Amy Pham

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 had seen lower growth among AREIT stocks recently, but there are signs 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 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 office sector, and gives us confidence we are sitting at 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 more higher quality, premium office assets – the Sydney vacancy rate for premium office is only 6% compared to the market at 15%.”

The Pengana High Conviction Property Securities Fund has delivered 9.3% per annum net of fees to investors since inception in 2020 for the period to 30 April 2025 – this compares to the S&P/ASX 300 A-REIT TR Index return of 5.6% per annum for the same period.

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Amy Pham

A-REIT securities are ripe for generating alpha as the asset class exhibits a wide divergence in performance among different stocks, according to a listed property investment specialist.

While the A-REIT index as a whole has rallied strongly, underlying performance across listed property is not uniform, according to Amy Pham, Portfolio Manager for the Pengana High Conviction Property Securities Fund, who recently hosted an investment and market update for Fund investors. “Interest rates stabilising and eventually coming down will benefit A-REITs.

“But the divergence in performance is currently the biggest I’ve seen, and is set to reward active management.

“There’s plenty of alpha to be generated over the medium-to-long-term while major sectors such as office continue to deal with structural change, and alternatives continue to grow.”

Ms Pham said much of the short-term focus will be on interest rates given listed property is known to move ahead of rate cuts. “We’re not economists, but whenever the RBA cuts interest rates A-REITs tend to outperform.

“The data shows A-REITs tend to move early, outperforming on average four months before the first interest rate cut.”

Structural changes in office property should continue to drive a divergence in performance, but office investors could take some heart in retail property’s recent trajectory. “There’s a sense that we’re closer to the bottom regarding office, but some structural shifts will take a little while to play out.

“More data is showing a structural shift to higher quality space. But vacancy rates are still high and it will take time to see the real earnings growth come back – and this is crucial because the recovery in office will need to be earnings led, not valuations led.

“Retail went through its own structural readjustment with online shopping, and many retail REITs are now doing well.

“Interest rates are obviously having some impact but recent reporting showed retail had been more resilient than the market anticipated.”

Ms Pham said several factors, including lower debt levels, have helped A-REITs to outperform global listed property over the last 12 months. “The average gearing levels for A-REIT stocks is 27%, which is modest globally and is influential considering interest rate settings.

“A-REITs performance also reflects the higher dividends paid when compared to G-REITs. We also see A-REITs have a higher exposure to A-Grade office property, while G-REITs are more exposed to B and C-Grade office property.”

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Amy Pham

2024 could be a turning point for AREITs following a period of rate hikes and rising bond yields, according to Amy Pham, Portfolio Manager for the Pengana High Conviction Property Securities Fund.

“While we don’t have a crystal ball the consensus view is that we are at or close to peak interest rates, which will be supportive for the sector.

“Australia tends to follow the US, and after a soft US CPI print in November the market is now factoring a rate cut as soon as first quarter of 2024.

“We saw bond yields locally and in the US retract below 5%, and the AREIT sector delivered close to 11% return for the month.”

Ms Pham said any recovery in AREITs over 2024 will not be a case of a rising tide lifting all boats. “There will be some AREITs that continue to be impacted by the high interest rates and struggle to generate earnings-per-share growth.

“The up-and-coming half yearly reporting season will be an important one. The market will assess who is best placed to take advantage of the recovery phase.”

The Pengana High Conviction Property Securities Fund continued to target quality AREITs, many of which were trading at more attractive valuations over 2023. “We have targeted some quality defensive stocks which have attractive leasing structures – for example, Scentre Group has been able to command long leases to major retailers with increases of CPI plus 2.5 per cent.

“For investors, the combination of steady income combined with underlying capital growth will always be powerful, and there has been good opportunity to target quality recently.”

Ms Pham said alternative property sectors including assets investing in healthcare, childcare, and data centres, would continue to provide counter-cyclical resilience to property portfolios.

“We are maintaining our weighting to the alternative sector with minor changes, switching amongst them as we see better value.

“Alternative property sectors often provide a way to invest in necessities, which are more resilient during economic downturns. The economy may slow but the need for critical services such as child care or data centres remains strong.

“We think alternatives will continue to have more presence in Australian real estate through 2024 and beyond”, Ms Pham concluded.

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Sustainability is becoming more closely linked to attracting quality tenants on longer leases, Ms Pham said. “Buildings have a large carbon footprint and anything to lower energy costs is going to increase yield.

“A more energy efficient building will reduce outgoings for the tenant and is more likely to attract more tenants and have higher occupancy levels.

“In the past three years, we are starting to see tenants’ preference for more sustainable buildings with high NABERS ratings of five stars and above – particularly from government tenants and large corporate tenants who may have substantial decarbonisation policies.

“This puts more pressure on older buildings and increases their risk of being latent.”

Ms Pham said AREITs were showing resilience but the transition to a higher interest rate regime was still playing out. “Earnings have been much more resilient than anticipated with most REITs maintaining their earnings guidance.

“As cost of capital has risen sharply from an average of 2.5% a year ago to now 5.5% the ability to deploy capital accretively is key to growing earnings and offsetting higher costs.

“For many years where the sector had benefited from cap rate compressions, many investors opted for a cheap passive exposure.

“Now we are entering a more challenging environment where the divergence in performance of different sub-sectors is greater than it has ever been – consider the difference between logistics vs office. Within sub-sectors such as office there has been a flight to quality.

“The ability to pick the best of breed managers and invest outside the benchmark is important in generating sound risk adjusted returns. Alternatives such as data centres, child care and health assets are also moving to the mainstream.”

