Listed property trusts should only play a supporting role in an investment portfolio: Morningstar

There is a place for listed property trusts in an investment portfolio, but only in a supporting capacity, says research firm Morningstar in its latest A-REITs update.

Morningstar says the fundamentals of the sector are now once again “broadly aligned with the core principles of steady, sustainable income-focused returns with the scope for some capital upside”, making AREITs “more attractive on the basis of pure fundamentals”.

However, this increased attractiveness has yet to flow through to increased investor appetite, with A-REITs delivering annual income returns well below global REITs and infrastructure funds – but better than large-cap stocks.

“Before investing in a dedicated A-REIT vehicle, investors and advisers should first assess the extent of any existing exposures,” says Mark Laidlaw, research analyst at Morningstar Australasia.

“We suggest an allocation of no more than 10% to Australian and global REIT strategies combined, although this will depend on individual needs, objectives, and risk profiles.

“Investors with a more income-focused orientation may look to prefer AREITs, while those seeking a greater growth profile may lean towards global property.

“Any listed property allocation should be considered a relatively defensive component of a broader Australian equities allocation, or housed within a broader global listed property sleeve,” he says.

In its analysis of the sector, Morningstar presents a mostly favourable picture of the sector and says most A-REITs have “cleaned up their business models” after being heavily leveraged and adopting riskier asset management endeavours pre-GFC.

Most A-REITs have returned to “reasonable payout ratios” – from paying out 100% of earnings around 2008 to paying around 80% of earnings currently.

This is much more sustainable, says Morningstar, “and leaves plenty of room to maintain the health of the properties and the trust”.

However, two structural shortcomings of  the A-REITs sector are the lack of diversification – a 47% retail assets allocation – and the concentration of the market in the hands of less than a dozen big developers.

More than 90% of the market capitalisation of the A-REIT sector is held by the top 10 stocks, with Westfield Group and its shopping centre spin-off Westfield Retail Trust accounting for around 40% of the pie.

The other major A-REITs are Stockland, Goodman Group, GPT, Centro, Mirvac, Dexus, Investa, Charter Hall Office REIT and Multiplex.

The sector could lean even more heavily towards retail if Woolworths goes ahead with plans to launch a $1.4 billion shopping centre trust holding around 70 Woolworths-owned and anchor tenanted centres.

Morningstar notes that some fund managers have broadened the range of stocks they invest in to include infrastructure and property-related stocks.

It warns, though, that any further reduction in sector constituents could critically impair fund managers' ability to build portfolios of investable stocks.