Grant Berry

The latest reporting season has reinforced the resilience of the AREIT sector, with improving residential momentum and stable operating fundamentals despite ongoing interest rate uncertainty, according to Grant Berry, AREIT portfolio manager at SG Hiscock.

“Reporting season reinforced the resilience of REITs,” said Berry. “While markets have been cautious, particularly around rates, fundamentals have held up well.”

Berry said residential was the clearest positive theme of the season.

“There was some caution around residential REITs heading into results, but first-half outcomes generally came in slightly above expectations,” he said.

Berry highlighted Mirvac, which exceeded first-half expectations, while improving sales trends were evident at Stockland, Peet, and Cedar Woods Properties.

“Peet was the standout, with EPS up more than 100 per cent on the previous half. That’s clear evidence that enquiries are translating into sales,” Berry said.

Importantly, demand has remained firm despite a recent rate rise and expectations of further modest tightening. Berry noted that real bond yields have remained broadly stable at around 2.4 – 2.5 per cent since early February.

“That stability is important because it means the valuation backdrop has not materially shifted,” he said.

“On short term rates unless we see two to three additional 25 basis point increases, we do not expect a material impact on underlying residential activity.

More broadly, AREIT operating fundamentals were stable to improving, despite the sector being down around 3 per cent over the month.

Occupancy levels remained stable across most subsectors. Retail sales growth averaged around 3 per cent, office leasing conditions were mixed but showed signs of bottoming, with some valuation upticks, while industrial assets continued to deliver solid re-leasing spreads.

“Office is where we continue to see opportunity,” he said. “Cromwell Property Group was a standout performer during the season following significant balance sheet repair and simplification in recent years.

“We initiated our position last year at a deep discount when an exiting securityholder created the opportunity. It performed strongly through reporting season.”

Dexus, the largest listed office REIT with a high-quality portfolio, also announced a buyback, highlighting the disconnect between underlying asset values and listed prices.

“That buyback was well received and underscores the value on offer.”

While Berry sees less relative value in some large-format retail, he noted that Scentre Group delivered solid operational outcomes but slightly disappointed the market with 4 per cent calendar year growth guidance.

In contrast, neighbourhood-focused retail remains attractive. Region Group, which predominantly owns neighbourhood shopping centres, continues to benefit from resilient tenant sales, leasing conditions and a strong balance sheet.

“It’s a well-defined, resilient business with a new CEO. It’s the sort of ‘sleep well at night’ stock we favour.”

Similarly, Waypoint REIT – focused on service station and convenience retail assets – has delivered resilient earnings and benefited from prior buybacks, with approximately 70 per cent of its portfolio in metropolitan locations.

“Despite concerns around EV disruption on service stations, this is fundamentally a land-rich real estate portfolio that has performed well.”

Berry emphasised that diversification remains essential, particularly given index concentration.

“The sector is highly concentrated, with Goodman Group representing roughly 35 per cent of the index. While Goodman remains a high-quality business, it slightly disappointed the market on data centre leasing.

“With real bond yields still elevated, valuation discipline is critical. We would rather position for value than be carried away by growth themes.”

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Grant Berry

Falling official interest rates means investors are seeking alternative forms of income, and real estate investment trusts (REITs) offer the opportunity to access reliable income and capital gains, with the current cycle of official interest rate cuts a positive for REITs, according to Grant Berry, portfolio manager at SG Hiscock & Company.

Contributing to this within Australia is the high demand from population growth, coupled with elevated construction costs and economic uncertainty, leading to less supply, which is all supporting returns from REITs, he says.

“While we see increasing downside risks for economic growth in Australia and offshore, there are still supportive tailwinds for the REIT sector. Population growth is robust, and forecast to continue,” says Mr Berry.

“Research from CBRE has forecasted that the Australian population will rise to 32 million by 2035, which represents an increase of 4.5 million people over next 10 years.

“Population growth ultimately drives occupancy demand for property. In Australia, the growth is much greater than most other developed nations, and that growth will help to support the demand for Australian commercial property.

“In particular, greater population numbers will raise the need for hospitals, housing, logistics facilities, and we will also need more retail and office space. The CBRE research shows that with each additional 1 million increase in the population, it will require 4,500,000 square metres for logistics, 800,000 square metres for retail, 800,000 square metres for office and 420,000 new residential dwellings. These are all significant numbers,” he says.

