Can the strength of Industrial REITs continue?

The Fund had a strong month up 5.4% compared to the Benchmark up 3.1%.  This was driven by our overweight position in logistics and residential exposed REITs such as Charter Hall Group (CHC), Centuria Capital (CNI) and Cedar Woods (CWP).

In this month’s commentary, we look at the recent strengths of Industrial REITS and provide an assessment on the likeliness of continued growth for this sector.

A recording of our recent webinar, as well as a CPD questionnaire, is available HERE.

Top Holdings (alphabetically)

Charter Hall Group Australia Diversified REITs

Charter Hall Social Infrastructure REIT Australia Specialized REITs

Dexus Australia Office REITs

Goodman Group Australia Industrial REITs

Mirvac Group Property Trust Australia Diversified REITs

The Fund had a strong month up 5.4% compared to the Benchmark up 3.1%.  This was driven by our overweight position in logistics and residential exposed REITs such as Charter Hall Group (CHC), Centuria Capital (CNI) and Cedar Woods (CWP).

Over the month, the highly anticipated Milestone portfolio of 45 logistic assets was sold for $3.8bn to ESR on a cap rate of 4%.  This transaction, in our view, sets a new benchmark for Industrial assets.  The sale highlights the strong demand for Industrial assets and suggests that re-pricing of these assets will continue. Based on average portfolio cap rates of Industrial REITs, the transaction implies significant valuation upside for the sector with a further 100 basis point of cap rate compression to be achieved.

The most leveraged exposures to the continued positive Industrial dynamics are the pure-play Industrial REITs such as Centuria Industrial REIT (CIP) with a $2.6 billion portfolio on a 4.9% cap rate.  Not only that, the positive momentum is flowing through into listed fund managers that are exposed to logistic assets such as Goodman (GMG), Charter Hall Group (CHC) and Centuria Capital (CNI) through higher management fees, performance fees and development fees.

As it stands, prime Industrial cap rates have firmed to 4.8% nationally, with Industrial cap rates now below prime Office (5.1%) and regional malls (5.3%).

So, what has driven this growth and can it be sustained?

• COVID-19 had minimal impact on Industrial assets with rental collection and occupancy maintained at pre-COVID levels.
• The structural shift to e-commerce, whilst hurting bricks and mortar of discretionary retail malls, is benefiting sectors such as logistics and data centres. This structural shift is expected to continue based on several retail chains in the U.S. having increased their estimate of where online penetration is likely to stabilise from 20%-30% to 40%-50%.  We see Australia following the same trend with current online penetration increasing from 11% to 20% by 2025.
• Inventory levels have increased through on-shoring of production and a move away from just-in-time inventory, which should see continued demand for logistics space.
• Vacancy rates for prime Industrial assets are at an all-time low at 2.5%, which indicates the strong demand for well-located assets, particularly in metro areas where there are high barriers to entry, to accommodate for e-commerce growth.
• Cap rate spreads to funding costs remain elevated. This allows REITs and offshore buyers to deploy excess capacity to acquire assets in an earnings-accretive manner. This yield spread is also likely to favour continued equity flows for fund managers, such as CHC and GMG.

We see the strength in logistics to continue over the medium term driven by the demand from online retailing and further capital chasing the sector.  With this in mind, our process aims to pick stocks that are best-of-breed with strong management and balance sheets to enable them to fully capture growth through acquisitions and development. In a highly competitive environment for good logistics assets, we favour REITs that have development capabilities to meet their customers’ needs, such as Goodman Group that currently has a development pipeline of over $9 billion to sustain earnings growth of over 12% for the medium term.