Delivering one of the highest positive earnings revisions this reporting season, the case for Australian Real Estate Investment Trusts (AREITs) was once again made with conviction. Offering yield, growth and value, AREITs are positioned to continue to outperform.

About 70% of of AREITs¹ upgraded their earnings guidance, a result of strong rental growth, lower financing costs and disciplined capital management. Across all listed sectors, AREITs delivered one of the highest positive earnings revisions of the season. The market response was predictably enthusiastic. The S&P/ASX300 AREIT sector rose 4.4% in August, outperforming the S&P/ASX 300, which was up 3.2%.

We expect the recovery to gather pace. With the widening of payout ratios between earnings and distributions, excess capital is being reinvested into a growing pool of attractive investment opportunities. This should lead to further earnings growth and higher future distributions. AREITs aren’t just back; they’re powering ahead.

Here are the sector highlights.  

Retail

Led by malls, retail AREITs outperformed. Minimal vacancies and unmet demand for larger, higher-quality space drove positive leasing spreads. On the supply side, Vicinity Centres and Scentre Group reported how tenants were increasing their space requirements and still paying a higher rate per sqm.

Consumer demand was equally encouraging. Across all geographies and most categories retail sales strengthened after the May interest rate cut. Enjoying historically low debt levels and with consumer spending powering the recent increase in quarterly GDP growth, tenants are well-positioned for growth.  

With supply still constrained and consumers finally opening their wallets after a difficult few years, we expect good rental growth and higher valuations.

Office

The post-Covid investment theme remains as true today as it was a few years ago. Selection is paramount. Office, more than any other asset class, shows the greatest bifurcation of performance based on a property’s quality, age, location and size. Quality is key.

This explains why institutional capital is targeting Sydney core premium properties despite Brisbane offering the best immediate prospective returns, where vacancy rates are less than 10%. The sector’s ongoing issues are best reflected in elevated tenant incentives and fit-out costs. Currently, office rents are not at the point where they will induce additional supply. 

Industrial

While forecast returns have moderated from former peak levels, underlying demand for efficient and well-located logistics and e-commerce-enabled space persists. The result is that industrial assets continue to attract all forms of capital.

Under-renting—where current rent is below market rent—is reducing but remains a tailwind. At Centuria Industrial, for example, under-renting is at about 20%. Land costs remain relatively high, not helped by data centres competing for sites, especially those with existing utility connections, but selective development continues where the economics are compelling.

In short, returns in the industrial sector are normalising but the structural growth tailwind is still blowing, this time being driven by data centres rather than the e-commerce boom of Covid.

Residential

Despite the political push for more built-form apartments, detached house and land subdivisions are getting more traction due lower construction costs and shorter lead times. NIMBYs are more easily avoided when you’re developing land without nearby residents.

The long-term issues aren’t going away, either. Policy incentives like stamp duty relief, first-home buyer schemes and infrastructure grants are designed to bring new demand to market while continued population growth adds to it. As a result, older landbanks now in production are benefiting from price inflation, with flexibility to activate mixed-use components.

South-East Queensland is the standout market and is expected to remain so through to the 2032 Olympics. Victoria is recovering as is Western Australia, while South Australia and New South Wales remain solid.

Delivering affordable product from a low supply starting point, land lease is becoming increasingly popular, delivering a government-supported and growing rental stream to landlords. More AREITs are increasing their investment into residential development as a result².

Alternatives

From childcare and healthcare to self-storage and service stations, the fundamental backdrop remains sound. Dynamic pricing in self-storage, for example, is delivering increased net absorption and rental growth³.

Private credit is starting to suffer, with more capital chasing lending deals. This is leading to some bad loans being written, with the covenants not reflecting the risks. Therefore, according to Centuria Capital, property fund returns looking more attractive.   

All up, with earnings upgrades, constrained supply leading to rental escalation and lower debt costs underwriting future earnings growth, AREIT investors are well-placed. There are however, a few, less well-known, factors in their favour.

First, the proposed RG97 amendments should allow domestic superannuation funds to increase their exposure to direct property. Through their funds management platforms, AREITs will become more accessible while the trend to being ‘capital-light’ will accelerate the move into funds management. Both are positive for the sector.

Second, institutional investors remain underweight property but, after a strong run in equities, are paying more attention to the sector. Offshore capital also views Australia as attractive and is more focused on performance, versus fee savings. We expect asset allocation to the AREIT sector to steadily increase.

Finally, with lower funding costs and most AREITs still trading below their Net Tangible Asset value, this sets the stage for increased mergers and acquisition activity. This is already a feature of overseas REIT markets and we fully expect that pattern to be repeated here. 

The dog days of the post-Covid slump are well and truly behind us. With income resilience built on long leases, diversified tenant bases and embedded rent escalations in higher-quality, well-located assets, AREIT investors have much to look forward to, and not just in terms of distributions.

Supported by attractive absolute value, rental growth and, potentially, further capitalisation rate compression through lower bond yields, the potential for capital growth in the months and years ahead is icing on the cake. 

Together, we expect many AREITs to deliver low double-digit forecast returns in the years ahead.

The satisfying results from the AREIT sector this reporting season may just be the start.