Silver lining for property stocks amid uncertain outlook for rates

Prospects for earnings growth from listed property stocks this year remain remarkably rosy despite a volatile outlook for interest rates hanging over a sector which is particularly sensitive to the price of money, according to analysts and fund managers.

Expectations on interest rates took a suddenly hawkish turn late last year after Reserve Bank of Australia governor Michele Bullock surprised the market by flagging an increase was possible if inflation could not be contained.

With previous hopes for a series of cuts this year dashed, many economists are anticipating hikes instead. Robust employment figures on Thursday have further underlined the case for an interest rate hike.

The listed property sector – real estate investment trusts – is particularly exposed to rates in several ways. Bond yields – a critical pricing metric in the REIT sector – can rise when interest rates rise. That in turn can weigh on the pricing of commercial property portfolios. As well, rising rates can dampen demand for all forms of real estate.

Most sensitive of all is housing, given that home buyers may become more reluctant acquirers as the cost of borrowing rises. That view led to a sharp sell-off in some of the big listed residential players, such as Mirvac and Stockland, when the rates outlook turned.

“Rate markets have been volatile and rate-sensitive resi names have underperformed, though the hurdle for a rate hike remains high,” Jarden analyst Tom Bodor wrote this month in a preview of the earnings season.

But, on the brighter side, Bodor noted that the hawkish view on rates is now factored into the pricing of Stockland and Mirvac as well as other listed housing providers in the land lease sector.

“We are increasingly bullish on residential names given recent underperformance, structural undersupply, government policy support, pipeline restocking measures and strong volume momentum,” he wrote.

That’s a view that is also shared by other analysts and fund managers, including Anna Milne, deputy portfolio manager at Wilson Asset Management. Anticipating the prospect of rate increases, Milne and her colleagues moved early to reduce their overweight position in the REITs last year.

As a result, that has given Milne the scope to buy back in selectively noting, like Bodor, that stocks such as Mirvac – which is a major player in apartment development – had been “sold off too aggressively” as the interest rate outlook switched.

“Clearly, the REIT sector is very highly correlated as a bit of a bond proxy and is therefore impacted by any changes in the long end of the curve,” Milne said.

“Looking forward into 2026, the REITs might be slightly on the nose, but I believe this will be outweighed by the positive fundamental story that we see in the REIT sector.

“Where there might be slightly anaemic returns in other sectors of the market, where they might be struggling for earnings growth and dividends. REITs really are a great tool to have – when you want reliable returns, you want strong asset backing and you want this positive earnings growth story coming through too.”

Along with the upside in residential developers, Milne believes that “money can be made” in global logistics giant Goodman as it executes on a pipeline of projects and partnerships in its ambitious global roll-out of data centres. Just before Christmas Goodman announced it had struck a $14 billion partnership with a Canadian pension fund giant to develop four data centres.

“It’s a waiting game for Goodman Group, but one that we think we’ll be rewarded in,” Milne said.

In Milne’s view, the big listed retail landlords, such as Westfield owner Scentre and Vicinity, players are now fully priced in – a view seconded by Jarden’s Bodor, who advises: “Consider funding resi from malls where, despite sound fundamentals, the positive theme has played out”.

Pengana Capital portfolio manager Amy Pham argues that the REIT sector’s much-discussed sensitivity to interest rate movements can be overestimated, especially since the sector reduced historically higher levels of gearing to be in line with the broader equities market. As well, many REITs took advantage of lower rates last year to hedge their debt and extend maturities, reducing their exposure to any rise in borrowing costs.

Having “locked in” their obligations, many REITs can also count their earnings growth with “high visibility”, where their revenue derives from rents that include contracted increases, such as shopping centre owners, said Pham.

“We certainly don’t invest based on whether there’s going to be a rate cut or rate hike. That’s not how we invest. We invest through the cycle, and we look at the fundamentals. Where’s the gearing at, where’s the visibility of earnings? What is the economy doing to generate our valuation?” she said.

Like others, Pham sees growth coming in data centres where demand is outstripping supply, and she is also positive on retail landlords for a similar reason, given the supply of new retail space is scarce, yet consumer demand rises as the population grows. She is selective in the residential sector, especially as affordability bites – but that can make land lease operators such as GemLife which provide budget housing more appealing.

Read the original AFR Article HERE. 

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