Rate relief spurs rosy outlook for REITs

ASX-listed listed property stocks, battered by two years’ of high interest rates, could soon become “buys” as inflation eases more quickly than expected, improving the prospects of rate cuts this year.

The outlook for REITs (real estate investment trusts) has turned decidedly bullish among analysts and fund managers ahead as the sector heads into its annual earnings season.

“We anticipate the next few months should present an attractive entry point into the sector,” Citi’s Howard Penny and his fellow analysts wrote in a flash note last week, following the release of CPI figures.

As inflation eases more quickly than anticipated, expectations for rate cuts are firming. That’s good news for the real sector whose fortunes are closely pegged to the cost of debt. Yields on long-term bonds can be a key indicator for expected returns from REIT stocks.

Citi expects the cash rate, now at 4.35 per cent, to fall to 3.85 per cent by the end of the year.

“As rates peak, the sector has a history of negative correlation to bond yields and interest rates, benefiting from both the plateau at the top of the interest rate cycle as well as the commencement of interest rate declines,” the Citi team wrote.

Analysis shows REITs usually start to outperform the market from up to four months before the RBA begins cutting rates. The REIT sector jumped more than 6 per cent last week, defying US jitters over the commercial property market and outperforming the broader equities market.

Strong balance sheet

The biggest stocks set to benefit from the rising tide are industrial giant Goodman, along with diversified developer Stockland and Westfield owner Scentre, according to Citi.

“Things are a lot more rosy for REITs,” said Pengana Capital Group fund manager Amy Pham.

“It’s no longer about fighting inflation. We think the next challenge for the sector is balancing between inflation and growth.

“The only way that you can get growth in this environment is if you’ve got a strong balance sheet and if you’ve got access to third-party capital.”

The turn toward funds management is gaining pace across the listed property sector. It’s already a key focus for its biggest players, including Goodman – which confirmed guidance of 9 per cent growth in earnings per share at its November trading update – and Charter Hall.

Investors and analysts will be closely watching Charter Hall for an update on its valuations, especially after the latest analysis on unlisted wholesale funds – including some managed by Charter Hall – showed negative returns.

Morgan Stanley analysts Simon Chan and Lauren Berry reported feedback from investors was that Charter Hall had so far been “perhaps aggressive in its asset values, as they had been lowered less than peers”.

The potential for more devaluation in the upcoming earnings might bring Charter Hall’s portfolio values back in line with its peers, they wrote in a note.

“This could alleviate investor concerns that its assets under management [total] is prone to outsized downgrades in [the] future.”

Other prominent stocks such Dexus and Mirvac have also been stepping up their funds-management activities.

Pengana’s Ms Pham is quietly confident the wave of downgrades reported in last year’s results is mostly over, although it may be too soon for upgrades because listed property players must still manage expensive debt books which can crimp earnings.

Housing undersupply

“In the meantime, what we’re looking at is the ability to grow. This is a time to position your portfolio for the next growth phase,” she said.

That could augur well for the major residential developers – such as Stockland and Mirvac – given the country’s housing undersupply and strong population growth.

“For resi developers, it’s their sweet spot right now. If you’ve got a large land bank, you’re ahead,” said Ms Pham. She is also favourable toward large shopping centre owners, such as Westfield owner Scentre, given the relative resilience of consumers.

Fund manager Grant Berry, at SG Hiscock, is positive on the longer-term prospects for residential development, even though sales have dipped more recently as would-be buyers baulk at high mortgage costs.

“Residential is a very good medium- to long-term story, but we would expect to see a low volume [in new sales and settlements] in the short term,” he said.

Like Ms Pham, Mr Berry notes that while the industrial and logistics sector remains strong, REIT investors should expect an easing in conditions for a market that has delivered soaring rental growth for several years.

Mr Berry noted California’s Inland Empire, which operates in one of the world’s top industrial markets, has been reporting falling rents.

“‘Don’t get complacent’ is our message, even though vacancy rates are low. No sector is immune to the cycle, and we are seeing that occur in one of the premier industrial markets globally.”