What is ultimately important is the quality of the properties (capital value) in the real estate fund, and the quality of the rental stream they generate (income). These two things can be impacted by all sorts of economic, market, company and tenant specific issues.
In assessing the asset quality of a portfolio, potential investors should look at factors such as the location, age and sector (such as office, retail, industrial) of the assets held:
- Location can impact the attractiveness of the building to potential tenants.
- Age of the building will determine what level of capital spending may be required over the life of the asset.
- Depending on the wider economy, varying sectors will be in favour at different times, impacting supply and demand and hence the valuation of the asset.
In assessing the income stream of a REIT, investors should look at factors such as the type and size of tenants the properties are leased to, the term of the leases, and the value of the lease in comparison to the wider rental market:
- Tenant type can impact on the security of the lease. For example, a government department or listed company potentially may offer greater security in terms of rental guarantees.
- The term of the lease (which over the whole portfolio is stated as Weighted Average Lease Expiry or WALE) can add value to the asset as it represents a secure income stream. However, in times of high demand, a longer lease may result in rental terms that are less favourable than the current market rents.
In addition, gearing can have an impact on REITs’ returns. Gearing (the amount of debt used to finance assets) can help to increase returns on investor equity, however gearing also magnifies losses when valuations fall.
Like any investment, diversification in terms of properties, tenants, leases, geographies and sectors can help to mitigate the risks discussed. Single sector REITs (for example, retail) will have a performance that rises and falls with that sector’s cycle, whereas a REIT with assets in office, retail and industrial sectors can provide a diversified return that softens the ups and downs of the cycle.
Most importantly, investing in property via REITs should be viewed as an investment to be held over the long term, one that can generate secure, stable, growing distributions with the long-term potential for capital growth.
(https://www.cromwell.com.au/insights/news/a-quick-guide-to-reits)
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