Income still attractive

Domestic investors are still wary of Australian-listed property..

Domestic investors are still wary of Australian-listed property. Despite the sector gaining more than 20 per cent over the past year, making it the best-performing sector of the Australian sharemarket, domestic investors are not buying into the recovery. Many are still haunted by memories of the sector's spectacular blow-up during the depths of the global financial crisis.

During 2008, the S&P/ASX200 A-REITs (Australian real estate investment trusts) index fell 54 per cent compared with a fall by the wider sharemarket of 38 per cent. The reason for the bigger hit to listed property was that many trusts had high gearing levels and complex corporate structures. During the 10 years prior to the crisis, many trusts changed from collecting rents from the buildings they owned into riskier activities such as property development. Those running the trusts were urged by market analysts to re-engineer their "lazy" balance sheets. They borrowed against their properties to acquire more properties and expanded into overseas real estate markets. The trusts' debt-fuelled growth resulted in a few years of spectacular returns. Many of their small investors had invested in the trusts prior to this because they were conservative investments providing stable income.

In a recent report on the sector, researcher Morningstar shows the trusts' income has remained fairly stable. After producing income of 3.41 per cent in 2008, they have produced income of about 8 per cent in 2009 and about 6 per cent for each of 2010 and 2011. With the cash rate cut last week to 3.25 per cent and more to come, the income from the trusts is attractive.

But the flip side is that while the trusts have reduced their borrowings and re-focused their businesses towards rent collecting, their correlation with the broader sharemarket remains high. Investors are still likely worried that their share prices will again be hit by any setback on the wider sharemarket.

Another factor is that it is foreign investors who have been investing in the trusts rather than Australian investors. Despite the strong Australian dollar, which makes the trusts more expensive for foreign investors to buy, overseas super funds have been favouring good-quality Australian property given the ongoing instability in Europe and the US.

The risk for local investors is that this interest could be fickle, and a change in currency exchange rates and other factors could prompt the super funds to sell. Morningstar says, however, that the income-return potential should remain strong even if the capital gains of the past year go into reverse.

As for the property securities funds - the managed funds that invest in the trusts - Morningstar says the listed property sector is dominated by a few large trusts, making it difficult for fund managers to outperform the index.

Morningstar says many funds are showing returns similar to the index once fees are deducted. Only one fund has been awarded Morningstar's highest gold rating, the Vanguard Property Securities Index Fund, which mirrors the returns of the index and has low fees.

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