Feature Stories | 11:25 AM
Higher rates, falling house prices and weak consumer sentiment are weighing on the outlook for A-REITs in FY27, but it's not all bad news.
- Rising rates, falling house prices and weak consumer sentiment to pressure A-REITs
- High occupancy, tenant waitlists and weak supply offer support
- Sector already is trading on discounted valuations
- Sector analysts nominate their Top Picks and preferences
By Greg Peel
FY26 was a good year for the buildings in the portfolios of Australian real estate investment trusts (REITs), but a poor one for their share prices, Morgans notes.
Yet, occupancy is at or near full across industrial and convenience retail, leasing spreads were positive (re-leasing at a higher rent) at almost every name, and like-for-like net income growth ran 3 8%.
Yet, the A-REIT index fell -15.5% over twelve months while the bond index fell just -1.3%.
Investors were clearly more focused on, and concerned about, interest rates than REIT fundamentals. The RBA cash rate was cut to 3.60% by August 2025, then returned to 4.35% on three increases in calendar 2026.
Weighted average cost of debt rose for most names and FY27 assumptions are higher again.
The rates outlook is shifting higher, with inflationary pressures prompting UBS’ Australian economists to bring forward their forecast 25bp cash-rate hike from November to September.
They still expect the cash rate to peak at 4.60% (one hike) through to 2027-end, with risks biased to the upside, meaning a greater chance of two hikes versus none.
Global pressures are also mounting, with UBS’ US economists prior to this week's FOMC meeting forecasting Fed hikes in both September and November, up from none, following a stronger-than-expected August US employment number.
UBS’ year-end US ten-year yield forecast has been lifted to 4.80% from 4.35%. That yield is currently at 4.947%, having risen to 5% earlier this week.
It was not expected to change much even if the Fed had decided to pause in September.
Cap Rates
An important metric when valuing REITs is the capitalisation rate.
A cap rate is calculated as net operating income (rent net of debt, maintenance costs) divided by the current market value of the property.
A cap rate is similar to a dividend yield. A higher cap rate indicates a higher expected return but also a higher risk, while a lower cap rate suggests lower risk and potential returns.
Investors are increasingly concerned that rising rates could drive another correction in commercial property values, with the Aussie ten-year yield currently at 5.27%.
UBS’ analysis suggests a 12-18 month lag is typical before cap rates shift in response to changes in bond yields, with a 0.50 correlation between movements in bond yields and cap rates when lagging cap rates by five quarters.
This contrasts with a negligible correlation (0.02) when measuring movements in bond yields and cap rates with no lag.
Cap rate spreads to the real ten-year yield are currently narrow compared to history, UBS notes, at 3.8% for office, 3.0% for retail and 3.3% for industrial versus the long-term range of 4%-6%.
Property valuers are however likely to adjust cap rates slowly, rather than immediately “marking to-market” to spot for the ten-year yield.
REITs’ increased interest bill due to higher rates absorbed most of their rent growth, Morgans notes.
REITs hedge their exposure, which slows the transition to higher rates, but higher rates then diminish the level of hedging.
For example, Morgans notes Centuria Industrial REIT's ((CIP)) hedging fell to 54% from 86%, Dexus Industria ((DXI)) to 54% from 70% and HomeCo Daily Needs ((HDN)) to 68.4% from 81.0% with tenor down to 0.8 years.
Morgans reports few REITs see a benefit from further hedging at current rates.
Cap rates compressed at most names and net tangible asset (NTA) valuations rose, yet discounts of -21% to -48% persist across ten of the 15 names covered by Morgans.
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