Two REIT opportunities in the current tough climate

A series of rate rises have hit a number of property trusts quick hard over the past year. The disappearance of the “Bond Proxy” plus rising interest repayments all have conspired against our nation's largest collective of property owners, the REITs sector.

While we all know in our investing hearts that calling an end to the listed real estate market is folly, one can't help but feel nervous about what the current environment will do to prices longer term.

However, for this article I have decided to focus on two REITS that are future proof in the sense that they don’t require a total re-engineering of their asset base they are aligned with a growing thematic , and they are not exclusively involved in warehouses!

I am talking about the theme of “people” (remember us?!?) and two trusts that are leveraged to people are Arena REIT No 1 (ASX:ARF) and Charter Hall Social Infrastructure REIT (ASX:CQE) . Both have experienced big price pullbacks from highs, however the pullback could create opportunities for savvy long term investors looking for stocks with a ‘people’ thematic, which looks positive over a multi-year timeframe.

I have held these stocks before, and will likely hold again, given the right conditions. With recent pullbacks it is tempting. So how do they look at the moment?

ASX: ARF Arena REIT

StockRank 80

Quality Rank 85

A$3.17

Price from all time high (close): -37.2%

Dividend Yield (forecast): 5.6%

Arena REIT No 1 (ASX:ARF) is a real estate investment trust (REIT). They develop, own and manage social infrastructure properties such as childcare and healthcare.

It is important to stress here that they own the properties... they do not run individual centres or sites.

They own 272 properties all across Australia to the value of $1.57 Billion. The vast majority of those are early learning child care centres, but they also own 9 healthcare centres. Their weighted average lease expiry is 19.3 years, which is very strong relative to other REITs and should provide some comfort to investors on the Tennant profile.

Because as well as providing essential services to the community, the growing sectors ARF are focused on have favourable demographic and economic trends, plus bi-partisan government support.

Following recent revaluations, the value of their portfolio actually rose. They currently have a Net Asset Value ( NAV) per security of $3.42.

You will notice that the current price of $3.17 is at a discount to the NAV. While the reasons for this discrepancy are wide ranging from investors thinking valuations could drop ftom here or that sentiment is making investors act irrationally, either way the stock is trading per share at a discount to the asset value per share. You then need to establish the view as to whether the discount is justified or whether this provides an opportunity

From ARF Annual Report 2023 (Page 8)

Quality

This is the highest ranking factor for ARF. Return On Equity and Capital Employed are solid. Margins are incredibly strong. Sales and Cash flow keep growing strongly and the company is not too highly geared.

Some investors may be wondering why the significant drop in Net Profit over 2023? The reason is back in 2022, ARF realised a very large $240M uplift in asset valuations. Accounting standards require that this asset revaluation is captured in the P&L. As 2023 did not include a revaluation anywhere near that size, post tax earnings normalised. Perhaps what is a better measure here is Operating profit which excludes the impact of revaluations and that figure has risen in line with sales.

What is also pleasing is the consistent trend in growth in cash flow, both operating and free cash flow. The later most important as capital expenditure for ARF is a big deal as they look to establish new centres regularly and keep them up to date.

Value

While the trust is trading at a discount relative to the NTA per share value. On traditional metrics the stock is trading more at fair value.

As the trust is asset heavy, price to book valuations are always going to be a challenge. Further on a price to sales, free cash flow and earnings the basis the stock is not dirt cheap (irrespective of the price pullback)

However there are a few things to like from a value perspective. One which is considered in the Factor score is the trusts dividend. While unfranked, it is still decent and has been growing consistently since listing.

The other item of interest which is not part of the factor score is that prior to FY23 the stock had consistently traded above the NTA. This current phenomenon of the price being at a discount to the NTA per share is actually a rare occurrence through the trusts life cycle- and by extension may create an opportunity.

Momentum

As mentioned at the very start of this article, price Momentum as well as analyst revisions have worked against the company.

