Criterion: With declining rates, the marked-down REITs sector is starting to purr

With the Reserve Bank this week reducing interest rates and flagging more cuts, real estate investment trusts (REITs) will be among the biggest ASX beneficiaries.

The REIT stuff: with interest rates falling, property trust investors are feline a lot better. Pic via Getty

• Real estate investment trusts, or REITs are a key beneficiary of lower interest rates

• The sector is recovering from its post pandemic lows, but many REITs still trade below net asset backing

• Citi prefers retail REITs as landlords rediscover their pricing power and shoppers flock to the malls

With the Reserve Bank of Australia this week dispensing 25 basis points of rates relief and signalling more to come, real estate investment trusts (REITs) look like being one of the ASX’s biggest beneficiaries.

REITs are both inherently geared and usually exposed to the domestic economy, which the cuts will support.

Recent REIT updates suggest workers are returning to the office – albeit slowly – and shoppers are flocking to the malls.

Industrial REITs continue to find favour, especially the ones that own data centres.

As for residential REITs, the lower cost of capital puts them in an ideal position to crank up their development pipelines and address the fabled housing shortage.

According to Janus Henderson Investors’ portfolio manager Guy Barnard, historically attractive valuations “make the present an opportune time for investors to consider real estate equities.”

There are REITs and REITs

The recovery already is evident, with S&P/ASX200 REITs index gaining 16% from its April 9 nadir (but remains remaining 6% below its October 2024 peak).

Cut another way, the sector has declined 1% calendar year to date, dragged down by the 13% decline in sector big daddy Goodman Group (ASX:GMG) (which accounts for 40% of the index).

However, many REITs are still trading at a discount to net tangible asset backing and value hunters are taking note.

Of course, there are REITs and there are REITs.

According to Barnard, landlords with longer lease durations and non-discretionary assets (such as healthcare) have outperformed more sensitive sectors such as hotels, retail and office.

Shop 'til you drop

Broker Citi likes the retail REITs, which stand to benefit from resilient consumers and population growth via immigration.

Landlords are in control again, evidenced by higher occupancies, positive leasing spreads and inflation escalators of 2% plus.

The half-owner of half of the monolithic Chadstone, Vicinity Centres (ASX:VCX) said it was likely to hit the top end of its fully-year earnings guidance.

The owner of 42 Westfield malls, Scentre Group (ASX:SCG) reported a 99.6% occupancy as at the end of March, with average rent rises of 4.4% during the quarter.

“We see a stronger argument for value in retail real estate thanks to other subsectors with larger fundamental headwinds and lower net rental growth such as office,” Citi says.

“Retail vacancies continue to improve, resulting in high occupancies across the sector.”

Back to the office

Ord Minnett points to “green shoots” of an office recovery, “albeit this could take some years to play out”.

The firm’s real estate analyst Leanne Truong says office value is emerging amid “overly pessimistic” expectations, with the market implying a further 18% decline in valuations.

That’s despite office valuations having been written down around 25% from peak level.

“In the near term, we are encouraged by the stabilisation and improvements in key metrics, setting up the office market for a stronger medium-term outlook,” she says.

Sector leader Dexus (ASX:DXS) reports a flight to quality to CBD locations, which is just as well as 76% of the REIT’s $9.6 billion office portfolio is located there.

“Our investment portfolio continues to deliver resilient income streams, with a strong balance sheet supported by a disciplined approach to capital management,” Dexus chief Ross Du Vernot says.

Affirming its earnings guidance last week, the pure-play Centuria Office REIT (ASX:COF) reported occupancies of 91.4%, well above the national office average of a lowly 84%.

Constrained new supply should spur valuations

Henderson Investors’ Barnard says divining  the impact of tariffs, currencies on global earnings is harder than it has ever been.

“Therefore, domestic earnings versus global earnings is a key consideration – in this regard, real estate is about as local a business as you can find.”

(With 60% of its earnings derived offshore, Goodman Group is heavily investing in data centres to ride the AI boom).

Ord Minnett says inflation, planning bottlenecks and elevated wages all are affecting new projects, especially in the  “chronically undersupplied” housing market.

As for the land itself, God’s not making any more of it.

Originally published as Criterion: With declining rates, the marked-down REITs sector is starting to purr