Where Is The Growth In A-REITs?

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How badly is outlook for the A-REIT sector affected by the latest wave of coronavirus and lockdowns? Where does the growth lie?

-A-REITs generally have healthy balance sheets and liquidity
-Record prices, higher asset values should drive performance fee increases
-Is the market underestimating the growth potential of retail A-REITs?
 

By Eva Brocklehurst

In seeking areas of growth from listed property vehicles, Australian real estate investment trusts (A-REIT), brokers are sifting through the evidence from the various asset classes, noting few provided much in the way of earnings guidance during the latest reporting season.

Therefore, visibility on the sector is clouded by uncertainties, largely relating to how the economy will emerge from the current lockdowns. Those that have provided guidance, such as fund managers and residential portfolios, tend to have more favourable operating fundamentals, Citi observes.

Yet Jarden warns, while A-REITs are trying to do more with funds management, history has shown many are unable to show consistent returns or the growth that is required.

Credit Suisse notes A-REITs outperformed the ASX 200 in July by 3.76% and delivered a total return of 6.26%. A yield spread over bonds of 2.59% is also above the 2.0% longer term average, and should provide continued support.

Forecasting FY22 sector growth is a function of a recovery in some A-REITs, the broker suggests, while for others a continuation of the track record is key. Overall, Credit Suisse notes balance sheets are generally healthy and there is good liquidity across the sector, while the refinancing risk remains low for the short term.

Finding avenues for growth is key to Macquarie's view, as returns ease back. Core businesses are observed to be under pressure from structural changes in office and retail. As a result, A-REITs such as Dexus Property ((DXS)) and Stockland ((SGP)) have re-positioned their focus on returns via capital recycling.

Vicinity Centres ((VCX)) is looking to mixed-use developments and Lendlease ((LLC)) is employing cost reduction targets. Funds management ambitions have also been emphasised by Dexus, Vicinity Centres, Mirvac Group ((MGR)), GPT Group ((GPT)), Stockland, and Growthpoint Properties ((GOZ)) alongside those growing their funds management arm such as Goodman Group ((GMG)), Charter Hall Group ((CHC)) and Lendlease.

Macquarie believes the current slowdown in the economic cycle is positive for A-REITs, although an increase in yields resulting from a tapering of financial stimulus by the US Federal Reserve remains a risk. Goldman Sachs emphasises defensive characteristics, including long lease terms with essential services, strong rental escalation and government support in areas such as childcare.

Stocks

Macquarie continues to believe earnings growth is on the cards for Charter Hall and Goodman Group, supporting Outperform ratings. Dexus is upgraded to Outperform given the resilience of its earnings and valuation, the broker noting the recent capital recycling program has improved the quality of assets and should be accretive to cash flow.

Macquarie also retains a preference for Mirvac amid upside from the apartment pipeline. Meanwhile, some uncertainty exists for Stockland because of the business review and despite resilient land sales.

Citi has a contrary view, with a Sell rating on Dexus because of structural headwinds in office. A growing divergence between rents and asset values is expected as the weak fundamental backdrop combines with increases to book values.

Looking ahead the broker suggests these headwinds in office should lead to market rental declines of -30% or more. Asset values are also expected to decline by around -5% until the end of 2022.

Top picks include Charter Hall, Goodman, Stockland and Lendlease. On the other hand, the broker agrees low rates, rising asset values and demand for real estate is driving upside for the fund managers.

Recent transaction activity points to record prices and higher asset value and this should drive further increases to performance fees. Despite Charter Hall and Goodman trading at historical highs Citi still finds potential for outperformance.

Pre-sales in residential have risen, providing evidence for a short-term earnings boost and the broker envisages scope for FY22 guidance, where it exists, to prove conservative.

UBS notes those A-REITs that outperformed during the recent reporting season include Centuria Capital ((CNI)), Scentre Group ((SCG)) and Ingenia Communities ((INA)) while those underperforming were BWP Trust ((BWP)), Goodman and Charter Hall Retail ((CQR)).

While retail results were ahead of the broker's cautious expectations, strong outlook statements were noted from fund managers. Scentre Group and Homeco Daily Needs ((HDN)) were the exception in providing guidance among retail A-REITs, UBS notes, while passive A-REITs elsewhere tended to provide a conservative minimum level of forecast earnings for FY22.

Goldman Sachs believes Charter Hall Social Infrastructure ((CQE)) is executing on its strategy, demonstrating an ability to source high quality accretive assets while the low cost of debt allows for an attractive yield spread.

Waypoint REIT ((WPR)) also has upside risk, given its guidance allows for no acquisitions in FY21. The balance sheet has large capacity as a number of non-core assets have been divested. Lifestyle Communities ((LIC)) is another alternate stock that has provided strong three-year guidance for new home settlements which should drive higher annuity rental earnings over the longer term.

The broker assesses the fundamentals and development pipeline are robust and remains confident, post lockdown, sales will recover sharply. Goldman Sachs has Buy ratings for these three stocks.

Retail

In retail, Citi expects a lack of appetite for large assets and, with pressure on both rental income and underlying property values, this remains its least preferred property class.

Headwinds are greatest for the larger shopping centres which is why Citi retains a Sell rating for Scentre Group. Credit Suisse also notes retail-exposed names are the ones least likely to provide earnings or distribution guidance, in part due to mandatory rent relief in NSW Victoria for tenants with $50m or less in turnover.

Jarden appreciates the structural pressures from online and cost inflation but believes the market is underestimating the growth potential for retail A-REITs, and expects 17-24% earnings (EBIT) growth for retail in 2022 in terms of the more discretionary retail A-REITs and 30% growth taking into account operating leverage.

The broker has recently upgraded both Scentre Group and Shopping Centres Australasia ((SCP)) to Buy from Overweight as a top picks in retail. GPT has also been upgraded to Overweight, on the back of a potential retail recovery and ongoing expansion in logistics.

Jarden upgrades Vicinity Centres to Neutral believing it will also benefit from the retail recovery, although a little later than Scentre Group because of CBD exposure. Charter Hall remains the broker's top pick amongst fund managers. On the other hand, Goodman Group's valuation is considered stretched.

Long WALE

In a backward looking view, over the past five years there has been a number of new vehicles which have focused on long WALE (weighted average lease expiry) rental structures and this seems to be an increasing focus of the sector, Jarden asserts.

In analysing the relationship between WALE and capitalisation rates (the ratio between market value and rental income) in more detail, the broker finds long WALE is not reflected in valuations and there is little correlation between the two measures.

While appreciating there is more to cap rates than the lease expiries the broker is still surprised valuers are not putting more emphasis on cashflow security. In the different asset classes, logistics long WALE stocks have gone up while retail long WALE stocks have come down. To the broker, this highlights the period since FY13 when logistics WALE has expanded significantly.

Otherwise, there is little consistency over asset class portfolios. In sum, Jarden believes longer WALE portfolios in social infrastructure and other alternative asset classes have more to go in terms of cap rate compression in order to reflect their rental security compared with other passive A-REITs.

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