Rising rates, coupled with the potential property market correction (that we are still yet to see) have conspired against the price.

From a support level, it is right on the edge. So for those that use charts, 'you won't have to wait long to know if you are wrong' with ARF. While it is highly unlikely COVID lows would be tested again, the prolonged bearish sentiment could act as an anchor to a potential rebound and see the discount to NTA remain more of the norm.

ASX:ARF 1 year Daily chart

Relative wise, it hasn’t been a great year, but it’s hardly an island in its sector or the broader market. Hopefully the price can find some support here.

Conclusion

A position in ARF requires an investor to weigh up the potential benefits of:

- trading at discount to NTA which it normally doesn't do

- plus an attractive yield which has kept rising

- plus a very long average lease profile

- plus heavy government fiscal support of the sectors they serve

Versus the bearish sentiment at the moment and the risk that there may be asset revaluations downward in the future.

ASX: CQE Charter Hall Social

StockRank 78

Quality Rank 83

A$2.38

Price from all time high (close): -42.6%

Dividend Yield (forecast): 6.8%

According to the organisation, CQE is the largest Australian property trust investing in social infrastructure properties within Australia and New Zealand. The Trust has total assets under management of $2.3 billion and 366 properties in its portfolio.

It boasts 100% occupancy, a 13.2 year WALE, and like ARF, trades at a discount to its NTA per share of $4.04.

Likewise, the majority of CQE's income comes from childcare centres, though they too have healthcare sites as well as other social infrastructure assets such as the offices of Geoscience Australia, the SA emergency Command Centre and Brisbane Bus Terminal.

From CQE Annual Report (Page 13)

Aligned closely with the themes of a growing and ageing population, plus plenty of government support there is a lot to support the long term prospects of CQE, despite the price pullback, there is a lot to like about CQE long term.

Further the company has 80% of its debt hedged at rates between 3% and 3.75% which cover it till 2025. The company is also 32% geared and well within covenants. The company also highlighted that 47% of rental income is subject to market rent reviews within the next five years, insulating it somewhat from inflation.

Quality

Similar to ARF, big asset revaluations the year prior hurt CQE on a comparable net profit basis, however operating profit and revenue both rose.

Return On Capital metrics are not as strong as ARF, though still reasonable against the market. While total cash rose, operating cash flow fell. This disconnect occurring in large part due to asset sales made by the trust (coincidentally CQE used to have an interest in ARF but in January sold its $44 million holding)

As previously mentioned, the company is well within its debt covenants and likewise margins are solid.

Value.

The significant price pullback has seen the price fall well below its NTA per share and its overall Factor score come in at 80.

The scale of the pullback now sees many of its ratios in more affordable positions, including dividend yield which analysts forecast to be 6.8% at the current price.

For those that have dodged a bullet, the value metrics look very attractive provided the trust can sustain valuation levels and its current level of cash generation

Momentum

The chart looks terrible and evidence needs to produced that things are turning around before committing to this.

ASX:CQE 5 year Weekly chart

With no real structural support between the current price and COVID lows, the price really needs a hand break applied, and then some new price action on which to base future possible moves on.

All relative measures look weak, though following the latest full year result the company was upgraded in regards to analysts covering it. While that hasn't stopped the price from falling, it does provide some comfort that at least on the operational level, the company is performing.

Conclusion

While some of the financial metrics don't look quite as solid as they do for ARF, there are some traits warrant a serious look at CQE right now. Not only do they share the same tailwinds, CQE:

- is trading at a bigger discount

- is larger

- is paying a better yield based on the pullback

- has a slightly more diversified portfolio

Either way, both CQE and ARF are trusts not likely to experience major structural challenges like office or retail trusts, nor are they trading at the lofty industrial portfolio valuations.

The price pullback is being driven by real market forces, however for those that have the time and patience to look through the cycle, supported by long term tailwinds, both are providing a unique opportunity at this point in time.

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