How more and more people are investing in property without buying bricks-and-mortar

A shift towards ‘virtual’ property investments is gathering pace. More investors are choosing stock market securities to access real estate assets without the downsides of owning bricks and mortar.

REAL ESTATE holds an unshakeable allure for Australian investors. Land is finite, intrinsically valuable, and less volatile than financial markets. But barriers to entry are colossal and assets are illiquid.

Contrast that with stock market securities, which many investors approach with caution. They’re seen as complex and risky financial instruments. Yet, securities are flexible, liquid, and enable exposure to underlying assets without coughing up the capital to own them outright.

Combine these two asset classes, and you get real estate securities – an accessible entry point to the property market.

“The idea that real estate securities are only for sophisticated investors is something that should be challenged,” says Fraser Allan, the Head of Premium Client Services at CMC Markets.

“They are companies that own or finance property and property development. It’s as simple as that.”

Property securities are known as REITs (Real Estate Investment Trusts). A REIT is a company that owns, manages or finances properties that produce income.

The term REIT sounds abstract. However, it is a vehicle to invest in some of the most tangible assets money can buy.

Fraser Allan, Head of Premium Client Services at CMC Markets

Supermarkets, shopping centres, apartment buildings, casinos, hotels, and even timberland forests fall into REIT indexes. They manage household names you likely shop in every week. 

Chances are, you already own them either directly or through your superfund. 

Goodman is one of Australia’s largest companies with a market cap of around AUD$37.71 billion. It owns and manages industrial and commercial real estate, such as Amazon logistics centres.

Scentre Group is another large Australian company, with a market cap of around AUD$11.22 billion. It operates retail real estate, including Westfields shopping centres. “These companies are essentially REITs,” says Allan. “They own and develop property. But people probably don’t realise they’re invested in this asset class already.”

The vast landscape of real estate

REITs are not sexy. But the indexes cover more than a dozen sectors that power the global economy.

Industrial REITs own and manage major facilities such as warehouses and distribution centres. Health care REITs cover hospitals, medical office buildings and aged care facilities. There are REITs that specialise in data centres, giving investors exposure to the engine rooms of the digital age. 

Some of the more colourful REITs indexes cover gaming, entertainment and lodging real estate, such as casinos, hotels and resorts. Timberland REITs own and manage forests that harvest and sell timber.

The powerful staple indexes of commercial, residential, and retail manage the real estate of the real economy, from skyscrapers to apartment buildings to student housing to shopping centres and supermarkets. This vast spread gives REIT investors the option for a broad real estate exposure or the ability to focus on a narrow thematic within the space.

The REIT advantage

REITs generally offer higher dividends and consistent income streams than stock dividends. This is because laws in countries like Australia and the U.S. require the companies pay at least 90% of profits to shareholders. While public companies generally pay dividends based on net income after tax, REITs pay dividends based on their entire taxable income. 

REITs can be less volatile than the broader stock market because of the underlying nature of the retail and commercial property sectors. Properties tend to trade less in their corresponding primary and secondary markets. Income tends to be relatively stable as well.

Compared with classic bricks and mortar investments, REITs are more accessible, liquid and diversified. Buying and selling REIT shares is much easier than dealing in physical property.

Who should invest in REITs?

REITs can adapt to various investment strategies, whether that be income, growth, or stability, making them suitable for different investor profiles.

But in general, this asset class serves investors seeking a stable, dividend-based income with low volatility. 

“You’ll often find retirees or those approaching retirement age are well-placed to invest in REITs,” says Allan.

“They want low-risk, stable income. Their investment horizon cannot accommodate significant drops in their capital.” 

But the investor profile is broadening, with more young Australians turning to them to gain exposure to the out-of-reach property market.

They’re suited to those looking for long-term, set-and-forget, low-risk, investments. 

“In theory, younger investors should be more comfortable with risk. But I know young investors who hate risk,” Allan says.

“Their money is sitting in the bank, getting X per cent in interest. That is not in the best interests of their financial well-being. 

“They’re happy with the nominal interest rate they get from the bank but forget economic cycles affect their real money. If your interest rate and inflation are both 4%, your money is going nowhere.”

