[+] Aussie REITs Brace for ‘Below-Book-Value’ Pain

Australia’s real estate investment trusts are bracing for a hairy end of financial year reporting season, off the back of record cash rate rises and limited transaction flows. Sales of commercial property in Australia fell to their lowest levels in more than a decade at the start of 2023, as increased debt costs and uncertainty over pricing continued to obstruct dealmaking, according to MSCI head of Pacific real assets research Benjamin Martin-Henry. “There are a lot of products on the market at the moment but pricing has become a real sticking point due to the soaring cost of debt,” Martin-Henry says. “Couple this with uncertainty around economic fundamentals and it’s no surprise that investors have been very subdued.” There is still investor demand for industrial assets, particularly those in defensive sectors such as healthcare. But some deals are coming to market at a discount to net asset values (NAV). Case in point is the March equity raise from HMC Capital, which acquired a $1.2-billion, 11 hospital property portfolio, which is leased by private hospital provider Healthscope. “This is an example of a REIT having to raise capital at a discount to their NAV,” Oracle Investment Management emerging markets portfolio manager Jack Magann says. “While this isn’t ideal, the assets are high quality with a very stable tenant with a 16-year weighted average lease expiry. “This was completed at an attractive yield of 5.8 per cent.” ▲ A childcare centre held by the ARENA REIT. Nevertheless, raising equity in this manner is a sub-optimal use of capital management, sending some REITs to debt markets for new deals or developments. ARENA REIT, which owns early childcare centres, increased its debt funding in late 2022 by $70 million or 15 per cent of total debt. “This was done to fund the acquisition of two childcare centres and the development of seven new greenfield centres,” Magann says. “This increased the weighted average cost of debt from 2.9 per cent to 3.5 per cent.” Other REITs are recycling their capital, selling out of poorer performing assets and buying higher-quality assets. HomeCO Daily Needs REIT divested two, low-yield retail super centres and reinvested that capital into higher-yield rural shopping villages. Abacus Property Group is spinning out its Storage King self-storage business as a separate REIT to unlock value, Magann says. “National Storage REIT is a standalone self-storage REIT trading at a premium to its NAV. Abacus Property Group currently trades at a 30 per cent discount to its NAV. “So management is hoping to realise a premium valuation with a standalone self-storage REIT. “The self-storage market is supported by a lack of supply and the growth of e-commerce.” ▲ Abacus is separating the Storage King into its own REIT. Operators in commercial property sectors such as retail and industrial are finding it challenging to deploy capital to create value. This is due to competition for assets and the fact valuations have not moved significantly from cyclical highs while debt costs have repriced substantially higher. “A number of operators have shelved office developments on this basis, which we have been expecting for some time now,” says fund manager with Pengana High Conviction Property Securities Fund Amy Pham. Alternative assets on the rise On the broader demand for industrial assets, Pham notes demand for industrial assets remains strong but investors should expect to pay a premium for performance. “US data suggests rents in industrial are only between 5 per cent to 10 per cent of total logistics costs,” she says, “whereas transport costs are between 50 per cent and 70 per cent of total logistics costs, suggesting rents remain low as a proportion of a company’s cost base. “They have the potential to rerate significantly higher given planning and development challenges and a lack of land in infill locations. “We’re also expecting strong growth in the alternatives space, with managers benefiting from a first-mover advantage and structural tailwinds. “Alternatives REITs in Australia only comprise 8 per cent of the index but in the US and UK they make up more than 50 per cent of the index. ▲ Healthcare is among alternative assets viewed favourably. “We believe there is a significant opportunity domestically in this regard.” Alternative sectors include self-storage, land lease, healthcare and data centres. Specialist sectors such as regional shopping centres are also in high demand. “These centres usually count Coles or Woolworths as their major tenants. These are reliable tenants who will normally have a CPI-linked lease,” Magann says. “As inflation continues to remain elevated, landlords will receive higher income from supermarkets.” Childcare is seen as a steady and safe investment as most of the income is backed by government subsidies. This is also a non-discretionary product for parents. Office remains out-of-favour At the other end of the market, investors are shunning office space, with the shift towards remote work prompting investors to become more selective about the properties in which they invest. “Assets with flexible leasing arrangements located in prime locations with good transportation links and amenities are likely to continue to attract investor interest,” founder and managing director of property development firm Salvest Anthony Ferraro says. He says investors are more cautious about retail properties. “They focus on assets that offer a unique value proposition, such as experiential retail or convenience-based retail.” ▲ Investors remain wary of retail if there’s no point of difference. Investor appetite Demand for commercial property assets is expected to continue to come from the major banks, which have an approximate 70 per cent market share of commercial real estate lending. “The major Australian banks are extremely well capitalised in a global context with significant buffers in place to protect against downturns,” Pham says. “They are well diversified in terms of exposure across retail, office, industrial, residential and alternatives.” While there has been a dislocation in global banking markets, that’s not expected to reduce access to capital for local commercial property businesses. As for the future, there is now an expectation the full-year results season in August will have more writedowns in commercial property. “Sectors like childcare and data centres are expected to hold their value and avoid cap rate expansion,” Magann says. “This is unlike office and discretionary retail assets which are expected to see cap rate expansion of around 0.75 per cent.” The message to property investors is, there are opportunities out there, but the market is yet to settle. So be circumspect about selecting assets and do substantial due diligence to reinforce the investment thesis and reduce risk. You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

[+] Aussie REITs Brace for ‘Below-Book-Value’ Pain

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