The news gets worse for investors facing Labor’s franking credits crush

The Australian

28 January 2019

James Kirby, Wealth Editor

Investors scrambling to avoid the Opposition’s looming clampdown on franked dividends are facing an uphill battle as property trusts — regularly cited as a safe alternative for income investors — are due to hit a wall of trouble in the months ahead.

Australian investors have traditionally depended on fully-franked blue chip shares, especially banks, to underpin investment income. But the Labor Party’s controversial plan, which scraps cash refunds to retirees who hold franked shares, is forcing many shareholders to seek new sources of income.

Advisers and brokers are constantly recommending property trusts (also known as A-REITs) since they are income-focused trusts where the dividends are taxed at the shareholder level. As a result there is no franking credit to be lost in this area.

But the news keeps getting worse for property companies — especially retail focused trusts, which represent roughly half the entire sector’s market capitalisation.

A potent combination of online retailing, fading consumer sentiment and falling house prices is creating ever more difficult conditions.

The headwinds are most intense among big names names such as Scentre, Westfield and Vicinity, where the questions run to the very future of shopping centres as we know them.

The Vicinity group stunned the market recently with an announcement it had voluntarily cut its own valuations for properties in its portfolio: the group, which owns the flagship Chadstone centre in Melbourne, is being dragged lower by clear difficulties in its less glamorous regional centres. Property analysts now expect further valuation cuts across the A-REIT sector with a focus on the shopping centre giants.

Sentiment in the property trusts is also being hit by rounds of increasingly negative forecasts for the housing market. The latest came this week from the CoreLogic group, which is now suggesting top-to-bottom price falls in Sydney and Melbourne of 20 per cent (from previous estimations of 15 per cent).

Though lower house prices are not an immediate worry for the A-REIT sector (which is less than 10 per cent residential), the potential negative effect on consumer sentiment is a real danger.

Shopping centres have always depended on department stores and large retail chains as anchor tenants. However, current difficulties faced by retailers as diverse as David Jones and Kmart mean that centre operators face increasingly difficult discussions when re-leasing negotiations emerge.

Growth projections for the wider real estate sector are already falling behind general industrial stocks, with industry-wide earnings per share growth for A-REITs expected to be about 4.8 per cent, against 5.4 per cent for industrial stocks.

For investors, the reality of moving out of bank stocks paying higher dividends — even before franking is taken into account — means the numbers involved in any switching of stock portfolios may simply not stack up.

Leading banks such as Westpac and NAB are currently offering forward dividend yields of 7.2 per cent and 8 per cent respectively. For many investors this will translate to a post franking dividend rate of 8 per cent to 10 per cent — this is an exceptional level of income return.

Meanwhile unfranked A-REITs are showing modest forecast dividend yields levels in the order of 6 per cent for groups such as Scentre and even lower at highly priced stocks such as Bunnings Warehouse Property Trust (4.8 per cent).

Finding a way to protect yourself from the looming changes in franking credits is not going to be easy. Certainly, rolling over investments into A-REITs at this time in the cycle would appear to be a risk rarely worth the effort.