The supply dynamics are also an interesting aspect in that brining on supply is challenging in many subsectors due to land constraints, associated planning or economics due to elevated construction costs. Strong demand and low levels of new supply supports the investment case for existing quality real estate. According to Mr Berry retail spaces are a challenge, and vacancy rates in offices are slowing down supply.

“It is a challenge to supply retail spaces, as the associated planning and costs to build on land in urban locations is proving difficult. In the office space, planning and supply is easier given the vertical nature of office buildings. However, vacancy rates are elevated, and construction costs have risen in the order of 40 per cent in recent years. Hence not much supply there. In the industrial and logistics space, there is more supply and while there are areas that are more challenging, such as infill locations, we did in fact have a record year of supply in 2024.  Which is why we prefer retail and office.

“On top of all of this, lower quality assets can be withdrawn from the market for alternative uses such as old office buildings converted to residential,” he says.

Further interest rate cuts and government policy are additional tailwinds for the residential subsector. Mr Berry says that a relatively good regulatory environment and corporate governance in Australia is favourable for commercial property investment in Australia from an international perspective with a low Australian dollar a potential attraction.

Meanwhile, falling bond yields and healthy credit spreads make the real estate sector’s dividend payments more appealing; these securities historically paid higher dividend yields than other equity classes, offering an alternative source of potential income, according to Mr Berry.

“Bond yields for valuation metrics, that is nominal bond yields, feed into discount rates and inflation linked bonds (real bonds), which we believe have relevance to capitalisation rates and property yields. Both are currently elevated in a post GFC context. If property is priced with reference to this, it sets up the asset class for good long-term returns.

“Investing in an Australian REIT can help investors diversify, have exposure to high quality assets and lower transaction costs without buying actual property. Investors gain exposure to different property sectors and real estate assets and such diversification is hard to achieve by investing directly in commercial property given the significant costs and scale involved,” Mr Berry says.

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Grant Berry

Australian investors need to focus less on short-term disruptions and place greater emphasis on investments likely to offer long term sustainable earnings growth, according to SG Hiscock & Company portfolio managers.

Hamish Tadgell, portfolio manager of the SGH High Conviction Fund, said the emergence of the omicron variant of COVID-19 highlights the current uncertainty facing investors and need to take advantage of developments through taking a longer a long-term view that allows for flexibility.

“Investors need to be aware that an over-reliance on models can be dangerous, resulting in them not seeing the wood for the trees, or understanding the real issues facing them. They need to be able to adapt to change and take advantage of emerging trends such as the seismic shifts underway in decarbonisation and social infrastructure.

“It’s important that investors don’t fear uncertainty – it forces change, new ways of doing things, ingenuity, entrepreneurship. It is fundamental to an understanding of social, technological, and economic progress.“If we can manage risk, we can not only live with uncertainty but paradoxically enjoy it!

Uncertainty forces change, new ways of doing things, ingenuity, entrepreneurship. It is fundamental to an understanding of social, technological, and economic progress.

“We need to think about how to position the portfolio in the face of heightened inflation risk,” he said.

Mr Tadgell said it is hard to know if the current inflation pressures will be more structural in nature starting a regime change and shift from the deflationary era of the last 30 years to an inflationary era.

“But there is little question in our mind the inflation risk has increased with the COVID shock and unprecedented fiscal intervention and it seems prudent portfolio risk management to build some inflation protection into portfolios.“Long term secular forces are important drivers of future returns but we think it is important to have a barbell approach to manage the short-term forces and uncertainty. Identifying quality stocks with sustainable earnings growth is key in this environment. Some areas of likely growth include social infrastructure, debcarbonisation and national security,” he said.

Portfolio manager of the SGH Medical Technology Fund, Rory Hunter, agrees, and said seismic shifts in the way people live are accelerating technological and social investment themes, in particular.

“While there is currently excess liquidity in the market, investors are being more selective in identifying longer term stocks.

“All the demand drivers are in place to drive the performance of medical technology investments but there are valuation headwinds in the near-term. Investors continue to position portfolios to withstand a removal of the excess liquidity which has been a mainstay of financial markets since the onset of the pandemic.

“An oversupply of healthcare companies listing on the ASX and the macroeconomic backdrop has created short-term headwinds,” he said.

