Listed property rebounds, but still headwinds for retail

Prices of listed real estate investment trusts (REITs) have reverted to pre-pandemic levels as economic activity returns to cities and strong demand for property is buoying residential REITs.

However, while greater office and industrial activity will benefit other trusts, retail REITs will struggle over the longer term with e-commerce the biggest threat, asset managers say.

Rick Romano, managing director at PGIM Real Estate and head of the Global Real Estate Securities (GRES), says since the March sell-down, REITs have benefitted from the three Rs: re-opening, reflation and reversion, and as a result should perform well versus general equities over the coming year.  

“The pandemic hit at the heart of real estate with many property types closed,” Romano says. As a result, REITs significantly underperformed broad equity markets and are now poised for a significant reversion of relative performance versus general equities.”

“In a reflating economy, with many property types experiencing a re-opening boost of pent-up demand, cash flows can grow well above inflation and REITs can provide an attractive total return for investors.”

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Diversified REIT Stockland (ASX: SGP) is a notable example, with its securities up around 64 per cent over the year to 14 May, compared to the S&P/ASX 200, which has gained around 28 per cent in 12 months. Along with residential REIT Mirvac (ASX: MGR), up 30 per cent, both have been buoyed by the record demand for residential property, helped on by the government’ HomeBuilder scheme, according to Alexander Prineas, Morningstar’s REIT analyst.

“However, with the program being a short-term stimulus measure which came to an end in March 2021, our long-term expectations for the no-moat name Stockland remain steady and we make no change to our $4.05 fair value estimate,” says Prineas. He believes Stockland is overvalued, trading at around $4.62.

Morningstar removed its moat rating on Stockland in early 2020 due to competition from e-commerce; the diversified REIT has a large exposure to department stores, which is one of the most pressured sectors in retail.

Morningstar valuations for Australian real estate investment trusts

Shoppers to return

For retail REITs, and owners of high-quality malls, Prineas expects foot traffic and sales volumes should eventually recover to pre-pandemic levels.

“Evidence of the near-term recovery comes from Scentre Group's (ASX: SCG) disclosure … that customer visitation at the end of April 2021 has improved to 93 per cent of 2019 levels, suggesting pre-pandemic visitation could be surpassed once virus concerns fade … Vicinity Centres (ASX: VCX) showed a similar story,” he says.

“However, the likely short-term recovery for malls needs to be weighed against long-term competitive pressures from e-commerce, which are growing.”

This will likely weigh on the values of the Australia’s biggest retail REITs. With a 43 per cent loss in Scentre unit prices over the past five years to 14 May and a 53 per cent fall for Vicinity, Australia’s two largest mall REITs look about fairly valued, though cheap, Prineas says.

Unlike the retail sector, the industrial REIT sector will fare better, having benefited from COVID-19 lockdowns, according to Scott Haslem, chief investment officer at Crestone Wealth Management. As COVID-19 lockdowns eased, demand for high-quality industrial and logistics property.  

“COVID-19 has accelerated pre-existing trends in e-commerce and has served to highlight the need for companies to have logistics and distribution capabilities that match this trajectory … industrial/logistics remains a clear beneficiary with long-term structural tailwinds.”

Industrial property REITs with strong balance sheets and capital to invest in logistic assets are likely to outperform in the period ahead, with Australia’s largest industrial property REIT Goodman Group (ASX: GMG) a good example, according to Haslem.

Office trusts too will benefit from improved demand. “It is the disconnect between COVID-19 realities and listed share prices that might make this the most attractive opportunity. Indeed, UBS rates the office sector as its number one exposure in the listed equity space, given its relative resilience of income, better balance sheets and an over-reaction of share prices to the WFH thematic,” says Haslem.

Value picks and dividend plays

Recent UBS research names GPT Group (ASX: GPT) and Centuria Office REIT (ASX: COF) as value picks among the listed property trusts. They are expected to pay distributions yields of 5.5 per cent and 7.5 per cent, respectively.  Haslem also like office owner Dexus (ASX: DXS), which is expected to deliver a distribution yield of 4.8 per cent while Stockland is expected to deliver a yield of 5.7 per cent, according to the research from UBS.

Investors should note that unlike share dividends, distributions from A-REITs don't have franking credits attached. That's because REIT income isn't taxed. Distributions are therefore paid to investors without franking credits attached.

Globally, the upward trend is the same, according to GRES’ Romano. As well as providing a more diversified, listed exposure across sectors, investors in global REITs (GREITs) can also take advantage of mispricing. “While GREITs underperformed broader equity and bond markets in 2020, many property types have been resilient, particularly those with exposure to data centres and logistics that have benefited from the move to digitisation and e-commerce.”

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