What is an Australian Real Estate Investment Trust (A-REIT)?

A-REITs enable individuals to invest in the property market without buying a property. Picture: Amy Hirsch/Unsplash

An Australian Real Estate Investment Trust is an investment trust that owns and usually operates a portfolio of income-producing property.

It is listed on the Australian stock exchange and derives most of its earnings from rent. It is one of the easiest ways to invest in property and allows investors to do so without the hassle of becoming a landlord.

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How does it work?

Put simply, Australian Real Estate Investment Trusts (A-REITs) pull the resources of investors together to buy a range of property assets, which the trust then manages for a profit. They generate most of their income through rent, with the lion’s share then returned to investors via dividends.

A-REITs are managed by a fund management team, which selects and manages the investment properties on behalf of investors. In addition to rent, A-REITs generate income through capital growth of assets, property development and property-related fund management earnings.

Melbourne

A-REITs typically have investments in numerous sectors of the property market. Picture: Tom Rumble/Unsplash

What are the benefits?

The main benefit of A-REITs is that they provide a means of investing in the property market to individuals who otherwise wouldn’t have had enough money to do so, as the funds of investors are pooled together. This means that the minimum initial investment required for an A-REIT is usually no more than $500.

That each A-REIT is controlled by a fund management team means that not only do investors gain exposure to property investments without actually buying a property, they do so without managing one, too. These are the main benefits – although they’re far from the only two.

According to Bianca Rose, Portfolio Manager of Properties and Equities at Ibbotsen, A-REITs offer diversification benefits, too, as they invest in properties across numerous sectors and locations.

She also notes that “A-REITs must distribute at least 90% of their income to investors (in the form of dividends) so they may be attractive investments for investors looking for income-oriented investments” – although “dividends from A-REITs typically do not provide franking credits as they are taxed at the investor level, rather than at the trust level”.

Finally, investments in A-REITs enjoy greater liquidity than most property investments, as the trusts trade publicly on the stock exchange.

2 Duke Street, NT

A-REITs offer diversification and liquidity benefits. Picture: realcommercial.com.au

What are the risks?

A-REITs generate most of their income from rent so if rental incomes fall, so do profits. This can happen, for example, when tenants default on payments or vacate the premises. It may be hard to find tenants if the location is poor, if there is an oversupply of similar properties, or if the condition of the property is left wanting.

Rose also warns of the risks of an A-REIT paying too much for a property or borrowing too much. “The management team of the A-REIT could pay too much for property assets, which subsequently drop in value,” she says.

Or they “could borrow too much money, and may be forced to default on its investment if the A-REIT can’t make the interest payments or if the asset value falls significantly in value”. Which is why thorough due diligence on the management team is required before you invest in the fund it manages.

stock market

Most A-REITs are traded publicly on the Australian Stock Exchange. Picture: William Iven/Unsplash

What should I look for in an A-REIT?

Peter Sahui, Senior Analyst at Property Investment Research (PIR) offers this advice to investors:

“An A-REIT must be able to generate sustainable cashflow, which requires a combination of (a) well-leased assets (stable tenants, long lease terms, healthy tenant demand relative to market supply), and (b) a secure balance sheet, with manageable gearing and interest cover ratios.”

Bianca Rose agrees, adding she also looks at “different valuation measures (such as price to net asset value, price to earnings ratios, and dividend yields) to assess whether we think the AREITs’ share prices appear reasonable or not”.

How are A-REITs taxed?

The ATO allows A-REITs to pass on their income to investors on an untaxed basis, so long as the income is generated through passive activities, such as the collection of rent.

This is why A-REITs don’t technically pay “dividends” to their shareholders, but rather pass on “distributions”, which aren’t franked because the income passed on to investors isn’t taxed. Which is also why investors who use franking credits might want to instead invest in fully-franked dividend stock.

Level 9, 60 Park Street, NSW

A-REITs have diverse portfolios and pass on 90% of their pre-tax income to investors. Picture: realcommercial.com.au

Are A-REITs tax deferred?

A-REITs often distribute tax-deferred income to their investors. This happens when the value of the property trust’s distributable income is higher than its taxable income, which usually occurs as a result of depreciation claimed on the decline in value of both the building and the assets contained within it.

These depreciation deductions provide a return of capital to investors that is only assessable when the investor sells their REIT investment. Which is helpful to investors, as they can choose to pay tax on the income when their marginal tax rate has either been heavily reduced (e.g. during retirement) or completely abolished (e.g. during pension phase).