Clouds Parting For Australia’s REIT Sector

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This story features SCENTRE GROUP, and other companies.
For more info SHARE ANALYSIS: SCG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

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.

Data Centres

Once upon a time, REITs were loosely split into the three categories of retail, office and logistics (warehouses). While there has since been growth in sub-categories (eg wellness, child care, storage centres), the greatest focus in this day and age is on data centres.

Bell Potter analysts recently spent some time in Asia with key data centre (DC) industry contacts which reinforced the growing demand in the region, consistent with data that suggests Australia is facing a circa -40% supply shortage for DC capacity over the next three years (supply 1.8GW versus 2.5-3.5GW demand).

Asia-Pacific could form around a third of total DC demand through to 2028 as cloud growth continues and AI workloads accelerate.

While there still appear to be numerous managers trying to get set, Bell Potter thinks the early movers and scaled players with multiple tenant-take outs are likely to prevail as the ability to secure power and builders determine where capital is directed as cost and power availability challenges become increasingly prevalent.

Yields on cost are likely to come under pressure from cost growth, Bell Potter notes, but the opportunity for double digit returns remains.

Which REITs?

As mentioned, UBS suggests the next leg of share price performance could be driven by NTA growth, which would further improve balance sheet capacity and the cost of equity across REITs.

UBS’ case study of large cap passive REITs –-Scentre Group ((SCG)), Vicinity Centres ((VCX)), Dexus ((DXS)), GPT Group ((GPT))— confirms the well-established inverse relationship between 10-year bond yields and PE multiples.

Post-covid, we saw this relationship invert for some REITs (Scentre, Vicinity) as strong earnings and NTA growth more than offset rate increases given retail rents and valuations re-based during the early covid period.

Looking forward, UBS expects names trading at a discount could still see solid share price performance without high earnings growth should a declining 10-year yield materially lift asset values across the space.

Only three REITs surpass Morgans’ greater than 20% total shareholder return threshold for a Buy recommendation: Digico Infrastructure REIT ((DGT)), with the catalyst being a material leasing transaction; HMC Capital ((HMC)), trading at NTA and a leveraged play on a turnaround of the underlying funds; and Eureka Group ((EGH)), delivering above average earnings growth from sustained rental increases of 5-7% plus accretive acquisitions.

Earnings growth across the REIT sector remains selective and sub-sector specific, Morgans suggests. On the positive, Garda Property ((GDF)) has seen earnings improve from the sale of its North Lakes site and Cairns office building. Goodman Group ((GMG)) continues to deliver growth through its data centre opportunity and retained earnings.

As a side note, Bell Potter notes September is historically a weak trading month for Goodman Group, post-result, given management’s share block trade sale, which the broker believes presents a buying opportunity with positive recent tenant and peer news.

Eureka Group is growing earnings on the back of a fully funded acquisition program, Morgans notes, while Homeco Daily Needs REIT ((HDN)) has seen a third year of 6% releasing spreads continue to improve funds from operation.

On the negative side, Centuria Office REIT’s ((COF)) earnings continue to decline (pending a supply-led turnaround in metro office). Dexus Industria REIT ((DXI)), following the sale of its high-yielding BTP office park, has seen forward earnings decline.

The Digico Infrastructure turnaround is contingent on a material lease, Morgans warns. The REIT is guiding to an additional 6MW of contracted DC capacity across the Australian business in FY26. The 20cps dividend is drawn into question as the business focuses on a payout ratio of sub-100% of funds from operations.

Eureka Group is ramping up its acquisition program following its November 2024 capital raise, which sees the business growing above industry average.

Retail arguably remains the most in-demand sub-sector, Morgans notes, as limited supply and resurgent consumer demand support positive rental spreads and funds from operations growth, a backdrop which should see HomeCo Daily Needs’ 6.3% distribution yield grow.

Cash Rate Hedges

Morgan Stanley comes in from a different angle, evaluating REITs on the basis of their hedges against movements in the RBA cash rate. The RBA has cut rates by -75bps, to 3.6% currently, and Morgan Stanley’s economists are expecting this to fall to 3.1% by February next year, broadly in line with the market.

There are REITs whose hedged rates through to FY28 and beyond are somewhat above 3.1%, Morgan Stanley notes. Similarly, there are REITs whose current hedges are below 3.1%.

GPT Group looks interesting to the broker — 75%/68% of its 2026/27 interest rate hedges are locked in at 3.7%/3.8%, hence there is a latent 4.3% adjusted funds from operations benefit on a mark-to-market basis.

Stockland ((SGP)), HomeCo Daily Needs and Centuria Office REIT ((COF)) too have swaps that are above market, although the portion of the borrowings hedged are not as elevated as GPT’s.

Charter Hall Long Wale REIT ((CLW)), Centuria Industrial REIT ((CIP)) and BWP Trust ((BWP)) have hedged rates that are below 3.1%. Morgan Stanley suggests funds from operations growth could be modest when these instruments roll off.

REITs on average have hedged their base interest rates at 3.1-3.2% over the next two years, broadly in line with the 3.1% that Morgan Stanley is expecting the RBA to land.

But for the stocks that have hedged at higher rates, the broker thinks there is latent earnings upside, which could come to fruition: (i) immediately if the swaps are broken, (ii) progressively if management does a blend-and-extend, or (iii) eventually, when the instruments expire, generally post FY28.

On Friday, Simon Kent-Jones, CFA, Head of Private Wealth Research at Ord Minnett offered his own set of sector observations and preferred exposures.

In August, Kent-Jones reports, two-thirds of A-REITs outperformed the ASX200 Index. Retail and Residential sectors led the recovery, supported by improved trading conditions, rent growth, and re-leasing spreads. Office showed signs of stabilisation, though development margins remain challenged.

It is Ord Minnett’s view A-REITs delivered a robust FY25 reporting season, demonstrating resilience across most asset classes. The sector-wide occupancy rate remained stable at 97.9%, with notable strength in Retail, Childcare, and Regional Centres.

Office and Convenience assets experienced only minor declines, while Self-Storage and Residential showed signs of recovery.

Ord Minnett’s preferred sector exposures include Large-caps Vicinity Centres ((VCX)), Scentre Group ((SCG)), and GPT Group ((GPT)) and Small-caps Arena REIT ((ARF)), Charter Hall Social Infrastructure REIT ((CQE)), HomeCo Daily Needs REIT ((HDN)), HMC Capital ((HMC)), and DigiCo Infrastructure REIT ((DGT)).

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