returns for their investors has put me off owning investments in this sector. That's not to say there isn't money to be made here, or that investors can't find the odd diamond. But those, at least in my experience, are few and far between.
