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Why It Is No Time to Be Dumping REITs

If you followed the advice of the mainstream press, you would have dumped your holdings in Australian Real estate investment trusts (REITs) by now.

REITs enable investors to own a slice of some of the biggest commercial properties. From shopping malls, industrial complexes and supermarkets, through to office blocks and residential developments.

Of course, if you’re well-healed, you could always buy your own commercial property directly. But unless you’ve got millions to invest, it’s hard to get a start. Plus, you’ve got to deal with all the responsibilities that come with it.

For example, what happens if a tenant goes broke, or falls behind on their lease? And what about the cost of maintaining the property? Then there’s the insurance, and all the other day-to-day expenses.

By buying into property via a REIT, an investor gains exposure to the property market without all the hassles that come with being a property owner. A REIT appoints a property manager to manage the properties. It’s their job to collect the rent and deal with all the headaches.

Meanwhile, an investor collects regular distributions from the income the REIT generates. However, while income is a key attraction, it’s not the only reason investors buy REITs.

REITs regularly revalue their properties. Gradual and regular rental increases flow through to higher property valuations. If these properties increase in value, it flows through to the value of its shares.

Of course, it’s not a one-way street. If commercial property prices were to fall, it would negatively impact the value of the REIT.

It’s about income

While some stocks pay regular and reliable dividends, others are less reliable. Even the Big Four banks had to reduce their dividends in the wake of the great subprime fiasco.

However, because of their regular and reliable rental income, you’ll often read that investors value REITs (and infrastructure assets like toll roads, for example) like a bond. Because of this, income-focused funds will often split their investments between bonds and REITs.

It’s the job of the fund to allocate its money where it will get the highest return. Which means that if interest rates rise, this money can flow out of REITs and into bonds.

When the Fed in the US went into tightening mode, we saw REITs sold off in the second half of 2016. Even though rates aren’t expected to follow the US lead so rapidly in Australia, the market now believes that the current interest rate cycle has bottomed.

That’s why some investors have sold their holdings in REITs.

It’s not only about rates

But it’s not just interest rates that have caused such a big impact in our market. The impending arrival of Amazon saw investors scramble. Not only out of retail-facing REITs, but across the retail sector more broadly.

Retail darling JB Hi-Fi Ltd [ASX:JBH] fell from over $30 a share in February, to as low as $21.50 in the space of four months earlier this year. And Harvey Norman Holdings Ltd [ASX:HVN] didn’t fare well, either. It, too, fell from over $5, trading as low as $3.60 in June this year.

There’s no doubting Amazon has tremendous firepower, but it’s yet to make its start. As Lowes and Woolworths Ltd [ASX:WOW] discovered with its Masters joint venture, sometimes money isn’t enough.

Look at the sector it operates in

However, it’s important not to lump all REITs together. While retail-facing REITs (and stocks) have been under pressure, other lesser-known REITs have actually been climbing in value.

Take agricultural REIT Rural Funds Group [ASX:RFF] — a member of my income advisory buy-list, Total Income. RFF owns agricultural properties that it leases on long-term deals (average 13 years) to almond, poultry, cattle, vineyard and cotton producers.

While other REITs have been sold off, RFF is up around 20% this year alone. And that’s before you include dividends. Go back a bit further, and RFF’s share price has doubled in a little over two years.

Another REIT on the Total Income buy-list that has performed strongly over the same time is childcare-centre landlord Arena REIT [ASX:ARF]. While its share price isn’t up as far as RFF, it has gained around 50% in the last couple of years. Again, that’s before you include dividends.

The performance of these two REITs shows that you’ve got to look beyond the headlines to see where to (or not to) invest.

If you ignore this sector completely, these are the kind of gains you could be missing out on.

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