Thank you, Mr Bond (market)

It’s a confusing time for investors, and just about everyone else. The experts were wrong about Brexit, Trump and many things in between. After market commentators (including APN analysts) forecast that ‘lower for longer’ was indeed a thing, Trump’s election victory prompted a rapid rise in long term bond yields that dented that view, at least temporarily.

Who cares, you might ask? Well, investors in Australian real estate investment trusts for one. If they’re looking for a reason why the REIT sector has fallen around the globe, blame it on Trump. Or Janet Yellen, who is busy talking up the prospect of rising rates in the US while the President-elect moves towards higher government debt.

All this chatter has had a local impact. Domestic bonds have been sold-off in sympathy, perpetuating a corresponding sell-off in dividend focussed stocks like AREITs. The effect is to detract from impressive first quarter operating updates from the sector, which offer better evidence of sound performance irrespective of bond market movements.

So, if you can see the value in focussing on factual reality rather than sentiment-driven speculation, which tends to drive short term movements in stock prices and bond markets, this is where income investors might look.

In short, the Australian economy and commercial property market are ticking along nicely. Office occupancy is high and rising (particularly the key office markets in Sydney and Melbourne), major shopping centres have very low vacancy and retailers are reporting sales growth. All of these are good for property trust investors because they bolster income security. Across the range of listed property trusts we cover, each either confirmed or increased their distribution guidance for the full year. It was further evidence that income investors need not worry about the recent sell off.

The following charts, showing four well-known and established AREITs that account for about half the sector’s capitalisation, tell the story.

Scentre Group (SCG) $21.9b market capitalisation In 2015, over 525 million customers visited a Scentre Group shopping centre, spending in excess of $22 billion

  • Occupancy >99.5%
  • Specialty store rental growth 4.6%
  • Growth in NTA of 10.6%
scg

Stockland (SGP) $9.9b market capitalisation Founded in 1952, today Stockland owns, manages and develops a diversified portfolio of $15.8b in real estate

  • Total residential net deposits up 47.8%
  • Growth in NTA of 3.8%
sgp

GPT Group (GPT) $8.2b market capitalisation Australia’s first property trust now manages over $19b in assets for over 30,000 investors

  • Office occupancy up 2.6% to >98%
  • Growth in NTA of 8.7%
gpt

Dexus Property Group (DXS) $8.4b market capitalisation Owner and/or manager of 1.8m square metres of office space spanning across 58 office properties 

  • Occupancy >96%
  • Office portfolio weighted average lease expiry extended to 4.9 years
  • Growth in NTA of 12.7%

Source: UBS Research, Company Announcements, Bloomberg, APN Property Group – 17 November 2016

dxs

Over the past 12 months these results show that key sector metrics are either stable or improving (the blue and black lines). And yet while earnings, distributions and net tangible assets (NTA) are rising, stock prices are falling (the red line). What’s going on?

If interest rates were actually rising, the share price decline might have some justification. Rising interest rates can directly affect a property trust’s net earnings (due to higher interest expenses). But rates aren’t rising in Australia and there’s not much evidence that they will for quite some time. So the income from property trusts is not under threat. However, rising bond rates can affect the investment market’s assessment of capitalisation rates, which has an impact on valuations.

Domestic interest rates are at historically low levels with no discernible catalyst for a rise. According to Bloomberg, 34 global economists arrived at a median forecast for the RBA cash rate of 1.25% by December 2017. That would be a new historic low. Eventually, rates will increase but the recent reaction in the local bond market looks like another false start.

It does, however, create an opportunity for genuine, income-focussed investors. Just three months ago APN’s AREIT Fund was yielding 5.56% pa (as at 1 August 2016)1. Now that figure has increased to 6.45% pa (as at 28 November 2016), and we have Mr Bond Market to thank for it.

The recent quarterly updates from Australia’s biggest property trusts should provide income investors with confidence. Operationally, the sector is travelling well. And, with domestic interest rates expected to test new historical lows, the secure, sustainable and transparent nature of AREIT distributions looks more attractive now than it did three months ago.

This article has been prepared by APN Funds Management Limited (ACN 080 674 479, AFSL No. 237500) for general information purposes only and without taking your objectives, financial situation or needs into account. You should consider these matters and read the product disclosure statement (PDS) for each of the funds described in this article in its entirety before you make an investment decision. The PDS contains important information about risks, costs and fees associated with an investment in the relevant fund. For a copy of the PDS and more details about a fund and its performance click here. To receive further updates and insights from the APN team, sign up for Review, our monthly email newsletter.

  1. As at 31 October 2016. Current running yield is calculated daily by dividing the annualised distribution rate by the latest entry unit price. Distributions may include a capital gains component. Past performance is not an indicator of future returns.