Two sectors (and two stocks) that can help enhance your property returns

Real estate stocks are primarily known for two traits - the ability to pay a healthy yield and for providing a liquidity that you could not get in actual real estate or physical housing itself. But the last year has been anything but shining for local real estate stocks at the capital appreciation level, with the ASX REIT Index trailing the XJO by a considerable margin.

Globally, the story is much more nuanced. While office-linked stocks continue to struggle, other sectors like industrials and retail have remained surprisingly resilient. And within those two sectors, there is even more outperformance to be found at the individual stock level.

That's why David Kruth and his team at the Dexus Global REIT Fund are so adamant on their bottom-up approach to separating great REIT stocks from good or bad ones. 

In this edition of Expert Insights, we've asked Kruth to pull back the curtain on his process and share two stocks that explain why you should get involved in the REITs space even when the macro overlay does not look as appetising.

EDITED TRANSCRIPT

LW: Why should a REIT investor consider global companies and funds like yours?

Kruth: The diversification and getting into sectors or being allocated into sectors at a much stronger or have very good strength on the front foot going forward so you get that diversification, and you get access to a larger economy like the United States and Canada. So I think that's for forefront. 

Number two is because of the noise that you're seeing around the world with the central banks and the raising of interest rates and inflation, the stocks have come off quite a lot, and our view is that they're trading at fairly material discounts to private market valuations of high quality real estate. We're not talking secondary or tertiary quality. We're talking primary assets in great markets run professionally, lowly levered, trading at very reasonable prices. 

And we believe that if you have a medium term outlook, say one to three years, you're going to find that we're past peak inflation and we're past peak interest rates. The world's going to moderate and we're going to get back to growth. And we believe that those assets are going to perform very, very well on a risk adjusted basis.

LW: Why is the fund heavily weighted towards retail and industrial assets?

Kruth: When you think about what's happened pre and post COVID, there's a couple of things I'd point out. One is from the supply chain perspective. In the United States, we had a broken supply chain, a lot of the world had broken supply chains, and it was very clear that in the US you want to be able to have more inventory on hand on the ground at all times. We call it re-shoring, some people call it just in case inventory, which means on balance there's more stuff being stored on the ground.

Number two is that the main markets we like, which are the coastal markets of New York, LA, San Francisco, Miami, and Washington DC. That's where the big populations are, and they're also very wealthy populations. The amount of available space to be industrial has been declining. So if you look at the New York City area or Miami, there's less available space to be industrial than there was 10 years ago, so we have a declining base. That means more demand, less inventory, means rental prices have been going up. 

For example, the companies that we invest in today have on average about 40 to 50% rent increases as their tenant leases expire. That is a very, very strong metric, and we think we see that happening. And the leases are about five years. So you're going to see compounded growth of eight to 10% in their earnings, which is, for real estate, a tremendous number.

On retail, we stay away from highly discretionary, high-end, Cartier-like real estate centres. We typically look for non-discretionary open air where you can drive to it near your home, it has the grocers, it has the pharmacies, it has your local restaurants, the Starbucks that we had talked about before. And that is a recurring theme where you want to be there, the companies do well, it does well in recessionary periods and also in growth-y periods. And the real estate is not priced very robustly. You've got very modest valuations on that kind of real estate so we like that around the world, and that's where we're positioned mostly.

LW: Tell us about a favourite industrial and retail holding in the fund.

Kruth: So one of our biggest positions in the fund is a company called RPT Realty (NYSE: RPT). The ticker is actually RPT, which is kind of easy. They're a New York based company. They own open air retail centres in some of the strongest markets in the US. 

More recently, they've been expanding in places like Boston because that has a very high intellectual capital, life sciences, education, technology, it's a very good market, high incomes.

In Miami, their biggest asset now is an asset in Brickell Village, which is the heart of Miami. And if you haven't paid attention, Miami as a market is on fire, in a good way, you have a lot of Americans moving down there, high tax states going to Miami. It's becoming a big market for hedge funds and managers because of low tax. So it's really, really becoming a Mecca, and they are expanding their business in that area dramatically. 

They own one of the best real estate assets in all of Florida, and it trades at a material discount to private asset valuations. And we think management's very, very strong. And they have partnerships with great institutional money like GIC out of Singapore, one of the biggest pension funds in the world. So we think that whole package of great real estate, undervalued, modest balance sheet and great partners leads it to be a great winning formula for us over time.

When industrial, I would point out a company that we own in LA, it's a LA specific company. It's called Rexford (NYSE: REXR), REXR is the ticker. Rexford is a sharp shooter specialist and that they're the largest industrial owner in all of Los Angeles. So think about that's the port of call for anywhere Asia, and also it's one of the largest single economies in the US. They are very big on distribution and because of the road patterns and how hard it is to get around, you want to have all your real estate, your industrial real estate, on the west side, the urban side, where all the population tends to be, wealthy population and they are by far the 800 pound gorilla. 

They own more than anybody else and because of that, they get first call to buy buildings. More importantly, they have been able to reposition those buildings, make them bigger in some cases, tear them down, make them bigger. So they have extremely good rental growth and extremely good operations, and they're very low levered. So very different than RPT, but a very specific company in the best industrial market, perhaps in the world.

Broaden your income horizons

With demand for industrial properties strong and vacancies at record lows, the outlook for rents and valuations remains attractive, a view reflected in our positioning within the Dexus Global REIT Fund. Inside the world of industrial REITs, things are better than their share prices imply. And therein lies the opportunity. Click here to learn more about our offerings.

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