With increased volatility caused by geopolitical tensions and rising oil prices, defensive sectors such as REITs are starting to look attractive again.
A-REITs have been sold off as much as -8% year to date compared to the broader market of -5%, on the back of an anticipated aggressive rate hike cycle. The market is expecting the official cash rate to rise to over 2% by the end of 2023 from current levels of 0.10%. Our views depart from consensus in that we believe inflation is more transitory due to supply chain bottlenecks and labour shortages, which will dissipate as the economy recovers from the pandemic. All the disinflationary forces prevalent in the past decade remain – aging population, technology and globalisation.
We believe that interest rates will rise from these very low levels, but the amount and timing will be fewer and further apart, thereby supporting further investor interest in the oversold A-REIT sector.
Key takeaways from the last reporting season include:
- Valuations remain strong, particularly for industrial, self-storage and convenient retail. For discretionary retail and the office sector, valuations are bottoming out and improving. The sector is trading at an 8% discount to NTA (excluding fund managers such as Goodman Group (GMG), Charter Hall Group (CHC) and Centuria Capital Group (CNI)).
- Growing expectations of rising rental collections and improved visibility of earnings, particularly for retail REITs given the end of the rental code of conduct in NSW and VIC.
- Strong balance sheets, with the sector’s average gearing of 27% further supporting growth through acquisitions and developments.
- An improving economic back drop of record low unemployment, rising business and consumer confidence, supporting commercial property market fundamentals, lowering vacancy and fewer rental abatements.
- Strong earnings forecasts of over 20% for FY22 as retail rebounds from the COVID drag and fund managers such as GMG, CHC and CNI continue to upgrade earnings.
We continue to support REITs with positive free cashflow and a strong balance sheet to provide earnings growth through acquisitions and developments. The portfolio is also leveraged to long term secular trends with over 20% exposure to healthcare, retirement living, data centres, manufactured homes estates and childcare centres, all of which offer diversification and more sustainable earnings growth.
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