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Outlook for A-REITs mixed

Nicki Bourlioufas  |  24 Jul 2017Text size  Decrease  Increase  |  

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Australian property trusts have performed poorly over the last year, with much of the performance related to the dire performance of the retail sector.

 

Looking ahead, and with talk of Amazon coming to local shores, the listed Australian real estate investment trust (A-REIT) sector could continue to struggle, but that may result in some bargains.

The benchmark S&P/ASX 200 A-REIT Index fell by about 10 per cent over the year to 20 July. That compares to the S&P/ASX 200, which is up by about 10 per cent.

The index has been dragged down by the poor performance of retail trusts, though industrial and office are in favour, says Morningstar senior analyst, Tony Sherlock.

"The decline in the share price of the retail REITs reflects a confluence of factors, the most significant being weakening investor sentiment due to slowing sales performance and a lift in the number of retailers in financial distress. There are also heightened concerns about the impact the forthcoming arrival of Amazon will have on incumbent retailers," says Sherlock.

The US online retail giant plans to open a handful of very large shopping warehouses in Australia and many analysts are speculating this could harm local shopping centres.

"A longer-term concern is the marked slowdown in the rate of Australian wages growth, which is now at a 20-year low of 1.9 per cent, and an increase in the proportion of part-time workers in the workforce," says Sherlock.

Along with very high levels of household debt, this has stunted consumer spending, which has hurt the performance many of A-REITs.

The benchmark S&P/ASX 200 A-REIT Index is dominated by retail heavyweights Scentre Group (ASX: SCG), Westfield (ASX: WFD), and Vicinity Centres (ASX: VCX). Westfield was down around 16 per cent over the year to 20 July, Scentre lost around 10 per cent, and Vicinity was down around 12 per cent.

Julia Forrest, co-portfolio manager of BT Investment Management's Australian listed property funds, says the outperformance of the A-REIT sector in recent years has been fed by low interest rates, but that has now reversed alongside a recovery for other shares.

"The listed property sector has lagged the broader share market over the last year as market earnings growth has recovered, particularly for resource stocks," says Forrest.

"At current pricing, the sector offers a solid 4.7 per cent yield with 3 to 4 per cent earnings growth, but I would say that A-REIT prices and asset values are looking a little full relative to our valuations, so further growth beyond these total return expectations of around 8 per cent in the short term may be limited," she says.

However, Forrest sees office space in Sydney as a strong growth area, with returns for retail centres less certain due to the Amazon threat.

"We have been very bullish on Sydney office property for the last two years, although it's really only started to be reflected in A-REIT prices for the last year. We continue to believe the undersupply of A/B office space in Sydney will see strong net effective rental growth until a supply response kicks in around 2020," says Forrest.

She explains that office space has three levels: A, B, and C; with A being the best and brightest, and B the mid-level.

According to Sherlock, on average, the 26 Australian and New Zealand REITs under Morningstar's coverage are 2 per cent overvalued.

"Just Westfield Corporation and Hotel Property Investments (ASX: HPI) [are] rated 4 stars [investment rating], both of which are Best Ideas ... Westfield was put on the Best Ideas list in June as we view the stock as being oversold on concerns around struggling US apparel brands," says Sherlock.

Despite the challenge from online retailers, "Westfield has the option to reallocate space that is currently occupied by struggling fashion brands to alternative uses such as dining and services," he says.

"We see Westfield's retail malls evolving to become de-facto town centres, rich with entertainment, dining, and essential services, but also extended trading hours.

"The combination of an attractive tenant mix and the higher household income of inner-city locations is forecast to result in the sales and rental performance of Westfield's larger centrally located malls outperforming the broader market."

BT's Forrest says the listed property has undergone change and consolidation in recent years. In the lead-up to the GFC there were over 50 listed A-REITs and today that number is down to 30 in the benchmark S&P/ASX 200 A-REIT Index. But the asset base has broadened and diversification opportunities are greater.

"Today we have the opportunity to invest in groups that have investments in residential property assets in addition to well-established operators in retail, office, and industrial property," she says.

"The property universe also includes assets such as childcare centres, storage facilities, petrol stations, retirement living, and even healthcare property assets, so while the number of companies has reduced, the range of assets has expanded."

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

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