Rising bond yields and takeover rumours point to an active year for listed property trusts.
By Lachlan Colquhoun
Listed property has traditionally behaved differently from other sectors of the share market.
It began life as a defensive play, and has evolved into a proxy for bond yields. When bond yields are down, money moves into listed property. When yields go up, the money moves out.
Australia’s real estate investment trust (A-REIT) sector gyrated to this pattern in the second half of 2016 as volatile bond yields became one of the year’s top investment stories.
What had been a buoyant first part of calendar 2016 for A-REITs started to deteriorate when, inspired by UK’s Brexit and the Trump presidential election victory, bond yields began to move higher.
How will bond yields affect A-REITs?
Foreign institutional investors are very active in the A-REIT sector, comprising up to 40 per cent of the share registers of some of the biggest names, so the sector was always going to suffer when they went hunting for yield elsewhere.
A look at the ASX/S&P A-REIT index confirms this story. It started February 2016 at around 1820 points and spiked to 1970 in April before a Brexit-inspired July slump to 1729. It has since recovered, but only to levels of 12 months previously, hovering around 1840 points in February 2017.
More of the same looks likely for 2017. It is shaping to be, in the words of Simon Chan, Bank of America Merrill Lynch director of equity research for real estate and utilities, a “year of consequence”.
By that, he means that the prices of A-REITs will once again suffer the consequences of movements in bond yields.
Chan points out that the yield on 10-year Australian Government bonds stood at 1.8 per cent in August 2016. In February 2017 the yield had risen to 2.7 per cent, and Merrill Lynch is forecasting a bond rate of 3.25 per cent by the middle of 2017.
“This is going to be an interesting year for REITs, and it’s hard to see a massive scope for outperformance given the bond yield forecast,” says Chan.
A big year of mergers and acquisitions for A-REITs?
To make 2017 even more interesting, Chan says this could also be an active year for corporate activity, with consolidation an ongoing theme. Shopping Centres Australia announced in November 2016 that it had taken 4.9 per cent of Charter Hall Retail REIT, and the market is expecting some more action when the two announce their interim results.
There is also speculation about possible takeover bids for Mirvac and Investa Office Trust.
Chan has a different view of the outlook for the market sub-sectors. While supply and demand dynamics create a positive outlook for the office and industrial markets, retail is more problematic largely because of digital disruption making bricks and mortar shopping more of a risk, he says.
CPA Q&A. Access a handpicked selection of resources each month and complete a short monthly assessment to earn CPD hours. Exclusively available to CPA Australia members.
Foreign investors quit A-REITs
At accounting and advisory firm BDO Australia, Sebastian Stevens is another keen observer of the REIT sector in his role as the national leader of the firm’s real estate and construction team.
Stevens and his colleagues put together an annual survey of A-REITs, now in its 22nd year, which ranks the trusts on key financial and investment indicators over the financial year.
The BDO report shows the top 10 trusts had a total return of 24.6 per cent in the 2016 financial year, following 20.2 per cent in 2015 and 11 per cent in 2014.
Stevens offers the same assessment as Chan on the latter part of 2016.
The market, he says, was going “swimmingly” until July when rising bond yields turned the heads of the foreign investors and their “much less sticky” money went elsewhere.
Stevens says this is a source of frustration because the sector has excellent fundamentals.
A-REITs cut debt and innovate
Major trusts addressed their gearing levels in 2016 and locked in low interest rates with long tenors, valuations are continuing to rise and tenants are locked into long-term leases at the premium end of the office market.
There has even been some innovation in the industry in recent years, with “niche” trusts covering sectors such as health, pubs and kindergartens coming to the market.
“Because they were focusing on these niche markets they didn’t have so much competition for assets, so they could cherrypick properties and some of them did really well,” says Stevens.
The sector’s fundamentals continue to be sound, he says, but in 2017 its performance in terms of share price will again be driven by bond yields and the sentiment of foreign investors.
Domestic investors, says Stevens, are holding A-REITs for the long term. They understand the market, know the various players well, and appreciate the stability of the solid dividend income, which is a useful component in constructing overall investment portfolios.
So it could be a good year for investors who pocket the dividends and temper their expectations of general share price rises – but who also make sure they are on the right side of any takeover bids.
What you should know about the risks of the property market