WEEKLY E-MAIL

3 October 2022

AUSTRALIAN REAL ESTATE INVESTMENT TRUSTS (A-REITs) – LOOKING THROUGH THE VOLATILITY

By Amelia Paullo

A-REITs are listed investment vehicles that provide exposure to property assets such as office towers, shopping malls, industrial buildings – even hotels and cinemas.

A-REITs enable you to join with other investors to gain access to large-scale commercial property assets that are likely to be out of your reach as an individual. Depending on the A-REIT, they can expose you to a diversified property portfolio or a specialist sector with particular income and growth characteristics.

A-REITs delivered strong results for FY22, with an average of 19% earnings growth. However, for the Calendar Year, A-REITs have underperformed the ASX by almost 20%. The ASX200 A-REIT Index is trading at 14.6 times earnings which is just above its 25-year average. At current market pricing, the A-REIT sector has an estimated dividend yield of 5.9% and earnings growth of 4.6%.

Many investors have been concerned about the recent underperformance of A-REITs compared to the broader market, questioning the volatility of these stocks primarily made up of land and buildings. Rising long-term interest rates are the main factors contributing to the A-REIT sector’s recent underperformance.

When valuing assets, rising interest rates mean that future cash flows are now being discounted at a higher rate than previously, reducing their present-day value. The rising cost of debt also means that higher interest costs may reduce future earnings, particularly for those highly leveraged A-REITs and those exposed to variable interest rates. On the flipside, in this high inflation environment, A-REITs that have inflation indexation built into their leases will be able to pass on most of the inflation to their tenants. Inflation will also erode the real value of their debt over time.

However, not all A-REITs are created equal. Some have more debt. Some have locked in their cost of debt for many years in advance. Some have long leases with low levels of annual escalation, and others have shorter leases with inflation indexation.

There are also the different sectors of commercial real estate that A-REITs have exposure to. For example, Industrial real estate has been a hot commodity recently, with COVID lockdowns leading to an increase in online purchases and companies holding increased inventory which requires more industrial warehouse space. On the other hand, office space has seen an increase in vacancy as employees work from home and some companies require less office space. There has been a divergence in the performance between A grade and B grade office space, where A grade space has maintained occupancy while B grade space and less is suffering more as tenants have more choices and may choose to upgrade.

Retail has bounced back strongly from its COVID lows. Still, there is also a difference in performance between suburban shopping centres, which are doing well, while CBD shopping centres are not doing so well due to fewer workers, tourists and international students. Some retail centres focus more on discretionary spending, and some are less resistant to online shopping.

Lastly, rising interest rates and surging development costs have largely impacted A-REITs’ profitability with exposure to the residential development sector.

Although the A-REITs have sold off considerably since the beginning of the year, with many of them trading at discounts of 30% or more to their net tangible assets, private market valuations of these assets have not moved nearly as much. There is little transactional evidence yet to suggest such broad-based asset value declines. Although some weakening in asset prices is expected to occur, especially in the office sector, which is currently struggling with low utilisation, private market valuations are expected to hold up reasonably well as they have done in previous cycles.

We continue to believe that A-REITs with strong balance sheets, a diverse range of credit-worthy tenants and leases with good escalation built into them will be able to weather the storm while providing unit holders with a steady and growing stream of income.

Amelia Paullo
Financial Planner
Authorised Representative No. 1243426

If you have any questions or comments, please email me at amelia@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution.  The information here is of a generic nature, and does not take into account your investment objectives or financial needs.  No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

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