Investors should broaden their exposure to property trusts

J.P. Morgan and Citi both see 2025 as an ‘inflection year’ for listed property trusts with rate cuts set to broaden support for the sector, but they differ over favourites.

Traders work on the floor of the New York Stock Exchange. Picture: Michael M. Santiago/AFP

It’s no secret that official interest rates will start falling this year, potentially as soon as next month.

Economists are expecting the cash rate target to fall from 4.35 to 3.6 per cent this year.

What’s less widely understood is the broadbased tailwind that should give ASX-listed property stocks after a somewhat bifurcated and at times dismal performance in the past few years.

Property trusts are “bond proxies” as they pay most of their profits to shareholders as dividends.

If the yield on “risk-free” Australian bond government bonds falls in response to lower funding costs as interest rates come down, property trusts will be relatively more attractive.

They could also benefit from stronger economic activity.

Interestingly, a couple of big brokers have predicted a significant positive change for the sector in recent weeks with both Citi and J.P. Morgan calling for an “inflection point.”

But while both have Scentre, GPT and retail property trusts as a group in their top picks for 2025, there’s quite a bit of difference in their preferred buys in the sector.

Excluding dividends, the S&P/ASX 200 Real Estate sector rose 12.4 per cent in 2024 and 11.5 per cent in 2023, exceeding returns of 7.5 per cent and 7.8 per cent from the S&P/ASX 200 index.

2022 was something of a broadbased disaster for property trusts as the sector bore the brunt of interest rate hikes, falling 24 per cent versus a 5.5 per cent fall in the ASX 200 broader market.

Barangaroo in Sydney. Picture: Gaye Gerard/NCA Newswire

But the elephant in the room for the past two years has been Goodman Group.

Goodman soared 87 per cent over the past two years thanks to the AI boom and its exposure to data centres. However, a majority of property trusts actually fell in each of the past three years.

Goodman is now by far the biggest Australian property trust, with a market cap of almost $46bn.

It’s almost four times bigger than the next biggest property trust, Scentre Group.

Whether or not Goodman outperforms again this year may depend on the strength of the interest rate tailwind for other property stocks and of course the strength of the tailwind for data centres.

Donald Trump’s plan to direct $US500bn ($800bn) toward his “Stargate” AI project over the next four years could boost data centre demand, although it’s unclear where all the money is coming from.

“2024 was all about owning Goodman – and to a lesser degree, Charter Hall and Scentre,” said J.P. Morgan’s head of Australian real estate investment trusts coverage, Richard Jones.

“In 2025, we believe portfolio outperformance will require a broader set of stock exposures.

“REIT earnings are at an inflection point, having seen growth wiped out by rising debt costs over the past two years.”

Mr Jones expects earnings growth to turn positive this year and accelerating over the next two years.

Moderating inflation and below-trend economic growth should see an above-consensus 100 basis points of official cash rate cuts in 2025, according to J.P. Morgan.

That should drive the 10-year bond yield down toward 4 per cent from 4.46 per cent now, according to Mr Jones.

In the past, property trusts have generated strong absolute returns and outperformed the ASX200 around the start of interest rate cuts. But property fundamentals are varied. Industrial is slowing from a three-year period of outperformance, while retail has a “healthy backdrop” for 2025, according to J. P. Morgan’s Jones.

The office sector should “finally show improvement”, particularly in Sydney, as more employees return to the office.

But residential volumes will “remain constrained” until at least two rate cuts come through.

“We expect positive momentum in transaction activity to continue with a wider array of institutional investors – including REITs and domestic and offshore institutions – all active,” he said.

J.P. Morgan made a raft of rating changes, upgrading Vicinity and Abacus Storage king to Overweight and Region to Neutral, while downgrading Goodman and Hotel Property to Neutral and Charter Hall Long Wale to Underweight.

Its large cap Overweights are Scentre, GPT, Vicinity Centres, Dexus and Charter Hall, and Retail is its preferred property sector plan.

Citi also sees an “inflection year” for AREITs amid interest rate cuts.

“We expect declining financing costs will provide additional tailwinds, supporting earnings growth across the broader sector,” said Citi’s Co-Head of Real Estate Research, Howard Penny.

“This will likely generate increasing interest from generalist investors as they anticipate a more stable cap rate and finance cost environment.”

While there will be some continued finance cost pressure in some AREITs in the first half of 2025, he sees a “more positive investment landscape” for Aussie real Estate stocks this year.

But while seeing a particularly strong outlook for retail, self-storage and land lease, where structural operational momentum continues to deliver robust returns, he’s just as positive on data centres.

“The strong structural development growth of global data-centres remains attractive for Goodman Group in 2025 and beyond,” he said.

“Although Goodman has performed well over the last two years, the stock remains attractive in our view, benefiting from compounding development growth through global data-centre demand.”

Mr Penny sees a “slower recovery” in Australian office markets, where elevated vacancy rates and persistent tenant incentives are likely to delay a meaningful shift in the demand-supply dynamics.

His top picks are Goodman, National Storage, Ingenia, Stockland, Scentre and GPT.