Feature Stories | 3:19 PM
Historically defensive yield-plays, REITs have suffered a volatile year due to interest rate uncertainty and economic challenges. But is there now light at the end of the tunnel?
-A-REITs have underperformed the market
-Bond market volatility has fuelled REIT volatility
-Challenges remain for office
-Residential poised to bounce
-Broker preferences
By Greg Peel
In the month of June, Australian-listed real estate investment trusts (REIT) delivered a flat return, underperforming the ASX200 by -1.9%. Year to date, REITs have outperformed by 7%. June brought the surprisingly strong May CPI print, which upended both the bond and stock markets.
That 7% is misleading as it includes a 38% gain for the largest REIT, Goodman Group ((GMG)). While Goodman is indeed a REIT, and a property fund manager, its alignment with the AI thematic through its development/management of data centres has turned it into an AI story, more so than a real estate story.
Ex-Goodman, the REIT sector is down -4% year to date, and large-cap REITs are down -8%.
The Australian ten-year bond yield, the benchmark against which REIT returns are measured, began 2024 under 4%. Expectations were high in the US that the Federal Reserve was about to embark on a rate cutting cycle and it was assumed the RBA would eventually follow suit.
But 2024 has since proven volatile in that regard with sticky inflation eroding rate cut hopes (Aussie ten-year 4.6% in April). Back then a generally weakening inflation trend was leading economists to predict the first RBA cut as soon as August (yield down to 4.1%). The May CPI represented the first actual uptick in the inflation trend, and today the yield is around 4.35% (equivalent to the RBA cash rate). The market is now pricing a 50/50 chance of another RBA rate hike by year's end.
Bond yield volatility has led to share price volatility for the historically defensive, plodding REIT sector, typically bought for yield rather than growth.
The question now is: have REIT valuations fallen far enough?
The Bad and the Good
With another rate increase now expected, UBS suggests the sector needs to confront several challenges.
Excluding Goodman Group, UBS notes growth into FY25-26 is muted, due to dilutive asset sales and higher debt costs. Generating outperformance through development/funds management has become more challenging.
The dividend yield spread to bond yields is -114 basis points below long term averages (ex Goodman). UBS sees very stretched valuations for names with growth, such as Goodman and HMC Capital ((HMC)), versus the rest, for which catalysts are lacking, with high office vacancy and logistics/retail slowing after a period of strength.
Yet, having hosted some of Australia's leading real estate companies (listed and unlisted) at its annual property conference, Barrenjoey learned globally a significant amount of capital is sitting on the sidelines waiting to deploy, and institutions are typically underweight real estate versus their target allocations.
Australian superfunds have strong equity inflow projections, and the government's Your Super Your Future legislation (2020-21 budget), which requires APRA to conduct an annual performance test for MySuper products and other prescribed products, implies continued investment in traditional and alternative real estate sectors.
The tremendous drop in cap rates is still unwinding and Australia has been slower to reprice than the US and Europe. Independent valuations could take another 6-12 months to fully adjust, Barrenjoey learned, and cap rates will expand by another 50-60 basis points to average 6%.
The capitalisation (cap) rate is annual rental income produced by a real estate asset divided by its current market value.
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