Grant Berry, AREIT portfolio manager, says the trend of short-term headwinds but longer-term tailwinds can also be identified in listed real estate investments.

“Broader business and consumer conditions continue to have a major role to play in how the office and retail property sectors perform respectively. When out of lockdown, many retail assets are supporting tenant sales above pre-pandemic levels. While we expect online sales growth to outpace sales growth from physical retail, both are growing. Physical retail has responded with improved click and collect and longer-term mixed-use development opportunities.

“Likewise, while flexible working arrangements are affecting office demand, we are also seeing that changing “people occupancy” levels don’t automatically mean a rise in official building vacancy levels, as the office may have peak and off-peak demand days. For example, in Perth CBD people occupancy is at 76 per cent of the pre-pandemic levels yet the official vacancy rate has declined to the lowest level in over five years.

“Industrial property is the favoured subsector; however, with the sharpest yields and limited differentiation in pricing between quality and secondary assets, we are more cautious.

“For 2022, the overarching message is that investors should be prepared to deal with ongoing uncertainty but they shouldn’t fear this. Instead, they should be on the lookout for the quality investment opportunities that will inevitably arise.”

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Hamish Tadgell

The market continues to shift from the hope to the growth phase as the Australian economy rebounds from the shock of the COVID-19 pandemic and associated lockdowns, but new risks are emerging that investors’ need to position for, according to portfolio managers at SG Hiscock & Company.

Hamish Tadgell, Australian equities portfolio manager, said the recovery in the last 12 months has proceeded faster than widely expected driven by the extraordinary level of policy support and vaccine roll-out.

“The unique nature of this crisis has seen an unusually sharp rotation and outperformance of cyclical versus defensive sectors over the last year, but the recovery has followed a fairly typical pattern from despair to hope to growth.

“While the cyclical recovery is now clear for investors to see, the risk is we are fast approaching peak growth, and as this cycle matures, growth remains positive but slows.

It’s to be expected that the rate of change and growth momentum will start to slow, but it seems premature to be calling the end of the cycle.

Business confidence and conditions are at – or close to – all-time highs in most developed countries, including Australia, and labour markets are still recovering, with central banks, including the RBA, adopting a broader measure of full employment before considering policy normalisation.

“Against this backdrop, there are little signs government fiscal policies are about to be prematurely withdrawn,” said Mr Tadgell.

Grant Berry, AREIT portfolio manager, said this theme is apparent in domestic property markets also.

“While there are some property investments trading on very high multiples, there is also a number of AREIT assets that are underappreciated by the market. Low price doesn’t necessarily mean low quality at the moment; nor does high price mean high quality. There are opportunities to gain exposure to quality core real estate at a discount with attractive yields.

“For example, in the office property sector, there is no doubt the rise of working from home is having an impact on office occupation. However, there will remain a place for offices; the key is to select the locations and set-ups that can grow. CBD offices may still be challenged but we have been increasing our exposure to suburban offices with lower rents, good parking and more favourable tenancy demand,” he said.

Mr Berry is also seeing opportunities for REITs with convenience retail holdings, and is increasing the Fund’s exposure to this subsector, “given favourable pricing, while benefitting from consumers shopping more locally.”

He expects growth in niche property AREIT sectors, which can be less economically sensitive, however pricing needs to be considered as they can trade at premiums to private market levels as well as core real estate within the AREIT sector.

Mr Tadgell added that a key question for investors is around inflation risk, and whether inflation is transitory or structural and how central banks will respond to this dilemma.

“The thing we are conscious of is investors have not seen an environment of strong synchronised global growth, rising commodity prices and inflation expectations for three decades.

“Investors didn’t really expect high levels of inflation in the early 1970’s to persist initially. It took some time for expectations to adjust. Similarly, in the early 1980’s, investors were doubtful of the start of a new deflation trend. Looking back over the last 100 years it’s also notable rising inflation rate episodes were mostly due to unexpected supply shocks leading to sustained increases in prices.

“The COVID crisis has been a major shock to the system, and the effective lockdown of all economies has arguably resulted in the biggest global supply shock in history,” he said.

Mr Tadgell said it’s important to recognise the forces of deflation have proved to be powerful and persistent, and the combination of extreme monetary policy, technology disruption and an aging population have been highly influential in contributing to the economic circumstances and disinflationary setting.

