Weekly Reports | Jun 21 2024
Industrial versus Office property REITs; Citi cools on iron-ore prices, and Macquarie questions whether the ASX is large enough.
-The outlook for real-estate assets
-Morgans' fun facts on Goodman Group
-REITS, what's hot and what's not
-Iron ore prices softening
-Aussie super outgrowing the local share market
By Danielle Ecuyer
The outlook for Real-Estate Assets
In a higher interest rate environment, it is hardly surprising the brokers are sharpening the pencils and focusing on real-estate valuations, along with what's hot and what's not.
REITs will be dishing up asset valuation updates post June 30, and this has attracted the attention of Morgan Stanley. Divergence or not between industrial and office market cap rates versus 10-year bond yields?
As was highlighted in last week's In Brief, Morgan Stanley joins Barrenjoey to confirm on its own number crunching, the outlook for the office rental market is not too flash, still.
The spread of Office market cap rates versus the Australian 10-year bond yield is sitting around 1.97%, compared to the average since 2000 of 2.09%.
Assuming a lower income growth outlook for office, this infers the cap rate spread could move higher, which would equate to (still) lower valuations of office related assets.
Conversely, the conclusion for industrial property assets is more upbeat. Theoretically, industrial cap rates could expand by150bps as rental demand reverts to the lower long-term average.
While this is a potential risk, Morgan Stanley points to the rise in industrial rental returns post 2017/18 which, in turn, could be explained by the launch of Amazon and growth in online retailers.
Morgans overview from eight specialised guests
Morgans recently hosted eight guests across funds management, real estate and building materials, with Growthpoint Properties Australia ((GOZ)) pointing out an interesting calculation for the industrial property sector.
Each person in Australia requires around four-square metres of industrial space for their personal "footprint". This equates to demand of up to 2m square metres of industrial space simply on the back of around 1m to 1.5m people entering Australian in the next 3-5 years.
Looking at the commercial sector, Morgans notes concerns remain around higher replacement costs curtailing commercial real estate development and supply.
Morgans points to flat office rents and a fall in valuations of between -10% to -20% against a 25% lift in construction costs, with most office REITS trading below replacement cost.
Ultimately, population growth will support office rental growth, but for now, new developments are not financially worth the risk.
Against a higher interest rate/funding backdrop and inflated material costs, investors would prefer the yield on selective debt lending against equity, the guests suggested.
Speaking of costs, Morgans views the health of Australian builders as "better-than-feared"; margins have reset higher and reflect cost pressures.
Turning to private credit, the asset class du jour in a higher interest rate world...
The jury is still out, Morgans states, with the bulls upbeat on the private credit as an alternative to real-estate and ongoing falling valuations.
The bears, however, harbor concerns over defaults and insolvencies at a 25-year high, with the outlook continuing to erode as the RBA stands firm on no rate cuts with sticky inflation.
For many investors private credit is "ground zero", according to Morgans, with real estate, construction, hospitality, commercial property, and residential developers in the hot seat.
Goodman Group, Morgans' fun facts
Goodman Group represents 40% of the ASX200 A-REIT index with the top five REITS making up 70% of the index.
Some 60% of the Goodman shareholder register is foreign, with the company attracting global growth investors.
The premium valuation also generates attention, with Property Security Funds (PSF) struggling to align their investment criteria with the premium to NTA ascribed to Goodman. Their models rely on yield and expected rental income versus asset prices.
Simply put, global growth managers can stomach the plus 30x PER valuation for circa 15% p.a. earnings growth and a return on equity of around 15% with sectoral exposure to e-commerce and Ai via data centres. For your traditional property investor, these numbers do not have the same appeal.
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