From fear of inflation to fear of recession, and 2 factors to drive outperformance

The Australian REIT sector continued its rollercoaster ride of performance, delivering a +5.2% return in April, after the RBA’s pause in rates at 3.60%.  This saw the sector recover most of its decline in the previous month, with year-to-date performance slightly ahead of the broader market.

The Fund returned +4.2% in the month of April, with our exposure to Centuria Capital Group (CNI+13.6%) and Stockland Group (SGP +11.8%) contributing the most to performance, whilst our exposure to RAM Essential Services Property Fund (REP -2.0%) and HealthCo Healthcare and Wellness REIT (HCW -0.4%) detracted from performance.

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.

Stockland

Australia

Real Estate

Stockland is a diversified Australian property group. The Group develops and manages Retail centers, Residential Communities and Retirement Living assets with a focus on regional centers and outer metropolitan. Stockland also owns a portfolio of Office and Industrial assets.

The unexpected 25 bps cash rate rise to 3.85% on 3 May 2023 took the market by surprise, having expected the RBA to pause for the second time following its decision in April.

Whether the RBA continues to raise rates will depend on the unemployment rate and what’s happening in the U.S., with the market currently pricing in for a recession by the end of the year.  This is reflected in the inverted yield curve where the Australian 3-year bond yield is below the cash rate.

Looking at the health of the economy, inflation is still high at 7% (well outside the 2%-3% RBA target range), employment levels are still strong (with the unemployment rate at 3.5%), the housing shortage, and affordability, remains a concern with vacancy rates at an all-time low (<1%), and with strong recovery in migration expected over the next two years.

So how are we positioned?

The market will remain jittery as inflation remains high, but the risk now seems to shift from high inflation to slowing growth.  As we enter into a weaker economy, this tends to drive earnings downgrades and the outperformance of defensive over cyclical sectors.

For AREITs this means convenience retail over discretionary, and alternative assets such as healthcare, childcare, and retirement living over core office, retail, and industrials.

As interest rates stabilise, we are starting to see more confidence in the recovery of residential fundamentals with the CoreLogic home value index data released in early April posting a +0.6% monthly gain. This was the first month-on-month gain in national house prices since the housing downturn started in May 2022.

There are two factors why we think residential REITs will outperform over the medium term:

• With the embedded lack of housing supply (vacancy rates <1%) and affordability issues in Australia, we believe that housing, especially affordable housing, will continue to be supported; particularly as migration is set to pick up remarkably in the next couple of years (700,000 new migrants expected to come to Australia by the end of 2024), well above the long term average.
• Rate hikes are slowing, which should be supportive for residential markets, and more importantly, the market is pricing in a rate cut later in the year as the risk of the U.S. going into a recession increases.

The Fund continues to support defensive retailing with more than 15% exposure to convenience retail anchored by supermarkets and essential services, and our overweight exposure to affordable housing such as Stockland Group (SGP), Lifestyle Communities (LIC), and Peet Group (PPC).  These exposures support our strategy to deliver a solid yield of 5% and sustainable earnings growth of 4% to our investors.