“The dominant secular and structural trends emerging from this crisis are far from clear, but we are seeing the maturing of the cycle, changing growth outlook and inflation risks requiring a more nuanced approach rather than necessarily through the lens of growth versus value.

“As a result, we’re focusing on identifying opportunities and building a portfolio around companies with pricing power, cyclicals leveraged to the cycle, and structural growth companies that have been derated on the back of higher inflation expectations. We’re also avoiding longer-duration assets without an adequate margin of safety or clear catalyst to re-rating, said Mr Tadgell.

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Grant Berry

There continues to be exceptionally high quality opportunities in Australian real estate investment trusts (AREITs) which can deliver attractive and sustainable yield for investors, says Grant Berry, portfolio manager at SG Hiscock.

“While the economic recovery in Australia is well underway, it still has some way to run and we are particularly seeing this in AREITs where there are still assets that are underappreciated by the market.

“Low price doesn’t necessarily mean low quality at the moment, and we are still in the early stages of the rotation away from growth, which means that a number of good quality groups are still undervalued.”

Mr Berry pointed out that taking a conservative valuation approach and building in a rise in bond yields, the SGH property portfolio is considerably  cheaper than the AREIT sector overall.

“This is primarily due to our focus on companies that provide rental income as their main business, not those that are also undertaking other activities such as development or funds management.

“Over the past five years or so, there has been a huge shift within the AREIT sector where there are now a big proportion of groups that generate much of their operating earnings from activities other than owning and renting out properties, which creates risk for those taking an index approach.

“We believe that investors who focus on real assets and rent generation will benefit in the over the longer term,” Mr Berry said.

He also said that feedback from advisers shows that most have a preference for listed property in their clients’ investment portfolios, with the pricing of traditional REITs compared to direct property a key reason for this.

“When we surveyed some clients recently, over three quarters said that they prefer listed property over direct property, and over 90 percent said that the pricing of REITs is more appealing relative to direct property.

“Investors can also benefit from exposure to property sectors that they can’t otherwise easily access, some of which are experiencing good momentum at the moment.

“For instance, retail has undoubtedly had a challenging year but there are some real positives at the moment.

“Household balance sheets are in great shape, boosted by the limited travel opportunities over the past 12 months along with the wealth effect of rising house prices.  Coupled with very high consumer confidence levels, and momentum in foot traffic data, we believe that retail is showing good potential.

“The office sector is also in an interesting place right now.  The rise of “working from home” will definitely have an impact but at the same time, most people recognise the benefits of spending the majority of their time in an office environment.

“Certainly this is having a material impact on lower rental growth outlooks, particularly in CBD locations.  However, we have been increasing our exposure to suburban offices with have lower rents, good parking and more favourable tenancy demand. There are a number of office exposed REITs whose security prices are approximately 30 percent lower

“Overall, we believe that business conditions will trump disruption as the long term driver, and at the moment business conditions are rebounding strongly,” Mr Berry said.

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Grant Berry

The recent reporting season saw some good results for Australian real estate investment trusts (REITs) but the macro economic environment had a more significant role to play in performance during February, says Grant Berry, Director and Portfolio Manager at SG Hiscock & Company.

“Overall, it was a good reporting period for REITs, with relatively stable valuations compared with just six months ago and earlier expectations.  Occupancy has held up well and low interest rates have provided good tailwinds for REITs.

“In the retail sector, recent sales and foot traffic data are very encouraging, particularly in local shopping and large format centres.  In hindsight, the provisioning of retail-oriented REITs has been overly conservative.   We saw some tenants opportunistically pushed to change long term rental structures based on sales but ultimately this has not materialised.

“We now move into recovery with multi-decade high household savings, a buoyant housing market, strong consumer confidence, and the ability and willingness to get out more.”

Looking at the office sector, Mr Berry there are question marks over how the “work from home” trend takes shape in the future.

“Increased flexibility will be a feature going forward, with working from home having greater prominence than it did before the COVID-related lockdowns.  However, it will not become the “new normal”.  Incentives increased to around 30 percent in most markets over 2020, and we believe that business conditions will continue to be the long term driver for demand.

“In terms of industrial real estate, pricing is very firm with the lowest capitalisation rates of the core sectors – a beneficiary of lockdowns with increased demand from retail occupiers well beyond the normal run rate.