Ms Pham has incorporated ESG into her valuations for several years. “ESG is used to manage risk, and forms part of our model for property valuation. We currently assign 30% of an AREITs value to ESG factors.”

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Ms Pham said property’s defensive nature should come into play across 2023. “As we head into a more challenging economy in 2023 listed property’s defensive characteristics, such as regular CPI-linked rent reviews, may become more compelling to investors.”

Ms Pham said AREITs have rarely been this cheap and there is a good argument that many AREITs were oversold during 2022. “The sector is trading at an 18% discount to NAV and close to 20% discount to NTA (excluding the fund managers such as Charter Hall Group and Goodman Group).

“Relative to Industrials, the AREIT sector is trading at 15x PE, a 2pt P/E discount to the ASX industrials and a reasonable discount to the relative long-term average.”

Currently, the AREIT sector is offering a forecast yield of 6% with a sustainable earnings growth of 4%.

With reporting season underway, Ms Pham said her team was keeping a keen eye on issues including capital management among AREIT stocks. “We remain focused on how companies manage their balance sheets and hedging profiles.

“Well capitalised companies should be able to take advantage of the expected decline in asset values through acquisitions, be less impacted by rising interest expenses and continue to grow their development pipeline.”

Ms Pham says Pengana expects asset values to correct in the order of 13% from their peaks. “Investors’ required returns have risen from around 6.50% at the start of 2022 to 7.25% today due to the rising cost of debt. The sub-sector with the highest downside risk in our view is office due to the work-from-home thematic, vacancy levels, and high incentives, though some quality office assets are showing resilience.”

Ms Pham says residential REITs have the potential to surprise following a tough period, with several factors hinting at a recovery. “Residential REITs are likely to benefit from the introduction of First Home Buyers Choice, the increase in immigration, and low vacancy rates.

“Interest rates could also have an influence on residential REITs if expectations of a cut later this year come to fruition, however we avoid making predictions on rates”, Ms Pham concluded.

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Ms Pham said recent quarterly updates shows the only sectors which reported an increase in valuations had greater earnings certainty. “Property assets in childcare, healthcare, and non-discretionary retail reported cap rate compressions as they continue to attract capital flows due to their relatively stable earnings profile.

“Alternative assets such as childcare, healthcare, seniors living and defensive retailing will continue to be relatively insulated. Their certainty of income is based on demand, which is driven by secular trends and long term stable tenancies.”

Ms Pham cited some June 2022 preliminary valuation increases on December 2021 including Arena REIT up 7.8%, HomeCo Wellness REIT up 4.1%, and an increase of 4.6% for HomeCo Daily Needs REIT.

“In other sectors, cap rate spreads to real yields are elevated for retail, on par for office and below average for industrial.”

Ms Pham said the office sector was looking slightly more vulnerable when compared to industrial and retail property. “Further pressure is being placed on rents due to the slow rebound to physical occupancy from pre-COVID levels, vacancy rates of over 12% in major cities and 30% tenant incentives.

“The flight to quality has also seen an increase in capex for older assets dragging on operating income in the near term.”

While industrial would seem to have the most downside risk on the surface, Ms Pham says this does not take into account some ongoing tailwinds. “Industrial has a positive outlook for rental growth based on continued demand and limited supply.

“This has driven rental growth to record levels, which are now up around 10% year-on-year in several eastern seaboard infill markets.

“Whilst growth will moderate, there is potential for high single digit growth to remain over the next two-to-three years, offsetting pressure from higher rates, due to structural tailwinds from the growth in e-commerce.”

About Pengana High Conviction Property Securities Fund

Australia’s only high conviction AREIT fund with an ESG focus: The Pengana High Conviction Property Securities Fund believes each security has an underlying or intrinsic value and that securities become mispriced at times relative to their value and each other, and seeks to exploit such market inefficiencies by employing an active, value-based investment style to capture the underlying cashflows generated from real estate assets and/or real estate businesses.

We believe that responsible investing is important to generate long-term sustainable returns. Incorporating ESG factors alongside financial measures provides a complete view of the risk/return characteristics of our property investments.

All positions are high conviction and assessed on a risk-reward basis, resulting in a concentrated portfolio of 10-20 securities

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The Pengana High Conviction Property Securities Fund was launched by the $3.8 billion Pengana Capital Group in March 2020, and invests in a concentrated portfolio of up to 20 property stocks including some alternative property securities, and has delivered returns of 14.2% per annum since inception, compared to the benchmark’s return of 5.8% per annum for the same period.

In its review, Lonsec said incorporating ESG into the valuation process was a strength of the Fund. Lonsec added: “The Manager is differentiated by seeking out growth situations in alternative property sectors and the high proportion of ESG factors in its valuation models will favour stocks well-rated on this basis.”

Amy Pham, Portfolio Manager for the Fund, said ESG was becoming an important factor in property securities investing. “We’re not traders, we look to take a high conviction in property securities, and ESG plays a big role in forming our convictions.

“ESG is influential in valuing quality property assets, along with assessing the strength of the fund managers. There’s a strong link between ESG and performance in property.

“For example, an asset with a high NABERS rating will attract better tenants and generally have a higher occupancy rate than an asset with a low NABERS rating (NABERS measures the energy efficiency of a building).”

Ms Pham also said the Fund liked alternative real estate assets. “Alternatives provide an opportunity to invest in assets which are necessities, such as healthcare, childcare, data centres.

“These assets tend to be less cyclical and less impacted by inflation and interest rates than some other property assets.”

Amy and her team will be hosting an investor update webinar on Tuesday 17 May which will allow investors and prospective investors an opportunity to get insight into the team’s current portfolio positioning and outlook for the Australian property sector. Details on the webinar can be found at pengana.com/propertyfund

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