Interest rates to help AREIT growth, but uncertainty for office property remains

Potential for improved earnings growth among AREIT stocks is emerging as an additional boost to the sector following a second interest rate cut for the year, and while some office property is showing signs of green shoots, it’s still too early to be bullish on office as a whole, according to an AREIT investing expert.

High inflation and interest rates have seen lower growth among AREIT stocks recently, but there are signs that momentum is shifting, according to Amy Pham, Portfolio Manager for the Pengana High Conviction Property Securities Fund. “Inflation and rates coming down will help growth in the AREIT sector, and we forecast improving earnings growth in the sector of 3-5% across this calendar year.

“This is encouraging as AREITs are considered relatively defensive, due to lease structures and minimal exposures to operational risk.

“While markets have been unpredictable in recent years, we’re already seeing some increased signs of confidence given we’re now at the start of a new interest rate cycle.”

Ms Pham said some AREITs had shown positive sales growth before the most recent RBA cut, with residential stocks an obvious beneficiary of lower interest rates. “Sales growth has picked up for a lot of AREITs, for example, companies including Mirvac and Stockland reported a pick-up in pre-sales for residential property ahead of the most recent rate cut.

“Even if the rate cuts aren’t that deep, there has already been a shift in momentum among residential, particularly at the more affordable end of residential property.

“We are also positive about land lease communities and retirement living in the current climate.”

Yet Ms Pham is still looking for good investment fundamentals among AREIT stocks, given the uncertainty in how low rates will go. “The market will support AREITs with a strong balance sheet, and with third-party access to capital, so they are not relying on further debt to raise capital.”

Ms Pham said office property was seeing some green shoots among premium assets, but high vacancy rates and incentives remain a drag on the sector. “Office transactions seem to have picked up, which provides more evidence regarding the true valuation of the office sector, and gives us confidence we are sitting at the bottom of the valuation cycle.

“One thing we look at is free cash flow, and incentives are still very high, so free cash flow is quite poor.

“We are underweight office but are seeing some green shoots among the higher quality, premium office assets – the Sydney vacancy rate for premium office is only 6% compared to the market at 15%.”