2023 brings renewed optimism for REITs

2023 brings new optimism into the REIT sector with a slowing of cash rate hikes as inflation moderates, along with potentially the start of a cash rate easing cycle later in the year. As a result, REITs bounced strongly in January up +8.1%, outperforming the broader market by 2% and reversing some of the underperformance from 2022. In comparison, the Fund returned +7.3% with our investments in Real Estate Fund Managers contributing the most to performance (Charter Hall Group (CHC +14.9%) and Centuria Group (CNI +9.4%)) whilst our holdings in HealthCo Healthcare and Wellness REIT (HCW -5.8%) and Arena REIT (ARF -2.6%) 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.

Qualitas Ltd

Australia

Real Estate

Qualitas Limited operates as a real estate investment management firm. The Company specializes in real estate investment, private equity, investment management, superannuation, risk management, and refinance solutions. Qualitas serves customers worldwide.

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.

As we head into the reporting season, key areas of focus for our team are:

1. Capital management – With the rising cost of debt, we remain focused on how companies manage their balance sheets and hedging profiles. Well capitalised companies should be able to take advantage of the expected decline in asset values through acquisitions, be less impacted by rising interest expenses and continue to grow their development pipeline. As a result, we favour Real Estate Fund Managers with lower cost of capital and REITs that can recycle capital through selling non-core assets to strengthen their balance sheet or re-deploy into their development pipelines.
2. Asset valuations – We expect asset values to correct in the order of 13% from their peaks, as investors’ required returns have risen from around 6.50% at the start of 2022 to 7.25% today due to the rising cost of debt. The sub-sector with the highest downside risk in our view is office. The growth outlook for the sector remains weak with the challenges of the WFH (work from home) thematic still playing out, combined with high vacancies and incentive levels holding back net property income.
3. Sustainable earnings – We expect most REITs to reaffirm their FY23 earnings guidance. With the macro concerns now well understood, we expect medium-term outperformance to be driven by sustainable growth strategies. This means that management will have to demonstrate that they are best of breed in their selected asset classes and position the portfolio to benefit when the interest rate cycle turns.
4. Residential sector – The sector has been faced with a challenging year of i) rising cash rates that are still to affect a large portion of borrowers on fixed-rate mortgages; ii) declining affordability; and iii) construction cost inflation. We believe that a portion of the residential downturn has been played out through the second half of 2022. Looking ahead, a number of factors bode well for a recovery of residential REITs including 1) introduction of First Home Buyers Choice to make home ownership more affordable; 2) return of immigration to pre-COVID levels; 3) low vacancy rates; and 4) the RBA potentially cutting rates in late 2023.

When we combine the above factors, the Fund continues to focus on defensive exposures in the current environment, together with select positions in REITs that provide growth upside. We favour REITs with exposure to convenience retailers and the alternative sectors such as retirement living, childcare, healthcare and data centres for its sustainable earnings. Our exposure to logistics, Real Estate Fund Managers and residential REITs provide upside in terms of valuation and earnings growth.