Stable earnings despite rising cost of capital

The AREIT sector was up 9.9% in October, outperforming the broader market by 3.9%.

The catalyst for the outperformance was the optimism that bond yields may have peaked with the RBA slowing down the rate hike to 25 basis points versus market consensus of 50 basis points.  As a result, 10 year bonds closed 13 basis points lower to 3.76%.

The Fund returned 9.7% driven by our positions in Arena REIT (ARF: +18%), Lifestyle Communities (LIC: +15%) and SCA Property Group (SCP: +15%).

We recently held a Portfolio and Investment Update webinar, along with Q&A for shareholders, which is available below for your review. CPD points are applicable for Australian Financial Planners HERE. 

Top Holdings (alphabetically)

Charter Hall Group

Australia

Real Estate

Charter Hall Group invests in and develops real estate. The Company manages real estate investment funds and develops commercial, residential, and industrial properties.

Goodman Group

Australia

Real Estate

Goodman Group is an integrated industrial property group. The Group has operations in Australia, New Zealand, UK, Asia and Europe. Goodman's activities include property investment, funds management, property development and property services. The Group's property portfolio includes business parks, industrial estates, office parks and warehouse/distribution centers.

GPT Group

Australia

Real Estate

GPT Group is an active owner and manager of a diversified portfolio of Australian retail, office and industrial property assets. The Group's property portfolio include the MLC Centre, Australia Square, Rouse Hill Town Centre and Melbourne Central.

Lifestyle Communities

Australia

Real Estate

Lifestyle Communities Ltd Limited provides resort style housing for individuals in their fifties and older.

Shopping Centres Australasia Property Group

Australia

Real Estate

Shopping Centres Australasia Property Group is a real estate investment trust owning Woolworths Group anchored shopping centres and free standing retail assets.

Despite a continued rise in the cost of debt, the AREIT sector’s earnings profile remained resilient with forecast earnings guidance retained in the latest quarterly updates.  REITs such as DXS, SGP, MGR, VCX, CLW, CQE, GOZ and CIP all reiterated FY23 EPS guidance. This consistency in earnings can be attributed to the following;

1. The majority of earnings are contractual rents with average lease terms of 4-5 years
2. Average debt to asset ratios remain low at 27% with over 60% of debt hedged
3. A strong operating environment with high occupancies of over 90% coupled with a recovery in sales for retail and strong rental growth for industrial assets.

This allowed AREITs to provide investors with a stable distribution yield of 5% and forecast earnings growth of 4%.

Another impact of rising interest rates is on valuations.  Currently, there is a large disparity between the pricing of assets in the direct market versus the listed market, with a majority of REITs trading at large discounts (20%) to their book value or NTA (net asset value).  We are forecasting that cap rates will rise but will be largely offset by rental growth, especially in logistics, convenience retail and alternative asset classes.

Looking at the liquidity or funding position of the sector, there are early signs that availability of capital is decreasing and funding margins are increasing. Credit spreads have increased by approximately 50 basis points from the COVID period but this should be viewed in the context of excess liquidity caused by central banks to support markets during COVID.  Looking at the credit spread over the longer term, it is still within a normalised level of 100-150 basis points above the base rate.

In terms of capital allocation to the sector, there has been a structural under weight to real estate in the Asia Pacific Region, with allocations of less than 8% versus a target weighting of 11%. When we combine this with the current discrepancy in pricing between direct and listed real estate, this could favour REITs to the extent that they offer relatively better value and levels of liquidity. Australia is viewed as the most stable economy in the region and is a likely candidate for increased allocations.

Combining all of the above factors, we continue to favour REITs that have strong balance sheets, high quality assets and a capital light business model supporting growth through acquisitions and development.