Few investors will be unhappy with the performance of their AREIT holdings last calendar year. A return of 19.6% was well above the 2018 return of 3.3%. Despite underperforming Australian equities by 4.2% last year, AREITs have outperformed equities in three of the past five years.
Not only that, with equities delivering a return of 23.8%, the 4th highest return in 20 years and 15th highest in the past century, last year was particularly notable. A longer time frame is more revealing, however. Over the last decade, AREITs have enjoyed a total return of 11.6% p.a. (over half from dividends), 3.8% p.a. ahead of equities.
After a great first half (up 19.1%), the relative underperformance of AREITs compared to equities in the second half of 2019 was due to two factors. From the August low of 0.88%, Australian 10-year bonds rose 46 basis points (bps) – a staggering 52% no less – to 1.34% by year-end. Expectations of US bonds rising in 2020, meanwhile, drove the AREIT sell-off in the last month of the calendar year.
The second explanation was a result of success. After a strong period of performance, the sector was hit by understandable profit-taking. Hot money, both domestic and offshore, that had found shelter in the sector in mid-2018, sold down holdings in stocks like Dexus and Goodman, happy with the returns gained. Nevertheless, the attractions of the sector to local investors endured, underwritten by regular income and low risk.
Table 1: AREIT Performance comparisons and key metrics
|AREIT DPS Yield||4.7%||4.7%||5.5%||6.2%1|
|300 Equities/(vs.AREITs)||23.8% (+4.2%)||10.9% (-3.5%)||-3.1% (-6.4%)||7.8%(-3.8%)|
|10yr Bond Yield/Spread||1.34%(340bps)||1.77%(295bps)||2.32%(321bps)||5.72%(49bps)|
|AREIT Equity Raised ($b)||$6.5||$1.1||$4.01|
|Gearing (APN est)||25%||27%||27%||31%|
AREIT performance continues to be driven by sub-sectors, as Table 2 shows, with Industrial, Office and Diversified REITs significantly outperforming Retail and Specialised REITs.
Industrial benefitted from the push to reduce logistics costs and the growth in online retail, which has negatively impacted retailers and their landlords, emphasising the benefits of a sensibly diversified AREIT portfolio.
In the office markets of Sydney and Melbourne, the stars aligned. Both benefited from limited new supply, withdrawal of existing supply, especially in Sydney, strong tenant demand driving rental growth and investor appetite – international as well as local – pushing prices to record levels.
Table 2: 2019 Performance by sub-sector
|Sub-sector||1-year return||3-year return|
|Diversified REITs||33%||14% p.a.|
|Specialised REITs||7%||11% p.a.|
At a stock level, the best performer was Ingenia Communities (ASX:INA), which rose an eye-popping 71%, boosted by its inclusion in the S&P/ASX 200 AREIT Index. Next came Charter Hall (ASX:CHC), up 54%, Mirvac (ASX:MGR), which rose 47% and large format retail landlord Aventus (ASX:AVN), up 43%.
Retail landlords continued to struggle in comparison, with Charter Hall Retail (ASX:CQR), Scentre Group (ASX:SCG) and Vicinity (ASX:VCX) all delivering returns of less than 10%. Even the best performers – BWP Trust up 17%, Unibail Rodamco Westfield rising 13% and Shopping Centres Australia SCP up 11% – looked limp compared to top performers in other sectors.
The economic year ahead
While the retail headwinds of 2018, including weak wages growth and poor consumer sentiment, were again a factor last year, an improving residential housing market, tax cuts and lower interest rates should offer assistance into 2020. That’s good because we might need it.
GDP growth was tracking at 1.7% for last year but the impact of the bushfires is likely to weaken that figure in the months to come. Aside from the significant environmental and welfare cost, the immediate economic impacts are difficult to quantify, although agriculture, tourism, retail and construction will be hit.
The indirect impacts – lost workdays in construction, lower retail spending due to smoke haze etc – will be a further drag. That increases the prospects of a rate cut in the coming months as the RBA factors in the likely further reduction in future GDP growth.
It is worth noting that the Grattan Institute estimates that 80% of Australia’s GDP comes from 0.2% of its land mass – generally the most densely populated areas. Because significant bushfires occur mainly in non-productive, non-residential and non-cleared land, perhaps the drag will mainly be through secondary impacts like falls in tourism. Let’s hope so.
The RBA’s November Statement on Monetary Policy expects core inflation to remain below 2% for longer, with a return to 2.0% core inflation now forecast for 2021. As for unemployment, at December 2019, it’s at 5.1%. That doesn’t sound so bad, but the country suffers from underemployment and growing underutilisation, although if unemployment was to fall to 5% the RBA might put the brakes on further rate cuts.
As for wages growth, it’s been treading water at around 2.2% to 2.3% p.a. from 2018. Since 2011, the 3.9% post-GFC high in wages growth, it has steadily declined to a 2016 low of 1.9% p.a. The weakness in wages growth has continually caught the RBA out, with its forecasts generally above actual levels each year.
This isn’t great. Flat real wages growth feeds adverse consumer sentiment, which in turn impacts retail sales. Wage inflation, however, has been stronger than inflation in most quarters since the GFC, with the gap indicating a (modest) improvement in average real wages.
What this means for AREITs in 2020
In January 2010, the benchmark Australian Government 10-year bond rate was 5.7%. It finished the decade at a low of 1.32%. This reduction in interest costs delivered a major boost to Australian corporate profits, with AREITs benefitting significantly. With each interest rate cut, the sector became more attractive to a broader range of investors seeking higher levels of income and less volatility than the broader Australian equity market.
Households also benefited from reduced interest payments, but high debt levels and tighter bank lending standards discouraged additional borrowing. Conversely, savers, especially retirees living off term deposits and likely to spend their interest income, faced steadily reducing cash flows. They looked to AREITs as an ideal source to boost their reduced income.
That’s the recent history. What about the year ahead?
Bond yields fell further than REIT yields in 2019 suggesting value existed. The 10-year bond yield was down 94bps over 2019 to 1.38% while the AREIT sector’s dividend yield fell only 28bps to 4.7% over the same period. That means AREITs started the year relatively more attractive to investors than the previous year due to their wider spread or buffer to higher interest rates. This resulted in another strong start to the year with AREITs up 6.3% in January (Jan 2019 6.0%) as investors recognised this value.
We’re not expecting another repeat performance of 2019, just as we didn’t expect the returns we got in 2019 at the end of 2018. But with interest rates remaining low and possibly falling further, the Australian macro backdrop remains conducive to AREITs providing solid returns in 2020. Nothing is guaranteed but at these levels capital values should be reinforced and that steady income on which investors have come to rely should continue to flow.
In the coming weeks we’ll issue our AREIT sector and global outlooks. Watch out for them.