Quarterly operating updates shows resilience in earnings

The real estate sector is significantly undervalued after a sell off in September (-8.6%) and October (-5.8%) triggered by fears of higher bond yields putting more pressure on valuations and cost of capital.

Whilst further downside risk is possible, particularly for highly geared REITs, we see plenty of opportunities for investments in high-quality names with more favourable outlooks.

For the month of October, the Fund returned -4.7% outperforming the benchmark by 1.0%.  This was attributed to our clear strategy to be underweight office and our significant exposure to non-index stocks.

Top Holdings (alphabetically)

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.

NEXTDC Ltd

Australia

Information Technology

NEXTDC Ltd. develops data centers. The Company develops and operates carrier and systems integrator neutral data centers in Australia. NEXTDC's customers will also be able to use the data centers as connectivity and content hubs.

RAM Essential Services Propert

Australia

Real Estate

RAM Essential Services Property Fund operates as an investment management firm. The Company focuses on medical and neighbourhood convenience properties. RAM Essential Services serves customers in Australia.

Scentre Group

Australia

Real Estate

Scentre Group Limited owns and operates pre-eminent living centre. The Company specializes in the management, development, construction, leasing, and retail solutions. Scentre Group serves customers in Australia.

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 real estate sector is significantly undervalued after a sell off in September (-8.6%) and October (-5.8%) triggered by fears of higher bond yields putting more pressure on valuations and cost of capital.

Whilst further downside risk is possible, particularly for highly geared REITs, we see plenty of opportunities for investments in high-quality names with more favourable outlooks.

For the month of October, the Fund returned -4.7% outperforming the benchmark by 1.0%.  This was attributed to our clear strategy to be underweight office and our large exposure to non-index stocks.

In the recent quarterly company updates, a majority of REITs have maintained FY23 earnings guidance.  At a sub-sector level, office is still doing it tough. Dexus Group (DXS) reported that its office portfolio occupancy fell to 94.7%, which is the lowest point since 2014, whilst incentive levels have improved slightly from 30% to 28%.  Residential developers such as Mirvac (MGR) and Stockland (SGP) reported softer settlement volumes, whilst a modest recovery in presales provided a degree of confidence in reaching their FY24 guidance. Vicinity’s (VCX) update showed operating metrics are holding up and the consumer is more resilient than feared with strong leasing spreads of +4.5% boosted by sales in luxury (+6.3%) and a recovery in CBD sales growth (+7.2%).

So where to from here?

As it stands, the REIT sector is trading at a 28% discount to fresh NTAs with several trading at or below 40% discounts.  We believe the only way to close this gap is through earnings growth and strengthening balance sheets in order to take advantage of market dislocations.  Logistics and large retail malls have the best operating conditions to grow earnings with high occupancies (99%), high barriers to entry (lack of availability of land, long planning approval times, and high cost of new construction), and strong population growth providing a favourable macro backdrop for sustainable rental growth.

Another theme that is emerging in the sector is the sale of non-core assets to strengthen balance sheets.  This not only sets the REITs up for the next growth phase but also prevents highly dilutive capital raisings as we saw during the GFC and COVID.  In Goodman Group’s (GMG) market update, they highlighted that the best use of their capital is not only through developments but to acquire assets at below replacement costs in certain markets where there are more motivated sellers looking to reduce debt.  GMG has the strongest balance sheet in the sector with gearing of only 8% and available liquidity of $17bn (across the Partnership platforms).

Our differentiated strategy to look for opportunities outside the benchmark, particularly in alternative assets that are driven by secular trends, has protected the portfolio during times of volatility.  As the market recovers, our holdings in high quality REITs with strong balance sheets, such as Goodman Group (GMG) and Stockland Group (SGP), with the capacity to take advantage of opportunities to grow earnings through acquisitions and developments, are well placed to set themselves up for the next growth phase.