\n-Mixed views on outlook for residential A-REITs
\n-Industrial\/office remain most in demand<\/strong>
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By Eva Brocklehurst<\/p>\n
They may be underperforming the rest of the market but Australian Real Estate Investment Trusts (A-REITs) have begun 2020 strongly, adding 6% in the first few weeks.<\/p>\n
Official rate cuts anticipated in 2020 – JPMorgan economists forecast two – should drive further compression in required returns. Moreover, the broker suggests considerable acquisition capacity exists in many cases and the cost of capital remains competitive.<\/p>\n
As global growth accelerates, Macquarie anticipates yields on 10-year bonds will increase to 2.5% in the US and 1.9% domestically over 2020. This is, in isolation, a negative for the A-REITs sector, given the negative correlation historically.<\/p>\n
Nevertheless, the broker assesses yields under 2% domestically are still positive for A-REITs, and in this environment the fundamentals of the specific stock will come into greater focus.<\/p>\n
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Hence, a combination of earnings revisions, cash flow certainty, asset growth and sub-sector performance will be key to deriving returns from the sector, which is screening value, albeit skewed by retail A-REITs.<\/p>\n
Half the sector sits in the retail segment, the broker points out, which warrants a higher yield or lower multiple, given structural headwinds continue<\/strong>. This will impact earnings and distributions in the medium term.<\/p>\n While Macquarie considers it too early to make a call on retail conditions, offshore retail property experience indicates the grocery-anchored malls have historically outperformed discretionary malls.<\/p>\n The broker has upgraded Charter Hall Retail<\/strong> ((CQR)) to Outperform from Underperform and Shopping Centres Australasia<\/strong> ((SCP)) to Neutral from Underperform.<\/p>\n Over 2019 A-REITs as a group returned 19.4%, Macquarie calculates, below the markets 23.4% and, as Australian 10-year bond yields fell post August, any earlier outperformance by A-REITs was more than reversed in subsequent months.<\/p>\n However, there were a wide range of returns, JPMorgan points out, from 55% for Charter Hall<\/strong> ((CHC)) to 2% for retail laggards such as Vicinity Centres <\/strong>((VCX)) and Charter Hall Retail. The broker agrees stock selection will be most important in 2020 highlighting a preference, in fund management A-REITs, for Charter Hall over Goodman Group<\/strong> ((GMG)).<\/p>\n Residential<\/u><\/p>\n Macquarie's preferred segment is residential, given a supportive regulatory backdrop, low mortgage rates and favourable demand\/supply dynamics. The broker prefers Mirvac<\/strong> ((MGR)), rated Outperform, in this area. Improving markets in residential along with earnings upside from the proceeds of the equity raising are expected to support a re-rating of the stock in the short to medium term.<\/p>\n In contrast, a more demanding valuation for Stockland<\/strong> ((SGP)) is already pricing in future residential upside, while there is downside risk to the company's retail book, which is 45% of capital. Hence, Macquarie has an Underperform rating.<\/p>\n Citi finds the residential business, as with retail, has been over-earning and there are a range of impediments weighing on the growth outlook, particularly for Stockland. While a residential recovery may be underway, a record FY19 is being cycled.<\/p>\n Stockland's residential earnings are expected to decline over the next two years as a result of the cycling of peak earnings, and despite the large fall in house prices. Citi maintains a Sell rating on Stockland. In contrast, Goldman Sachs notes the stock still offers a 4% 12-month total return at current pricing and maintains a Buy rating.<\/p>\n Office<\/u><\/p>\n Office rents are expected to remain subdued because of increasing vacancy rates in most markets, although asset value should underpin returns and Macquarie upgrades Dexus Property<\/strong> ((DXS)) to Outperform. Charter Hall Long WALE REIT<\/strong> ((CLW)) is also upgraded, to Neutral.<\/p>\n JPMorgan prefers Dexus Property over GPT<\/strong> ((GPT)) in the office\/diversified A-REITs segment, highlighting the varied growth rates in industrial rents, ranging from 1% to 5%.<\/p>\n This remains the asset class most in demand from institutional investors as Goldman Sachs notes many are of the view that a further tightening of return hurdle rates over the next 12 months will drive valuation upside and, in turn, lift asset values.<\/p>\n This may even result in increased M&A activity as some asset-heavy A-REITs are taken private. Yet the offset will be the adoption of more realistic long-term rental assumptions, resulting in minimal net valuation moves.<\/p>\n In explanation, the broker points out that prime western Sydney and Melbourne logistics rental growth has failed to match inflation over the last 10, 20 or 30-year periods. Hence, there is doubt about the current rental growth of 2% per annum factored into valuations and whether it will be sustained over the next decade.<\/p>\n Goldman Sachs has upgraded Goodman Group to Neutral, assessing the stock is now fairly priced after a -4% decline over recent months. Charter Hall Social Infrastructure<\/strong> ((CQE)) is upgraded to Buy from Neutral.<\/p>\n The broker believes the weakness in the latter's share price has been driven by management changes and a potential change in strategy away from childcare. Although this is likely to remain a core holding in the portfolio, Goldman Sachs expects earnings growth will come through external opportunities including non-childcare acquisitions.<\/p>\n Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)<\/a>" – Warning this story contains unashamedly positive feedback on the service provided.<\/em><\/p>\n