Four key takeaways from AREIT reporting season FY24

The 2024 full year results across the AREIT sector confirm many of the themes evident in the half-year results from our wrap in February.

The growing recognition that the next move in interest rates is likely to be down and encouraging operating results is boosting AREIT share prices. The Dexus AREIT Fund has delivered total return of about 9%* over the intervening six-months and 19%* over the last 12 months to 31 August 2024. In comparison, the S&P/ASX AREIT Index returned ~11% and ~25% respectively.

Goodman Group explains much of the disparity. Comprising over a third of the AREIT Index, it has an outsized impact on performance. Over the six months to 31 August 2024, Goodman delivered total returns of 12.2% and 44.5% over the last 12-months.

That is an indication of its true nature. Goodman may be in the AREIT index but it has few of the features for which AREITs are famed, in particular a distribution yield of under 1%. It is a distortion to the index and, at present, a data centre play more akin to NextDC than ordinary AREITs. Income investors should appreciate the unique nature of its risks.

In that context, a 19%* total return for the Dexus AREIT Fund is more than satisfactory. It should not discourage prospective investors, either. Assuming a selective mindset, opportunities remain plentiful as the AREIT recovery has a long way to run. Being closer to the beginning of the recovery rather than the end of it, we’re aiming for high single-digit total returns in the coming years, delivered with manageable risk.

This has started to transpire over the last three-months, with the Dexus AREIT Fund outperforming the index by over 1%*.

Here are the four key takeaways from the recent reporting season:

1. Rates have peaked, AREIT prices are rising. Expect more to come.

Across the world, inflationary pressure is easing. In the U.S., where the labour market is weakening, the rate setting Federal Open Market Committee will meet three times before calendar year end. On 23 August, Federal Reserve chair Jerome Powell said, “the time has come for policy to adjust.” Fixed income markets expect rate reductions at all three meetings.

Whilst the Reserve Bank has yet to commit to rate cuts, expectations of it doing so are widespread. This expectation is already being built into AREIT prices. Back in March, we explained how “commentary on interest rates turned from wondering whether there would be an easing cycle to asking when it would start. This attitudinal change drove the sector’s returns through HY24.”

It has continued to do so. Three-month bank bill swap rate futures suggest the marginal cost of debt is falling to around 5% (all-in). Bond yields suggest a similar outcome.

Source: Jayden

With AREITs outperforming in two of the past three RBA interest rate cutting cycles, there’s a good chance history will repeat. Currently, lower bond yields are not being incorporated into AREIT forecasts. When they are, prices are likely to rise. This remains a time of opportunity.

2. Improving AREIT operational environment

Recent AREIT performance isn’t just about lower rate expectations. The latest reporting season revealed a mixed but improving operational environment.

Aided by technology, including artificial intelligence, and reduced transaction and development activity, corporate costs are falling. Some AREITs also took advantage of favourable interest rate movements to enter into newer, longer-dated hedging contracts. This zero-cost restructuring brings forward elevated future interest costs, creating a lower base on which to build forecast earnings growth. Payout ratios are also lower as excess free cash-flow is being reinvested back into AREIT portfolios. Given the more attractive opportunities on offer, delivering high internal rates of return and relatively elevated cost of financing, this too sets a platform for future outperformance.

Let’s now look at the performance of individual property sectors.

Retail

Generally, results surpassed expectations. Aggregate retail sales are still growing and many retailers are expanding their physical store network as omnichannel retailing becomes a widely adopted strategy.

Discretionary retail spending is being impacted by the rising cost of living, especially among footwear, apparel, homewares and jewellery but occupancy costs remain below pre-pandemic levels. Leasing spreads are also recording positive growth. There remains plenty of room for rental growth.

This especially true for AREIT portfolios, which typically hold higher quality, better performing retail assets than the broader sector. Whilst they cannot escape potential future consumer spending headwinds, they are less exposed to them. 

Source: Macquarie Group

Office

In contrast, the office sector continues to struggle. Tenants continue to take advantage of incentives to upgrade their space requirements and location, the key determinant in demand. The difference between high-quality, well-located assets and non-prime properties is becoming even more pronounced.

Again though, office-exposed AREITs hold the better performing assets. With capital to invest and superior locations, their ability to attract tenants remains powerful. As the chart shows, occupancy might be declining overall, but AREIT properties are suffering far less than overall CBD properties.

Source: Macquarie Group

Given this sector’s performance, previously proposed supply expansion is unlikely to eventuate, especially as much of it does not cater to small and medium-sized enterprises, where tenant demand is concentrated. 

Industrial

Whilst off its former peaks, industrial remains a creditable performer, although vacancy rates are beginning to rise from their all-time lows.

Source: JP Morgan

As with office, a similar bifurcation is now evident. Western and northern Melbourne, along with western Sydney are softer markets but portfolios remain under-rented. For those properties with pending expiries there is still capacity to deliver income growth near-term.

Residential

Whilst performing strongly overall, Victoria, where state policy adjustments have impacted investors in particular, is the exception. Given affordability and demand, land subdivision and land lease are the best performing sectors.

With rising costs, impacting affordability, and lead times, residential building remains challenging. Whilst approvals are in place to cater to demand, overall project feasibility, for developers and purchasers, remains a headwind.

3. Devaluations easing, transaction volumes improving

Improving operating metrics and expected lower rates are already having an impact across the sector. For most property sectors, we expect this calendar year to be the bottom - or close to it - for asset devaluations.

Indeed, transactions are showing signs of life. Demonstrating the value on offer, many acquisitions can now be executed below replacement costs.

Source: JP Morgan

Our on-the-ground research indicates that prospective purchasers are now quite active. If you’re looking to secure outsize returns, now is a good time to invest.

4. AREITs well positioned to deliver high single-digit returns

With rate cuts forecast, supply scarcity and AREIT fundamentals improving, after a long and testing period the market is moving in favour of landlords.

Even shopping centres are enjoying a return to favour. Scentre Group rose 13.4% in the six months to 31 August 2024, Stockland was up 16.2% and Vicinity Centres 17.6%. All significantly outperformed the AREIT 300 Index (+11%) over the six-months and are substantial holdings in the Fund.

Moreover, they are delivering higher distribution yields, at a growth rate higher than inflation. Interest rate falls would add to their tailwinds. All are an example of the kind of low risk, high yield opportunities still available. As ever, though, there are caveats. Deals are still taking longer to close Whilst it’s a generalisation, it is also true that assets in the mining-led states of Queensland, Western Australia and, to a lesser extent, South Australia, are performing better than Victoria and New South Wales. The message is to be selective.

AREITs with existing assets generating rent are better positioned compared to those relying on transactions, developments and fund-raising initiatives to deliver earnings growth. 

Overall, though, despite recent price increase, a careful selection of traditional AREITs still offer significant opportunities. Many are still trading at a discount to net tangible assets/net asset value, with the fund manager cohort and notable exception.

Offering attractive yields, a portfolio of suitably appealing AREITs, as exists within the Dexus AREIT Fund, delivers the realistic possibility of reliable, regular income and high-single digit annual total returns. 

The fear in the sector is only now dissipating. There is still time to get greedy.

^{*Returns after all fees and expenses. Assumes distributions are reinvested. Investors’ tax rates are not taken into account when calculating returns. Returns and values may rise and fall from one period to another. Past performance is not an indicator of future performance. Fund’s inception date used to determine the return.}