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A-Reits to return 9 per cent in 2017, but still underperform equities - CLSA

Property Markets / Outlook


Feb 05 2017

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by Mark Westfield

The Australian real estate investment trust (A-Reits) sector will return 9 per cent in 2017, split roughly 5 per cent yield and 4 per cent growth, says CLSA’s Sholto Maconochie and Stephen Lam, but still underperform equities after beating shares by 1.4 per cent in 2016.

“We don’t expect A-Reits to materially underperform equities, but the combination of slowing income growth, higher PEs relative to equities, and rising bond yields will potentially hold them back in 2017,” Maconochie and Lam write in a note, adding that they prefer active to passive A-Reits. The favourable tailwind of falling debt cost and rising asset values of the last five years was also running out of puff. “Put simply, over the last five years, a rising tide has lifted all boats and in a low-growth, low-yield world A-Reits and direct real estate have been direct beneficiaries.”

Despite these factors, the analysts believe the sector is attractive to investors. “With 29.3 per cent look-through gearing, the sector is not over-leveraged and payout ratios are 79 per cent, with the majority paying out below 100 per cent of adjusted funds from operations.

“A-Reits offer a dividend yield of 5.2 per cent, a 247 premium to the risk-free rate (2.7 per cent) compared with the 161 basis points longer-term average. The spread between the cash rate is 368 bps versus the long-term average of 224 bps,” the note says.

“There’s a lot of money chasing yield,” adds Maconochie. 

CLSA prefers Goodman Group, GPT, Mirvac, Scentre, Stockland and Westfield (upgraded to BUY from Underperform).

The firm “likes” office as an asset class but strong fundamentals are yet to translate into  earnings growth in the 2017 financial year for the office owners (Dexus, Investa and Mirvac). Dexus, CLSA says, is held back by its exposures to the Perth and Brisbane markets so have kept it on Underperform. CLSA sees Mirvac as the cheapest way to “play office”. In 2016, secondary office was the best performing asset with a return of 27.2 per cent, followed by neighbourhood retail (17.9 per cent) and prime office (17.7 per cent). The strong performance last year was marred by elevated incentives, however, these are coming down and CLSA says this augurs well for stronger rent growth in 2017.

Despite these mixed messages from the office class, CLSA nominates Sydney and Melbourne office along with regional retail and large format retail as the “winners” of the sector in 2017.

“In 2017 we expect secondary office to continue to perform, but it will be limited to Sydney, Melbourne and parts of Brisbane,” CLSA says. “Office incentives are still high (but reducing in Sydney and Melbourne) , but prime net cash yields are still attractive (4.4 per cent) with good effective rental growth (+7.4 per cent) and rental escalators at 3.75 per cent well above CPI at 1.5 per cent.

“With strong demand still chasing prime assets, there is a real possibility that Sydney prime CBD asset yields drop below 5 per cent (from 5.21 per cent currently) for relatively new assets with long weighted average lease expiries (WALEs).

“In our view office will outperform primarily due to strong demand for assets with improving fundamentals (Sydney, Melbourne and to a lesser extent Brisbane) and a lack of stock forcing investors into secondary assets for value add/development opportunities,” the CLSA note says.

Maconochie and Lam nominate Mirvac as a second derivative office play as it trades close to NTA and with the lowest age and longest WALE portfolio, Investa Offic e Fund for its secondary asset exposure and potential for corporate activity. “We like Dexus, but it’s relatively expensive and a 2018 financial year story for effective office rental growth.


SOURCE: Feature Article


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