A-REITs Subdued Despite Low Bond Yields

Australia | Sep 11 2019

Australia's real estate investment trusts, as a group, have outperformed the broader equity market but remain relatively subdued, largely because of the dominance of shopping centres.

-News flow very negative for shopping centres
-Fund managers better placed in current yield environment
-Moderating economic growth likely to impact on office leasing conditions


By Eva Brocklehurst

Operating conditions continue to vary among the segments of Australian Real Estate Investment Trusts (A-REITs). The headline valuation of the sector appears attractive, as history indicates a decline in bond yields means listed property outperforms broader equity markets.

Yet Macquarie points out, while this remains the case in 2019, the strength of the outperformance has been relatively weak, attributed in part to an A-REIT index which has significant exposure to retailing that, in turn, is facing uncertainty over cash flow.

Hence, the sector is not as defensive as it once was. The price/earnings multiple of the A-REIT sector is at a -0.8 percentage point discount relative to the ASX 200, having inverted from a 1.7 percentage point premium since May 2016.

Macquarie expects a decline in equity market volatility, as further cuts to official interest rates in the next 12 months provide for higher asset values and less volatility. In times of rising volatility, the broker observes the A-REIT sector typically outperforms. The FY19 reporting season has reinforced Macquarie's view on retail, as operating income growth was disappointing and occupancy costs rose.

Citi agrees the news flow has been very negative for retail and a further slowing of income growth is likely, amid growing evidence that shopping centre values are falling. The broker has maintained an increasingly bearish conviction on retail A-REITs.

Macquarie, too, remains cautious about the current leverage of retail vehicles and queries the active buybacks of both Scentre Group ((SCG)) and Vicinity Centres ((VCX)), downgrading the latter to Underperform recently. Moreover, Morgan Stanley lowers expectations for retail REITs globally, driven by a combination of rising fears of a recession and escalating trade wars that may adversely affect retailers.

While retail sales growth has shown some signs of life in the latest ASX reports, this has not translated into comparable income growth for many A-REITs, Baillieu asserts. The broker believes the outlook for the sector is skewed to double-digit earnings growth expectations for large-cap stocks such as Charter Hall ((CHC)) and Goodman Group ((GMG)).

Fund Managers Highlighted

Meanwhile, Charter Hall , Goodman Group and Lendlease ((LLC)) have fund management platforms which continue to benefit from a lower-for-longer yield environment. This outlook for fund managers is superior to passive retail A-REITs, in Macquarie's opinion.

Citi observes earnings growth for the sector based on company guidance is around 4% and any surprises to the upside are becoming more concentrated, with only Charter Hall, Goodman Group and Charter Hall Long WALE ((CLW)) offering above-sector earnings growth.

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