Australian Foundation Investment : AFIC expects good returns from property

Property attracts a lot of investor interest, and two high-quality property companies make up a small but valued portion of AFIC's diversified portfolio.Portfolio manager Brett McNeill takes a closer look at what makes these companies attractive.

Real estate was one of the better performing sectors on the ASX during August 2023, with the sector up by 1.5 per cent while the ASX200 index was down 0.7 per cent.

Just under four per cent of AFIC's portfolio is made up of real estate companies, comprising Mirvac and Goodman Group. Over the 2022/23 financial year, we increased our holdings in both companies.

Our approach to investing in companies in the property sector is the same for other sectors: we invest in companies that are well managed, have strong balance sheets, high-quality assets, and good growth prospects, and which are well placed to deliver attractive returns to shareholders over the long term.

The property sector generally has been doing it tough

The property sector had a tougher 2022-23 reporting season than other sectors. The real estate sector rose by 6.8 per cent over the financial year but underperformed the ASX200 index, which rose 16.6 per cent over the financial year.

The impact of higher interest rates drove up interest costs, which in turn affected property companies' profits and dividends, perhaps more than the market anticipated. Higher interest rates also forced a rebasing of property capitalisation rates, and there was some well-publicised pressure on the office sector.

Our property sector investments hold more promise

We believe that despite the general pressure on the property sector, Mirvac and Goodman Group are well placed to perform well over the long term.

Mirvac is set to benefit from its residential business, given there simply are not enough houses to meet the demands of Australia's growing population. Mirvac said in its FY23 financial results that a strong pipeline for apartments was supported by low unemployment, above-average wages growth, rising overseas migration, compelling relative affordability of apartments, and healthy household balance sheets.

Mirvac also owns a large portfolio of offices which is well placed because it is mostly at the premium end of the market. There is a large gap between premium or A-grade office space and B- and C-grade. Whilst Premium and A-grade offices are under pressure they are not as much as B- and C-grade. Customers don't want to occupy the lower-grade office space because it's low fit out quality, costs a lot to run, and doesn't have the desired ESG credentials.

Goodman Group is a best-in-class global manager and developer of industrial real estate and is a big beneficiary from e-commerce and demand for logistics facilities and warehouses. Goodman said in its FY23 financial results that despite macro-economic uncertainty, the digital economy was driving a need for more efficient and sustainable assets. In particular, there was increased demand for industrial land for the development of data centres with significant growth in data storage and AI driving the need for data centres.

AFIC's focus, therefore, is on the companies with high-quality assets, which again aligns with our investment approach to any sector.

We remain comfortable with our property investments

The property sector generally presents good value at the moment, and dividend yields are attractive. The sector has been out of favour with the markets, but that makes valuations favourable and presents buying opportunities.

We believe that the property stocks that we own are in good shape. They have quality assets, strong balance sheets, sustainable dividend payout ratios, and are well managed. They're a good source of income for the AFIC portfolio, they are diversified, and have an element of defensiveness, meaning they can navigate various economic conditions.