Clouds Parting For Australia’s REIT Sector

Australia | 11:43 AM

After a period of underperformance, Australian REITs have begun to outperform with RBA rate cuts in focus.

-REITs outperformed the ASX200 over August result season
-PEs expanding on modest earnings upgrades
-Prospects vary across REIT sub-sectors
-Interest rate hedges in focus amidst RBA rate cuts

By Greg Peel

In the second week of September, the ASX200 fell -0.2% but the real estate investment trust (REIT) sector rose 1.9%. This follows a strong FY25 reporting season in which the ASX200 rose 2.6% over August with REITs rising 4.1, as the sector turns the corner, Bell Potter notes, moving from headwinds to tailwinds, value (discount to net asset value) shifts to momentum, and a stable funding environment propels direct transaction markets (ex-office).

The August reporting season was a story of multiple (PE) expansion despite only moderate earnings revisions, UBS points out. While the majority of REITs saw upwards revisions to FY26 and beyond earnings per share forecasts, the magnitude was subdued (+1% FY26/+2% FY27/+1% FY28) with the more substantial move in share prices suggesting to UBS investors are increasingly optimistic around known REIT sector drivers (rent growth, limited new supply, development improving, rates peaking).

With the sector now pricing in a better outlook, UBS thinks FY26/27 becomes a period of delivery, with a more balanced upside/downside skew from current levels. Growth could be further enhanced by equity funded acquisitions, though this likely requires share prices moving  some 5-10% higher unless distressed sales emerge or REITs move down the quality spectrum to acquire higher yielding assets, in UBS’ view.

REIT PE to earnings growth ratios are better today compared to the last cutting cycle in 2015/16 (excluding covid). Against this, UBS thus sees risks emerging given the consensus positive view of the sector.

The broker’s discounted cash flow valuations assume bond yields at 4.0% (spot 4.3%), but lowering this -100bps to 3.0 would see valuations lifting by 13%.

This would see the sector screening as attractive versus UBS’ valuations, although moderate 10-year yield compression may already be priced in and UBS thinks the timing of a decline in the 10-year is difficult to gauge with yields stubbornly high.

Valuation

Given the potential tailwind from lower interest rates and the outlook for limited additional supply (as construction costs rarely justify additional new development at current rents), the investment case for the REIT sector continues to improve, Morgans suggests.

This broker argues relative low gearing and benign supply forecasts across most commercial real estate sectors have REITs in solid health. Even the office sector, hampered by elevated vacancies and incentives, has limited new supply to contend with.

To this end, anecdotal reports suggest loan margins continue to decline -- a further tailwind to the falling 2-3-year swap rate. With the three-year interest rate swap at 3.2% and margins at around 1.5%, the all-in debt cost of 4.7% is creating a positive spread across many commercial real estate markets, Morgans notes.

The sector has moved quickly to price in anticipated earnings growth from cash rate cuts, but we have not yet seen material positive asset revaluations in this cycle. UBS believes the next leg of share price performance could be driven by net tangible asset (NTA) growth which would further improve balance sheet capacity and the cost of equity across REITs.