Stuart Cartledge

The S&P/ASX 300 A-REIT Accumulation Index reversed some of 2022’s losses in the final quarter of the calendar year, gaining 11.6%. Results were choppy throughout the period, with a gain of 9.9% in October, followed by a 5.8% move higher in November, before a 4.0% drop in December. The property index outperformed the broader equity market, with the S&P/ASX 300 Accumulation Index up 9.1%.

Much like property market movements, Australian 10 Year Government Bond yields were volatile throughout the quarter. After beginning the quarter at 3.9%, they retreated to approximately 3.3% before finishing the quarter just above where they started at 4.0%. In this context, the strong performance of property stocks could be considered somewhat surprising, however this is probably less remarkable when considered more broadly, with the property index falling 20.1% during 2022. Industrial property owners outperformed in the December quarter.

Demand from tenants for industrial property continues to be strong, with limited vacancy in key markets. Whilst supply is coming online, it is not enough to match demand for well-located properties. As such, industrial market rental growth is very strong, supporting property values, despite expanding capitalisation rates. Dexus Industria REIT (DXI) rose 24.1% in the quarter and Centuria Industrial REIT (CIP) added 22.0%. CIP’s revaluations resulted in a 1.9% reduction to book values, concentrated in ultra-long weighted average lease expiry (WALE) properties. Capitalisation rates expanded 0.47% to 4.66%.

DXI’s portfolio was revalued 0.2% higher, despite capitalisation rates expanding by 0.09%. Owners of shopping centres also outperformed in the quarter, as consumer spending through the crucial holiday season appears to have been resilient, despite the drag of increased interest rates. Whether this continues into 2023 and beyond, as increased costs of living filter through and deplete savings, is uncertain. Offshore shopping centre owner Unibail-Rodamco-Westfield (URW) was a major outperformer, rising 26.1%, however this only served to regain a part of prior losses in recent periods. Australian shopping mall owners Scentre Group (SCG) and Vicinity Centres (VCX) were also outperformers, adding 13.4% and 15.3% respectively.

Owners of smaller neighbourhood shopping centres had mixed performance, with Region Group (RGN) up 18.5% and Charter Hall Retail REIT (CQR) underperforming the index, but still gaining 7.6%. Office property owners were once again underperformers in the final quarter of 2022. Physical occupancy continues to be troubled in key office markets and incentives on new leasing deals continue to be stubbornly high.

Each of Centuria Office REIT (COF), Dexus (DXS) and Cromwell Property Group (CMW) rose, but underperformed the index, lifting 7.6%, 4.0% and 2.1% respectively. GDI Property Group, predominantly a Perth office owner, was a large underperformer, falling 8.1% during the quarter. Property fund managers had mixed performance over the period. Property revaluations were broadly unmoved, supporting earnings for this financial year, however it appears as if inflows to funds will be more constrained moving forward.

Centuria Capital Group (CNI) outperformed, adding 14.6%, whilst Goodman Group (GMG) moved roughly in line with the index, up 11.0%. Alternatively, Charter Hall Group (CHC) and Elanor Investors Group (ENN) underperformed, with CHC gaining 6.2% and ENN up only 0.8%.

Market outlook

August’s reporting season was broadly positive for property stocks when looking into the recent past. However, forward looking outlook statements were cautious, with a focus on the impacts of higher interest rates. Those who released property valuations to 31 December 2022 mostly showed slightly negative revaluations with some reporting rental growth offsetting capitalisation rate expansion.

The industrial sub-sector continues to be the most sought after, given the tailwinds of e-commerce growth, the potential onshoring of key manufacturing categories and the decision by many corporates to build some redundancy into supply chains to cope with current disruptions. All of these factors will support ongoing demand for industrial space.

The jury is still out on exactly how tenants will use office space moving forward, but demand for good quality well located space remains. Transactional activity of office assets continues to provide some evidence of value, but transaction volumes have recently reduced.

We remain cognisant of the structural changes occurring in the retail sector with the growing penetration of online sales and the greater importance of experiential offering inside malls. Recent events will likely accelerate these changes. It is also interesting to note the juxtaposition of very high retail sales figures despite very low levels of consumer confidence, no doubt impacted by rising costs of living.

The recent increase in bond yields does present a headwind for all financial assets, and particularly yield based sectors such as property. However, with key large capitalisation REITs now trading at a significant discount to the value of their underlying assets and with no value ascribed to embedded active businesses, we believe the sector offers value, particularly in comparison to unlisted property.

Phoenix Portfolios has for some time discussed the risk of inflation, given the enormous fiscal stimulus and extreme monetary policy setting that we have lived through. In recent times, commentators and bond markets have begun to react to the presence of such a risk. In this environment, long leases with fixed rent bumps, which were previously in high demand, may become relatively less attractive. Historically, real assets such as property and infrastructure have performed well during inflationary periods.