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Value investors have good reason to beware Australian Real Estate Investment Trusts. Last year’s stunning rally has flowed into this year, making AREITs increasingly expensive. But some smaller AREITs still looking interesting for yield-driven investors.

This column has identified several small and mid-cap AREITs in the past 18 months: notably, Shopping Centres Australasia Property Group, BWP Trust, Charter Hall Retail REIT; and National Storage REIT and Asia Pacific Date Centre. The hotel AREITs, Ale Property Group and Hotel Property Investment were also covered favourably.

So far, so good. The 12-month return in those AREITs is:

AREIT

12 month total shareholder return %

Shopping Centres Australasia

31

BWP Trust

32

Charter Hall Retail REIT

26

National Storage REIT

47

Asia Pacific Data Centre Group

30

ALE Property Group

23

Hotel Property Investments

40

 

Source: Morningstar. 12-month total shareholder return assumes distributions are reinvested. Return to February 18, 2015.

It’s hard to put new money into those AREITs after such strong gains. Those who invested should continue to hold, for each AREIT has good long-term prospects and is well run. New investors should watch and wait for better value during a market or sector correction.

The AREIT sector is ripe for a price pullback or consolidation after recent price gains. The S&P/ASX 300 AREIT Accumulation index returned 26.8 per cent in 2014, and 7.4 per cent in January alone. As with the banks, falling interest rates are driving more investors into high-yielding AREITs.

Some good judges I know believe the AREIT sector is up to 10 per cent overvalued, based on a comparison between prices and net asset backing. One could say the same about big-four banks, but they keep rising as investor clamour for yield. Nevertheless, investors should be alert rather than alarmed about AREIT valuations and look further down the sector for value.

AREITs to watch

I add two small-cap AREITs to the list: Mantra Group and GDI Property Group.

Mantra was one of last year’s standout Initial Public Offerings (IPO). The accommodation operator raised $239 million and listed in June 2014, issuing $1.80 securities. It now trades at $3.06 and more broking are upgrading their valuations.

Chart 1: Mantra Group

Source: ASX

Mantra is Australia’s second largest accommodation provider, serving 2 million guests annually through its 115 combined Peppers, Mantra and Breakfree hotels.

It is benefitting from a slight uptick in corporate and leisure demand for its city hotels and continued improvement in its tourism activity as the lower Australian dollar attracts international tourists and encourages more locals to holiday domestically.

I like Mantra’s prospects. In the medium term, it should benefit from continued improvement in business and leisure travel. The lower Australian dollar is a big tailwind, although it will take time to be felt fully in the sector and flow through toe Mantra’s earnings.

Longer-term, a  capital-lite business model and sound balance sheet offer scope to continue opening new hotels and upgrade existing ones. It will add three new properties in Melbourne, Brisbane and New Zealand that were not in its prospectus forecasts.

Macquarie Equities Research has a $3.26 12-month price target and an Outperform recommendation. Other brokers are also lifting earnings forecasts after Mantra delivered a strong first half, and as new property openings suggest it can beat prospectus forecasts.

Mantra is not cheap and gains might be slower from here. But it has good growth prospects as several tailwinds for a portfolio of business and leisure hotels strengthen in the next few years.

GDI Property Group

Unlike Mantra, GDI Property Group has struggled since listing. It raised $310 million in an IPO, issuing $1 securities and listing in December 2013. But GDI’s exposure to the softening Perth commercial property market saw it fall to 91 cents.

Chart 1: GDI Property Group

Source: ASX

GDI’s latest net tangible assets (NTA) per securities is 97 cents, and it’s not hard to get that above $1 after adding earnings from its fund management business.

GDI has moderate debt, a solid portfolio of B-Grade city office tower, and an ability to build value through astute property acquisitions or restgelopments. GDI announced in November the proposed sale of its 233 Castlereagh Street property in Sydney for $156 million, a $27-million increase on its June 2014 independent valuation.

As investors scour the AREIT market for remaining value, smaller property trusts, such as GDI, stand out. It has not done much wrong since listing – its first half results were slight ahead of prospectus forecasts – and implied yield of more than 7 per cent in FY15 is attractive.

Managing director, Steve Gillard, said that the Annual General Meeting in November: “In the past two months we have seen leasing enquiry and deal flow strengthen, particularly in Sydney and Adelaide. We are on track to achieve our results in Brisbane and while the market perceives Perth to be challenging, we have fully leased 197 St Georges Terrace and are on track to achieve 5 Mill Street by FY15.”

Perth is the market’s chief concern for GDI. Signs of improvement would be a re-rating catalyst, given investors appear to have priced in plenty of bad news for the Perth properties.

Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at February 18, 2015