Julia Forrest: Retail and industrial lead the way in A-REIT sector

Recent results from the listed property sector show shopping malls are enjoying robust trading conditions, says Pendal’s JULIA FORREST

• Retail remains robust
• Normalisation of returns ahead
• Find out about Pendal Property Securities Fund

A SURPRISING rebound for shopping malls was the standout feature of this year’s real estate investment trust reporting season, says Pendal’s Julia Forrest.

Rising interest rates and the expiration of interest hedges meant earnings declined for many Australian REITs, surprising investors in a sector where performance is typically well-flagged.

“It was quite a strange reporting season for A-REITs because there were some really outsized moves in response to results which is very unusual,” says Forrest, who co-manages Pendal’s property trust portfolios.

“But the positive surprise was in shopping malls where operating metrics improved.

“Occupancy is pushing towards completely occupied — that’s a long way from where we were two or three years ago.

“There’s genuine demand by tenants for more space and for better space and there’s been no supply for four or five years so you’re seeing competitive tension between tenants.”

Positive leasing spreads

Forrest says the return of positive leasing spreads — where the rent charged for new leases is higher than the rent charged for expiring leases in the same property — has also surprised.

“Scentre Group, which has all the Westfield malls, has not reported positive leasing spreads since 2011. Nobody expected this change.”

This is a positive sign for property owners as it indicates an increase in demand for their property and allows them to generate higher income from the property.

It is also an indicator of a strong rental market and a competitive environment for tenants.

Forrest says several factors are driving this change.

A rising population and wages growth has sent overall retail sales 15 per cent above 2019 levels.

Alongside that is a lack of supply — for nearly five years there has been virtually no new supply of retail space, says Forrest.

“And the retailers themselves are in a better position because they’ve divested their bottom 5 to 10 per cent of stores, the ones that weren’t profitable.

“So, the ones that they have left are more profitable and many of them are still pursuing a growth strategy and opening new stores.”

Forrest says investors have been waiting for signs that interest rates will reduce retail spending.

“You’re beginning to see some deceleration of growth. If you look at the numbers for Scentre Group for July and August, the rate of growth of spending has come off in apparel and in home wares, but it’s still positive.

“But for food and beverage, we’re all still eating out. That’s still really strong.”

Rent reset

Forrest says the reset of rents lower during the COVID shutdown has set the base for a more sustainable outlook for the sector.

“Even if sales decelerate or go backwards, the starting point with rents does give you a bit of a buffer.”

Elsewhere in A-REITS, Forrest says the single standout performer was Goodman Group, which posted earnings growth of 16 per cent, well ahead of expectations of 9 per cent growth.

“They also announced the fact that a fair amount of their development pipeline is going to be data centres.

“Because data centre opportunities come with much bigger development margins, there’s a huge opportunity — $30 to $60 billion over the next five to 10 years. That was very well received by the market.”.

Industrial leasing spreads continue to be strong: “Spreads are still between 15 and 20 per cent. They are beginning to decelerate, but with a vacancy rate below 1 per cent landlords are still in a very strong bargaining position.”

In residential, pre-sales continue to struggle. “It’s coming off a massive base given the amount of stimulus where interest rates were over the last two years, so it’s only natural that the pre-sales numbers continued to struggle,” says Forrest.

“The likes of Stockland are doing smart things — cutting their land sizes to smaller and smaller blocks to keep them affordable. But even so, the numbers that they’re posting look low.

“First home buyers are a reasonable component of the market, and everything comes back to affordability.”

In office, the picture is mixed, she says.

“We are beginning to see a bit of top line growth for the highest quality offices. Office buildings exposed to tenants where everybody’s back at work and have got amenity and high-quality services, they’re doing well.

“But there a very long tail and in aggregate, it’s going sideways.”

Valuations attractive

Overall, Forrest says that with the volatility of the past year behind us, REIT investors are set for a return to more normal performance.

“If you think about FY24 earnings, we would have cycled through pretty much all of the rate hikes so from FY25 onwards, you’re looking more like your standard A-REIT performance.

“A dividend yield of 4.5-5 per cent plus maybe 3 per cent growth for a total return of 7 to 8 per cent.”

She says A-REIT valuations are compelling.

“The sector is pricing cap rates to move another 100 basis points, which implies the market is expecting asset prices to fall maybe another 15 to 18 per cent.

“They are unlikely to fall that far. So, the entry point is interesting.”

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

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