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Top-returning Aussie property stocks of 2019

Glenn Freeman  |  03 Jan 2020Text size  Decrease  Increase  |  
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Real estate investment trusts Mirvac and Stockland were among the top-performing listed property stocks of 2019, delivering returns as high as 50 per cent.

The popularity of A-REITs tends to peak when interest rates are low and share markets are volatile – which sums up the current environment for local investors.

Australia's official cash rate of 0.75 per cent is its lowest on record. And many industry commentators concede the equity market's unprecedented rise – in July the ASX 200 surpassed its previous record high of November 2007 – is unlikely to continue in 2020.

Morningstar's head of equity research Peter Warnes said as much last month in his 2020 forecast: "It's going to be difficult to replicate what you've seen in 2019".

And AMP Capital chief economist Shane Oliver in late December tipped another Reserve Bank of Australia interest rate cut in February, amid a weaker revenue outlook both in Australia and globally.

A-REITs are widely held to respond most markedly to changes in interest rates, and for a couple of reasons.

Because loan repayments are usually the largest business expense for companies, low rates reduce the expense of servicing that debt. All else being equal, this can lead to an increase in profits and greater demand for shares, which tends to push share prices higher.

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Property trusts and utilities are particularly sensitive to changes in interest rates, because investors usually seek them out for their yield potential. If rates are expected to decline, dividend-yield stocks such as those held by property securities may become more attractive compared to other interest-bearing account options.

Looking back over 2019, the following A-REITs stand out as the top performers among the 20 listed property stocks for which Morningstar Australia provides research coverage.

It's no coincidence that some of the top-performing REITs – listed below – also rank among the highest dividend payers of the year. This is because Morningstar's total return calculation for stocks assumes all income and capital-gains distributions are reinvested.

Market too bullish on Mirvac

Mirvac delivered a total return of 47 per cent for the year 2019.

Known predominantly for its residential developments, the majority of Mirvac's earnings growth actually comes from its portfolio of office and retail assets.

Rent from office buildings comprises around 60 per cent of earnings, retail contributes 30 per cent and industrial 8 per cent. Office stock is primarily in Australia's major cities.
Retail assets are spread across sub-regional and central business districts. Mirvac is increasing its retail focus on urban areas entertainment and food, and shifting away from department stores, jewellery and homewares as the outlook for consumer spending remains weak.

"Even so, we believe the growth rate for rents will slow from approximately 5 per cent to about 3 per cent during the next five years, as household balance sheets have become stretched and the Australian economic growth outlook appears anaemic," says Morningstar senior equity analyst Adrian Atkins.

Mirvac's residential development arm is the key differentiator from other A-REITs, and the low interest rate environment underpins the most positive scenarios for the company. This is because low rates support high residential sales volumes and margins, and also help maintain margins on Mirvac's office development pipeline.

But Atkins believes the market is overly optimistic about the office and industrial sectors, which he believes could become headwinds instead of tailwinds.

"We don’t predict doomsday, but compared with the current boom-time conditions, we forecast that the group’s commercial property portfolio will deliver a more pedestrian rental growth rate of between 2.2 and 3.3 per cent for much of the next decade," he says.

This largely explains the lack of an economic moat, along with Atkins' belief that Mirvac's property development operations have limited competitive advantage and are highly volatile.
With a Morningstar fair value estimate of $2.50, Mirvac's share price of $3.19 at today's market open sees it 28 per cent overvalued.

Stockland surges on rates sugar hit

Narrow-moat Stockland delivered a total return of 39.6 per cent over the course of 2019. Its share price grew from $3.47 at the start of January 2019 to end the year at $4.65.

The property conglomerate generates about 60 per cent of its earnings from commercial property of retail, office and industrial assets. Residential and retirement living make up the balance.

Morningstar director of equity research Mathew Hodge says the residential division performed slightly better than expected for the year, "due to a sugar hit from lower interest rates, relaxed lending restrictions from APRA, and a decisive federal election result."

