REITs recovering from high rates, office market fears
Traditional real estate segments, including offices, are showing signs of recovery.
Australian real estate investment trusts are back on the radar for sharemarket investors as the prospect of interest rate cuts firms, commercial deal making activity picks up and housing developers prepare for the next upswing.
Despite a patchy reporting season in which some key players turned in disappointing results, the sector is now poised to benefit as local investors see the direct market has stabilised, and global players expect positive international trends to play out in this market.
The lift in investor sentiment could propel the sector’s performance on a broader basis after periods in which it has been held up by sector giant, industrial property and data centre developer Goodman Group.
More traditional segments, including offices, are showing signs of recovery, and retail property continues to hold up despite sluggish consumer spending. Investors are also chasing exposures to alternative properties, with areas ranging from self-storage, manufactured housing, childcare property to pubs in focus.
They are now expecting the Australian real estate investment trust sector to follow parts of the US sector, where office companies have recovered, partly as staff return to work.
CLSA analysts James Druce and Adam Calvetti have put an overweight rating on the real estate investment trust sector in the wake of the reporting season.
They said there was a “clear inflection point” based on investor comfort that US rates have peaked, the prospect of rate cuts in Australia in the first half of 2025, and trough earnings for stocks such as Dexus, Mirvac, Vicinity Centres and Stockland, as well as signs that the transaction market is opening up and values are generally stabilising.
CLSA said transaction markets were reopening for fund managers as asset values stabilised, and the outlook improved, with rate cuts and a soft landing in prospect.
“We expect the residential sector to pick up again on rate cuts, after constant pressure on volumes and margins, from high construction costs, subcontractor delays and elevated interest costs,” its analysts said.
But they said that, on the downside, after an amazing run, industrial fundamentals were starting to soften, with incentives generally increasing and rents flattening.
They said the pace of US rate cuts, job indicators in both the US and Australia, and the outcome of big-ticket campaigns such as Mitsubishi Estate Asia’s offer of a stake in Salesforce Tower in Sydney, would be a guide to where the sector was headed.
The 56-storey, 263m-high Salesforce Tower is Sydney’s tallest commercial building.
Big deals have already helped some stocks, notably the $24bn sale of the AirTrunk portfolio to private equity giant Blackstone, which had supported the rerating of some industrial stocks with data centre plans. But the underlying demand for commercial property is also helping.
“Generally we are more comfortable asset values have troughed. We see more devaluations in office, between 3 per cent to 5 per cent based on transactions in the market,” the CLSA analysts said. They also warned that there was potential downside for retail malls, as some recent sales were struck below book values.
NextDC opened its $100m A1 Adelaide data centre recently.
The reporting season grabbed headlines due to large one-day moves. Dexus and Mirvac both fell 9 per cent after resetting their businesses and writing down assets. By contrast, Charter Hall jumped 16 per cent after beating market expectations and on the back of speculation it would be included in a major global index.
Barrenjoey head of REITs research Ben Brayshaw told investors the reporting season was uninspiring for trusts, but the fundamentals were in reasonable or good shape, with occupancy across their portfolios of 97.7 per cent; net income growth of 3.6 per cent per annum; and the standout being the strength in retail, which he said should persist.
He is upbeat, saying that bank funding costs have eased, which is being passed on to the trusts via lower margins. And although capitalisation rates – used to measure property values – have expanded 75 basis points since their peak, gearing ratios stabilised this season for the first time in 18 months.
“This puts REITs in a more favourable light,” Mr Brayshaw said.
“Investors could be well served to increase their allocation to the sector, in our view.”
He pointed to the strong performance of shopping centres. The reporting season had total sales growth slow to 2.7 per cent (from 5.3 per cent), and rent spreads declined to 2 per cent (from 3.2 per cent), but occupancy bumped up to 99.1 per cent. The three large retail trusts – Scentre, Vicinity and GPT – also guided to a continuation of positive sales growth and their managements were more positive than six months ago.
Scentre Group and Barrenjoey Private Capital are buying a half stake in Westfield West Lakes.
Mr Brayshaw said that guidance given by trusts looked conservative, and he tipped that Goodman, Vicinity Centres, Charter Hall, GPT and Stockland would perform ahead of market expectations.
“Elevated levels of rate volatility and consensus earnings downgrades have largely kept investors on the sidelines over the last two years, not knowing when to catch a falling knife,” Mr Brayshaw said.
“The cycle appears to have turned: average gearing levels stabilised this season, and credit conditions for REITs are starting to ease.”
Some fund managers are cautious. Resolution Capital said most trusts delivered results in line with expectations. The sector generated about 2 per cent earnings growth, skewed up by Goodman but weighed down by residential developers, office trusts, leveraged groups and property fund managers.
Resolution said earnings guidance for this year was generally below expectations, citing headwinds including higher interest expenses, lower trading profits, and earnings dilutive asset sales. But it also expects sector earnings to improve in 2026, when debt costs will have largely been repriced and a more stable interest rate environment benefits residential developers and fund managers.
JPMorgan analyst Richard Jones agreed that the reporting season had higher than normal volatility, with strong responses to earnings surprises. But investors appeared keen to get into the sector.
“We saw increased sector interest beyond the well-held Goodman Group as investors positioned for global central bank easing and turned more defensive amidst negative earnings revisions across much of the ASX 200,” he said.
Mr Jones said A-REITs delivered negative earnings growth last financial year – once giant Goodman was taken out of the analysis – as they faced a rising weighted average cost of debt from the low 3 per cent range to the high 4 per cent range, which neutralised sector growth. But conditions were on the rise.
