Property trusts still attractive, if a tad expensive

The outlook for increasingly pricey A-REITs is mixed, but analysts are broadly supportive.

The A-REITs are in demand, with the office trusts preferred over retail trusts. Picture: John Grainger

Australia’s increasingly expensive real estate investment trusts (also known property trusts) remain an investor favourite, harbouring a string of stocks with an ability to grow returns in the months ahead, according to a batch of analyst reports released following the recent reporting season.

Underpinned by well positioned office portfolios, the A-REITs sector remains in demand, though slowing retail sales create some headwinds and residential valuations clearly look less compelling.

On a macro perspective, analysts put forward interest rates — especially the trajectory of US interest rates — as the outstanding issue for the sector in the months ahead.

From a sector perspective, ­office A-REITs are preferred over retail-focused property trusts while among property managers, the active managers of assets are regularly preferred over passive players.

While the sector may struggle against rising rate expectations worldwide, investment brokers favour stocks with a so-called “growth bias”, such as Goodman Group (GMG), Lend Lease (LLC), Stockland (SGP), Mirvac (MGR) and Charter Hall Group (CHC), and Dexus Property (DXS) and Investa Office (IOF).

Among the major brokers the outlook is mixed, but broadly ­supportive:

• Morgan Stanley retains an “attractive industry” view, but observes the risks are present in rising bond yields, positive earnings momentum for industrial stocks and material tightening in credit conditions. In residential sub-sectors, there is still a sweet spot across the board, but the broker prefers Stockland to Mirvac because of the clarity in the outlook with a record level of net deposits.

• Stockbroker UBS considers residential valuations are less compelling now, but Mirvac appears the cheapest in terms of the implied value for its development business. Mirvac is the broker’s preferred choice among the large caps, with its NSW and office exposure and implied multiples for development business.

UBS continues to believe Australian property is attractive on a global basis, as its yields versus bonds are wider than average compared with other developed markets. USB is surprised by the robust outlook for the office market and sees an 11 per cent and 19 per cent upside to estimates for Dexus Property and Investa ­Office, respectively, over the ­medium term.

• Credit Suisse suggest that against spot bond rates A-REITs appears reasonably priced on most traditional valuation measures. The broker continues to view Investa Office and Mirvac’s office portfolios as best positioned in the current environment. Credit ­Suisse also finds the earnings quality questionable generally, with office A-REITs the largest beneficiaries of the expiry of incentives on leases being below that of replacement leases.

• Goldman Sachs believes settlement risk in the market is overstated in the residential sector and while volumes and margins are strong, the house price outlook is more mixed and construction approvals are flattening. This suggests to the broker that the cycle is close to a peak and pre-sales growth is likely to slow.

• According to Ord Minnett the highlight of profit season was the strength in residential, with both Stockland and Mirvac reporting higher sales and expanding margins. The broker also, notes Sydney office incentives have declined and monetising this in terms of better income growth is challenging. Looking at the wider reporting season for A-REITs, Ord Minnett highlights a stark contrast in earnings/cash flow growth, with developers and fund managers typically growing the fastest, and the passive rent collectors missing out.

• Stockbroker Macquarie says backdrop is strong for fund managers such as Goodman and ­Charter Hall, while Lend Lease has an attractive profile at a reasonable valuation. Stocks which serve as retail bond proxies, such as Vicinity Centres and Scentre Group, are expensive in Macquarie’s opinion, offering limited upside risk to earnings. Aventus Retail Property (AVN) is preferred by Macquarie in terms of its tenant base. Meanwhile, Westfield is considered expensive and translating lost earnings from dilutive asset sales into accretive developments will take time, in the broker’s view.

This is an edited version of a feature that first appeared atwww.fnarena.com