Over the twelve months to the December 2023 quarter, the Consumer Price Index rose to 4.1%. It’s an improvement on the previous year, which saw inflation rise to 7.8%. But inflation is still higher than interest earned in most savings accounts. 

“This money is actually going backwards,” says Allan.

“If you are a young investor with a low-risk appetite, REITs may be an appropriate investment option.”

“Reinvesting dividends also brings the benefit of compounding year after year.”

“People can simply learn more about REITs and understand these are household names. It doesn’t have to be as sophisticated or scary as you might think.”

Opportunities and returns

The main global REIT index is the FTSE Nareit All Equity REITs Index. It covers over 50% of tax-qualified U.S. equity REITs and is the sector’s benchmark.

Since 1972, the Nareit Index has delivered 2.5% higher total returns annually than the S&P500 (12.7% compared with 10.2%).

In recent years, that trend has reversed and the S&P500 has outperformed REITs. 

Over the last 10 years, stocks beat REITs by 2.5%. In the last five years, the difference grew to 5.5%. In 2023, equities delivered 15% higher returns. 

Keep in mind, these two investment options have dramatically different risk profiles. Equities generally have a higher risk profile than REITs.

What’s more, those staggering gains on the U.S. stock market were largely driven by the mega tech and AI rally. Portfolios without exposure to technology stocks missed this boom.

In Australia, the picture is different.

The country bounced back from the COVID-19 pandemic faster than most. Australians are besotted by real estate. Property development is booming. 

“This all makes for a very different market here,” says Allan.

“In theory, younger investors should be more comfortable with risk. But I know young investors who hate risk”.

In 2023, the Australian REIT market (A-REIT) was valued at AUD$144 billion.

In the last 10 years, the A-REIT has returned about 10% annually to investors, outperforming the ASX200, which returned about 8%.

In the last five years, Australian REITs saw a similar but softer reverse in fortunes as the U.S. market, with the A-REIT returning 3% less annually than the ASX200.

“That really highlights the impact of COVID and higher interest rates,” says Allan.  

“The REIT market suffered more than others.”

But in the past year, REITs have bounced back. It reported a whopping 25% total return, outperforming the broader ASX 200 index, which saw a 12% increase.

While this was partly due to a post-pandemic recovery, the broader trend is clear.

“If you consider total returns over a long investment period, REITs tend to outperform the overall index benchmark,” says Allan. “That will shock most people.”

Navigating the risks of REITs

Investing in REITs presents five main risks: concentration, cyclical sensitivity, volatility, high gearing, and interest rate sensitivity. 

Concentration risk arises when a portfolio is heavily invested in a limited number of assets or a single real estate sector. It is vulnerable if the focused sector underperforms. 

Inherently tied to the real estate market, REITs are susceptible to economic cycles, inflation, and unexpected events such as the COVID-19 pandemic.

Although REIT volatility is generally lower than stocks, it is higher than direct real estate investments, as the sector responds to broader stock market movements. 

Highly geared REITs are vulnerable in economic downturns. Some REITs take on huge debts to fund development. 

But this leads to large losses if the asset value falls or borrowing costs rise. 

Finally, REITs are sensitive to interest rate rises. When borrowing costs rise, fixed income becomes more attractive.  Allan points out these risks can be managed by diversifying portfolios, scrutinising debt levels, and adjusting investments when needed – something that is possible thanks to REIT liquidity.

Macroeconomic factors

In 2024, investors are concerned about geopolitical instability and core inflation. REITs are not immune. 

High inflation can erode consumer spending and impact retail occupancy rates and rental incomes.

But on the flipside, REITs operate in sectors such as healthcare and infrastructure, which are resilient during economic downturns. 

The key to navigating these challenges is strategic asset diversification, choosing sectors with inelastic demand, and making sure the REIT has a strong balance sheet that can withstand economic fluctuations. 

“Real estate exposure is a staple of a well-balanced portfolio,” says Allan. 

“REITs make that possible for more people.”

Far from being the complex and risky financial instrument that most people think, real estate securities make it easier for mainstream investors to access the valuable property market.

This article is intended to provide general information only and does not take into account your individual objectives, financial situation or needs. Seek independent advice and consider the relevant Terms and Conditions at when deciding whether to invest in CMC Markets products.

This story featured in Issue 10 of Forbes Australia. Tap here to secure your copy.

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