Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 183

Have A-REIT share prices bottomed out?

Record low bond yields have supported the valuations and profitability of Australian real estate investment trusts (A-REITs) over the past few years. A-REITs outperformed equities in 2014 (26.8% vs 5.3%) and 2015 (14.4% vs 2.8%).

The A-REIT/bonds correlation has been about -0.5% in 2016 (Figure 1), one of the highest on record. As a result, A-REIT prices have been driven down more by bond yield movements than other factors such as the real estate cycle.

Figure 1: 10 Year Bond Yields & A-REIT Total Returns: 12 Months to 31 October 2016

In recent months the yield curve has steepened as markets embrace increased fiscal stimulus from China and Japan and now the US (following Donald Trump’s election victory), and greater expectations of higher global inflation. Australian bond yields have followed, rising from a low of 1.8% in August 2016 to 2.3% at the end of October 2016. Since then, they’ve risen a further 0.40% to 2.7%.

Property trust prices continue to fall

This year, what was looking like another solid period for A-REITs is in danger of evaporating. Since the start of August, the sector has fallen 18.7% and is now down 2.8% YTD, while equity prices are up marginally YTD.

A-REITs aren’t alone. Global listed REITs in the US, UK, Singapore, and Hong Kong are down, while listed infrastructure and utilities equities have also been sold off.

Figure 2 ranks A-REITs in terms of price performance since August 2016. The largest have been hit the hardest – Scentre (SCG down 24.0%), Westfield (WFD down 20.9%), Vicinity (VCX down 20.9%), GPT (GPT down 20.6%) and Stockland (SGP down 20.1%) at time of writing.

In the hunt for yield, these large cap A-REITs have been well supported in recent years by generalist equity funds who have taken advantage of the liquidity they offer to park their money there. It is therefore not surprising that when the herd stampeded towards the exit then switched into more cyclical, growth-oriented stocks, the largest, most liquid A-REITs were hit hard.

Figure 2: A-REIT Price Movements, 1 August to 16 November 2016

With the recent sell-off, the A-REIT dividend yield has risen from 4.2% in July to 5.3%, but there is still a cushion of 260bps relative to the 2.7% 10-yr bond yield, which is above the long-term average of a 196bps spread.

The current yield is based on an average payout ratio of 84%, well below the 100% recorded pre-GFC, not that one wants to see A-REITs go back to those dark old days to boost their distribution yield.

The A-REIT sector is now trading at a price to NTA premium of circa 14%, down from 50% in July. There have been seven periods over the past 25 years when bond yields rose by more than 60 basis points. Figure 3 shows the performance of A-REITs relative to equities in each of these periods.

Figure 3: A-REIT and Equities Performance in Periods of Rising Bond Yields

A-REITs produced positive returns in only one period of rising bond yields (January–November 1994), a period when A-REITs also outperformed equities.

This time round we’ve seen the largest A-REIT sell-off compared with other periods of rising bond yields, despite the fact that bond yields have not risen as much as they did in 1998–2000 and December 2008–July 2009.

The extent of the recent sell-off is not surprising given the level to which bond yields fell and A-REIT prices rose. The dramatic bond sell-off over a short period has affected many yield-sensitive investments, and A-REITs have not been immune.

Will the pendulum swing back?

The question investors need to ask is whether the rapid rise in bonds will continue and A-REIT prices fall further, or has the pendulum swung too far, too quickly?

The A-REIT sector will remain captive to the gyrations of capital markets in the short term. Clearly, if bond yields continue to rise further there could be additional price risk.

However, the recent sell-off in the A-REIT sector has created some attractive buying opportunities. Investors with a longer-term view who can see out the short-term volatility can acquire some of the best real estate in Australia at more attractive prices than they could have three or four months ago.

Overall, A-REITs are in relatively good shape and almost incomparable to those in the lead up to the GFC. Gearing is lower (circa 30%), refinancing risk over the next few years is low (the majority of debt is due to expire in 2021 and beyond), asset quality has significantly improved, payout ratios are respectable and the exposure to offshore real estate is limited (Goodman and Westfield are the two exceptions).

Yet now is not the time to take a passive approach to the sector (i.e. indexing). We expect the variation of performance across the A-REIT universe to widen in the year ahead. Individual characteristics of each A-REIT will be more of a key performance driver than it has been in the past year or so.

Investors need to focus on those A-REITs that have quality management and can generate real value from their portfolios rather than simply relying on lower debt costs to support earnings and firming cap rates (property yields) to drive underlying asset values higher. As Warren Buffet says, “Only when the tide goes out do you discover who’s been swimming naked.”

 

Adrian Harrington is Head of Funds Management at Folkestone Limited (ASX:FLK). Folkestone is a sponsor of Cuffelinks. This article is general information and does not consider the circumstances of any individual.

 


 

Leave a Comment:

RELATED ARTICLES

State of play in listed real estate

The case for active management in A-REITs

A-REITS are looking at M&A activity again

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Shares

Exploiting Warren Buffett

Growth investors are using Buffett to justify buying blue chip stocks at almost any price. It’s a recipe for potential disaster, as investors in market darlings like CBA and Cochlear may be about to find out.

Property

Population density trends and what they mean for housing

With Australia’s population moving through the fastest rate of growth since the 1950s, our cities and towns are naturally densifying. This is a look at the latest trends and how they will impact the property market.

SMSF strategies

The ultimate superannuation EOFY checklist 2024

We're nearing the end of the financial year and it's time for SMSFs and other super funds to make the most of the strategies available to them. Here's a 24-point checklist of the most important issues to address.

Shares

The outlook for Nvidia, from a long-time investor

Nvidia has taken the world by storm and is now the third largest stock on the planet - larger than Meta, Amazon, and Alphabet. Here is the latest take on Nvidia from a fund manager who first invested in the company in 2016.

Economy

Gross National Happiness?

Despite being richer, surveyed measures of happiness have been flat to falling in Australia. Some suggest we should focus less on GDP and more on broader measures of wellbeing, though there are pros and cons to that approach.

Shares

The power of dividends

In an era where growth companies dominate and the likes of Nvidia grab all of the attention, dividend paying stocks are flying under the radar. Some of these stocks offer compelling prospective returns.

Fixed interest

The best opportunities in fixed income right now

After more than a decade of pitiful yields, bonds are back offering better prospects for income investors. What are the best ways to take advantage of the market inefficiencies in Australian fixed income?

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.