But he doesn't see this extending beyond fiscal 2020.

"An underlying housing shortage and strong population growth should see Stockland’s housing sales bottom in the next few years before growing, but not at the breakneck pace we saw up to 2018."

Stockland's last closing price of $4.65 sees it trading at a 19 per cent premium to Morningstar's fair value estimate of $3.90.

Party almost over for Charter Hall

Charter Hall Group delivered a total return of 54 per cent in 2019, its share price ending the year at $11.27 up from $7.41 at the start of January.

Charter Hall is a property fund manager and developer with assets primarily in Australia.
Morningstar senior equity analyst Gareth James last month upgraded his 2020 earnings forecast for narrow-moat Charter Hall, in line with an update from the company's management.

"We had already upgraded our fair value estimate by 9 per cent in August 2019, as we increased our medium-term outlook for the size of the group’s asset book," James says.

"But we maintain the view that the eventual arrival of supply in the currently hot office and industrial property sectors will end the party."

He expects Charter Hall’s asset book and revenue to continue rising for the next three years, but expects this to slow in the mid-2020s as asset prices fall on increasing supply.

Having closed at $11.14 on Thursday afternoon, Charter Hall's is currently more than 50 per cent above Morningstar's fair value estimate of $7.40.

Good but not great long-term outlook

Goodman Group delivered a total return of 28.4 per cent in 2019, its share price growing to $13.55 at the end of December 2019, from $10.75 at the start of January.

Goodman is a vertically integrated company that generates income from renting property assets, industrial property development and property funds management.

Regarded by Morningstar as holding a narrow moat, the company's competitive advantage in development stems from its extensive relationships with global third-party logistics providers and larger retailers and local-market knowledge.

"With an outlook for yields on long-term sovereign debt to remain low for at least the next three years, we expect strong institutional demand for Goodman's developments," says Morningstar director of equity research, Johannes Faul.

While this bodes well for the development pipeline and growth in assets under management, Faul views global economic contraction as a key risk over the medium-term. This would reduce demand for industrial property, and would affect the outlook for development projects and rental growth.

Goodman's share price of $13.44 at the market close on Thursday was 9 per cent above Morningstar's current fair value estimate of $12.30.

Cromwell rides the cycle

Finally, Cromwell Property Group delivered a total return of 28.46 per cent in 2019. Its share price was $1.16 at the end of 2019, from 99 cents at the start of January.

Cromwell is a property owner, developer and investor, with more than half of its revenue drawn from directly held Australian property. Some 85 per cent of this comprises office buildings, and industrial, healthcare and mixed-use sites make up the balance.

Morningstar equity analyst Alexander Prineas says Cromwell has "ridden the cycle well". He says it has benefitted from compressed interest rates, a shortage of supply in core CBD markets and an "unquenchable thirst for property assets from pension funds, sovereign wealth and private equity."

But he still thinks the good times will fade.

He says new supply of office buildings in central business districts in Melbourne and Sydney could see a decline of recent strong rental growth.

"Rents in some CBD locations rose more than 50 per cent over the five years to the end of fiscal 2019," Prineas says.

"A more realistic expectation is for rents to track inflation, with an additional scarcity premium for the best assets as population growth and infill development pushes properties to a higher use."

He notes that Cromwell's assets are often located on CBD fringes and suburbs rather than in prime positions – which largely explains the lack of an economic moat.

"We forecast decent 3 per cent rental growth on new leases in fiscal 2020, slowing to 2.5 per cent until 2022 before supply causes rents to fall," Prineas says.

"We then expect a period of flat rental growth as landlords in secondary locations fight to retain tenants from moving to new CBD developments."

Having closed trading on Thursday at $1.16, Cromwell is currently trading 11 per cent above Morningstar's $1.05 fair value estimate.

is senior editor for Morningstar Australia

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