The 2018 financial year, like the previous few years, turned out to be a security picker’s market in the listed property, or A-REIT, sector. Performance varied across the 31 stocks in the S&P/ASX300 A-REIT Index, ranging from Propertylink up 34.4% to Stockland Group down 3.6%.
Even within sectors, the performance variation was wide. Among the retail A-REITs, SCA Property Group took line honors with a total return of 18.4% while Aventus, the specialist large format retail centre owner, underperformed with a total return of just 4.7%. It was a similar story in the office A-REITs, GDI Property Group returned 33.8%, while Dexus returned just 7.5%. Among the diversified A-REITs, Abacus returned 25.5% and Stockland negative 3.6%.
Overall, the S&P/ASX300 A-REIT Accumulation Index finished FY18 on a high, returning 13.2%, in line with the broader equities market, with the last three months delivering a strong return of 9.8%. The strength in the A-REIT sector coincided with rising concerns of an escalation in a trade war between United States and China, political tensions in Europe, a pullback in US bond yields and the flattening of the Australian yield curve.
Office and industrial up, residential steady
In the current reporting season, valuations are up and earnings guidance ranges have narrowed towards the upper end supported by solid rental growth across most office and industrial markets. Notwithstanding the broader market concern about the weakening residential sector, strong settlements were recorded across the Stockland, Mirvac and Ingenia residential portfolios.
Darren Steinberg, CEO of Dexus, was on the money when he recently said:
“It is pleasing to see higher market rents being reflected in our latest round of valuations across many of our assets. In addition, valuers have taken into account recent transactions where there has been no softening in the underlying investment demand for good quality office and industrial properties which continue to attract a variety of domestic and offshore buyers.”
Looking ahead, we expect corporate activity to remain elevated reflecting many A-REITs’ inability to acquire assets in the direct market at reasonable prices. Finding bargains is next to impossible at this point in the cycle, and to grow, A-REITs are now looking to M&A. And we’ve seen this play before. Back in 1999-2000 and again in 2006-2007, M&As became defining factors in a relative hot property market.
Also, the lower Australian dollar is making the valuations of A-REITs increasingly attractive to foreign acquirers (note the Unibail-Rodamco acquisition of Westfield Group, Blackstone’s bid for Investa Office Fund, and Brookfield and Hometown’s fight for Gateway Lifestyle).
A-REITs trading at the smallest premiums or discounts to NTA will be most prone to being merged or taken private.
Overall, we expect the A-REIT sector to deliver relatively attractive returns given the continued low domestic interest rate environment. The two wildcards are the impact of more M&A activity and A-REITs, like interest rate sensitive sectors, being susceptible in the short term, to any major sell-off in global bond markets.
A-REITs owned by asset allocators
Unfortunately, short-term volatility is now a permanent feature of the A-REIT market. With more of the A-REITs being owned by general equity funds, hedge funds and global investors, the sector is more susceptible to the gyrations of these investors, who move in and out of the sector, at a whim. In January and February 2018, the A-REIT sector returned negative 3.2% and negative 3.3% respectively, as concerns about rising global inflation pushed global bond yields higher. Fast forward to May and June, when concerns about rising bond yields abated, the A-REIT sector rallied, with returns of 3.0% in May and 2.3% in June.
In such an environment, as an active manager that doesn’t follow the weighting of each A-REIT security in the Index, we favour those stocks with exposure to the social infrastructure and specialised property sub-sectors, selected real estate developers and managers that have growing funds management platforms. We also like securities with quality management and relatively attractive yields that have the ability to actively manage their portfolios to drive income growth. Not all A-REITs will perform the same.
Winston Sammat is the Managing Director of the Folkestone Maxim A-REIT Securities Fund. Folkestone is a sponsor of Cuffelinks.
For more articles and papers from Folkestone, please click here.