Post Bottom, Focus Shifts To A-REITs Potential

Feature Stories | 10:00 AM

After a long period of post-covid underperformance, analysts believe we are at or near a trough for the listed real estate sector.

-Cap rates up and valuations down in REIT sector
-Recent outperformance in falling market
-Transaction activity picking up
-Analysts calling the trough

By Greg Peel

In the two and a half years to December 2024, listed real estate investment trusts (REIT) have expanded their cap rates by 47-140 basis points depending on asset class, while valuations have declined as much as -26% in Office. Morgan Stanley thinks the revaluation cycle has bottomed, and this could be a timely period for equity investors to consider the Real Estate sector.

In simple terms, the capitalisation or cap rate is the ratio of net income on a property (rent less expenses) divided by the current value of that property. It is not a black-and-white measure, as while a higher cap rate appears on the surface to be good, if it reflects a weaker property valuation rather than rising rent, it is not so good. Just as a high dividend yield may result from a falling share price.

Typically, high cap rates are considered a concern, reflected in weakness in the REIT sector over the past high inflation, high interest rate period.

The Australian REIT sector weakened -4.2% in February, over the result season period. But there are two caveats. Firstly, the market in general suffered a Trump-led downdraught, and secondly if we remove Goodman Group ((GMG)) which has by far the biggest market cap in the sector, daylight second the REIT sector actually rose 0.6%, Jarden notes.

But volatility was excessive within the sector (as it was elsewhere too). Of the listed REITs under Jarden's coverage, fifteen saw share price moves over the month of more than 5%. Many share price reactions far exceeded changes to earnings forecasts following results, Jarden notes.

The ongoing market sell-off had REITs down -2.7% in the first week of March, but the sector outperformed the ASX200 by 80bps. As stock markets sell off here and in the US, there has been a flight to safety into bonds, pushing down yields. This has eased the pressure REITs have suffered ever since the post-covid inflation surge.

Trough?

One of the key concerns in A-REITs since mid-2022 has been cap rate expansion and associated decline in asset valuations, Morgan Stanley notes, especially on the back of rate hikes and ten-year bond yield escalations. This broker believes it is under-appreciated that in the stocks under its coverage, Industrial cap rates have expanded 140bps since June 2022, Office valuations have declined -26% since June 2022, and all Retail portfolios resumed positive revaluations in the December 2024 half.