SUMMARY
A-REITs delivered a 6.45% return for September, substantially outperforming the broader equities market by 3.38%, as the Fed delivered its first rate cut this cycle. As a comparison, the Fund returned 6.28% for the month, with key contributors including our overweight position in Lifestyle Communities (LIC +7.25%) and underweight to HMC Capital (HMC -7.21%).
Fund Manager Amy Pham and NSW Distribution Manager Chris Boyd recently hosted an interview-style update on the Pengana High Conviction Property Securities Fund. A recording is available below for your review. CPD points are applicable for Australian Financial Planners HERE.
COMMENTARY
As we head into quarterly company updates, we expect the performance of REITs to be largely driven by interest rate expectations. During the month, the larger-than-expected 50 basis point rate cut by the Fed to 4.75 – 5.00% drove AU bond yields to a low of close to 3.81% mid-month. This was tempered by relatively hawkish commentary from the RBA (24 Sep) as it held the cash rate at 4.35% and argued that reining in inflation remained the “highest priority”.
We believe this is an inflection point for REITs in terms of valuation. As rates stabilise, the two sectors to focus on are the beaten up office sector, where property valuations have fallen 21% from the peak 18 months ago, and the industrial sector being the strongest sub-sector delivering a staggering 74% return for the year to September, mainly driven by Goodman Group.
Looking at the office sector, JLL data shows the Sydney CBD office market recorded its strongest quarter of net absorption (space leased minus space vacated) since 2015. The rolling 12-month net absorption in Sydney is now 70,000sqm, in stark contrast to Melbourne (-95,000sqm). The drivers of the strong net absorption in Sydney included withdrawal of sub-lease space, centralisation back to the CBD, large tenants increasing footprints and completion of a small amount of pre-committed developments. We believe it is too early to tell if office fundamentals have turned the corner. As a result, we remain cautious and will monitor fourth quarter data to see if the trend continues.
For the logistics sector, throughout the reporting season we saw signs that conditions on the ground are moderating with reported leasing spreads softening (~34% at June 24) albeit off a high base (>40% at Dec 23). This is consistent with CBRE’s June 2024 logistic data, where average Sydney incentives have lifted to 15% from the recent low of 8%, despite vacancy rates lifting from 0.9% to only 2% over the same period. This data, combined with the anticipated increase in supply in Western Sydney Aerotropolis from CY26 onwards, suggests further softening in leasing spreads in the logistics market.
We are of the view that rental growth in the logistics sector will moderate. However, as vacancy rates remain low at 2% (compared to the equilibrium of 8%) in the near term, we expect sustainable rental growth of 3-4% to be achievable. In addition, we favour landlords who are able to expand into data centre developments at scale, such as Goodman Group, to provide above market earnings growth.
Our preference remains in the alternative sectors such as investments in data centres, childcare, senior living, and real estate private credit. This provides the Fund with diversification away from the core real estate sectors (such as office, retail, and industrials) and is less cyclical as earnings are driven by secular trends. Currently, the Fund has over 21% exposure to the alternative sector compared to the benchmark of 7%.