Why the outlook for the humble neighborhood mall could be stronger than some expect

It’s been a tough first half of the year for real estate investment trusts (REITS), but the latest addition to Morningstar’s ASX coverage universe could provide an undervalued opportunity for investors looking to capitalize on the recent market skepticism, according to a recent analyst report.

In comparison to other well-known ASX REITS, HomeCo Daily Needs REIT (HDN) stands out due to its portfolio of neighborhood malls, large-format retail and health and services properties.

Shares in the investment trust have tracked a rocky year-to-date, falling more almost 15% since the start of February.

HomeCo’s performance mimics other popular ASX property plays like Charter Hall Group (CHG) and Scentre Group (SCG), which have also charted downwards so far this year, pulled down in part by market concerns of a looming recession in a high-interest rate environment.

Despite the selloff, however, Morningstar equity analyst Alexander Prineas, who recently initiated coverage on HomeCo, says shares are screening as undervalued, compared to Morningstar assessed fair value of $1.45 apiece.

“The main opportunity lies in converting lower-rent large-format retail to more attractive neighbourhood shopping centres, which typically command higher rents and are less cyclical than large-format retail.”

“Key valuation inputs are weighted average cost of capital of 7.2%, above-peer 3.5% estimated rental uplifts on existing leases for the next decade, and our expectation that HomeCo redevelops and remixes some malls,” Prineas says.

While HomeCo's rents are currently a fraction of its rivals’—partly because its neighborhood malls are comparatively immature—Prineas says the trust’s property mix does present other benefits.

“Despite lower rents per square metre, large-format retail margins are reasonable due to low operating costs, and the REIT has been achieving good rental growth off a low base. The sizable weighting to bulky household goods retailers means exposure to new household formation,” he adds.

Around half of the trust’s property portfolio consists of large-format retailers in consumer durables like furniture and white goods, offerings Prineas says are likely to benefit from rising population and growing households.

The trust’s properties also house well-know brands, such as Bunnings, Coles and Woolies, with the latter two companies also anchoring several of HomeCo’s neighborhood malls. That said, while other neighborhood mall owners rely closely on these anchor supermarkets, Prineas says HomeCo appears less reliant.

“Unlike dedicated neighborhood mall operators where major supermarkets generate about half the revenue, Coles contributes only 3.7% of HomeCo's rent, and Woolworths 3.6%.
HomeCo's next largest tenants are home retailers The Good Guys, JB Hi-Fi, Harvey Norman, Freedom, Nick Scali, and outdoor retailers Anaconda and BCF, typical tenants for large-format sites.”

In terms of risks, Prineas points to the tougher macro conditions affecting the property sector, but adds that these precede potential longer-term tailwinds.

“HomeCo is susceptible to cyclical risks in the near future, as residential building approvals are currently depressed, and the economy faces a slowdown under the weight of rising interest rates.”

“HomeCo has longer-term tailwinds given it is likely to benefit more from population growth than rival REITs. HomeCo estimates population growth in its catchment areas of 1.9% from 2021 to 2026, versus a 1.5% nationwide average, a reasonable estimate given government policies support population growth and housing supply.”

Shares in HomeCo Daily Needs REIT last traded at a 19% discount to Morningstar’s fair value estimate of $1.45 per share and comes with a 7% yield.