“The question is: does what is now the sharpest priced subsector provide the best prospects for future returns? We would suggest this is unlikely, particularly if we move into an environment of rising real bond yields and a re-opening economy.

“The macro impact of rising bond yields overshadowed reporting season, making for a weak month for REIT prices impacted by the more growth orientated fund managers which make up around 30 percent of the index.

“Bond yields have risen quickly, putting pressure on bond beneficiaries and growth oriented entities, and have had an overall negative impact on the sector.  Our view is that there will be a concerted effort by central banks to keep bond yields low but the negative real yield scenario is not something we base our long term investment decisions on.  For this reason, we are allowing for some capitalisation rate expansion.

“There continues to be good value to be found in exceptional quality assets that were underappreciated by the market during the lock-down disruption and we believe the global recovery and reopening has further to run, along with the value rotation in markets, particularly, as vaccines continue to be rolled out.

“There are also interesting opportunities in alternative real estate for diversification and potential re-rating but we would caution investors not to overlook the core subsectors, where the discounts can be more prominent.

“We continue to position our portfolio for the recovery trade, and we have started to see the benefits first through residential, more recently retail and there is the prospects for selective office REITs recovery in the future,” Mr Berry said.

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Grant Berry

The Australian Real Estate Investment Trust (AREIT) sector may have taken a COVID-19 hit however short-term implications should not deter investors from taking a longer-term view of the market, says Grant Berry, SG Hiscock & Co portfolio manager of AREITs. 

“REITS are now in a far better position than where they were at the start of the last economic crisis, pre GFC – they’ve got lower gearing, more diversified debt, longer tenure and higher interest cover ratios.

“Real estate is also a real asset, with a growing income profile over time, and this will always prove attractive for many investors. Therefore, they are well positioned to recover from the current downturn.

“The extent of the recent REIT sell-off was surprising but, having said that, we had been cautioning for some time on the late cycle pricing and fundamentals. We had been pushing up capitalisation rates and assigning lower multiples for other income sources, so while the global shutdown impacted REITs, it wasn’t through inappropriate gearing up, owning poor assets or embarking on other non-core activities,” he said.

Furthermore, monetary policy and extensive fiscal stimulus measures announced by the Federal Government over recent months has also provided support to the REIT market. The improvement in the COVID-19 situation in Australia is ahead of expectations, which has led to the opening up of the economy, with REITs now positively impacted.

The temporary shutdown of assets had been especially disruptive for SME retail tenants, according to Mr Berry, with many landlords providing assistance through rental waivers and deferrals in line with the National Code of Conduct.

“The ability for landlords to work constructively with tenants will likely see businesses and the asset itself best positioned for the recovery phase,” he said.

At the retail subsector level, consumer sentiment has returned strongly from very low levels and, with the opening up of the economy, there has been material improvements in foot traffic, in many cases not far below pre-COVID levels. While conditions are tough and there will be challenges, Mr Berry identifies value across the retail REIT sector.

In terms of the office subsector, tenant demand has continued to soften and this is expected to continue in a recessionary environment.

“However, offsetting this vacancy are at low levels in the Sydney and Melbourne CBDs. The introduction of social distancing measures may further assist in pushing against the continued densification of workspaces, such as hot-desking, which is positive.

“Corporates have been largely working from home for a number of months now and, while there’s always been a degree of cynicism regarding staff productivity, COVID-19 has demonstrated that the workforce can be highly productive when working from home. The benefits of an office will remain for collaboration, idea generation and face-to-face meetings, but there will undoubtedly be some changes moving forward,” he said. 

As a result, Mr Berry believes the opportunities across east coast capital cities will be in suburban markets, largely due to uncertainty around office commuting.

“Our preferred CBD office market is Perth, as it’s in the recovery phase with more attractive value metrics and has a far easier commute to the CBD than other Australian capitals.

“Overall, REITs are managing through a very challenging environment…they were at the front line of closing down the economy but are poised to lead in the recovery,” he said.

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Grant Berry

The strong performance by the Australian Real Estate Investment Trust (AREIT) sector in 2019 will continue to be well supported throughout the coming 12 months should bond yields remain low, according to SG Hiscock & Co director and portfolio manager, Grant Berry.

However, Mr Berry said 2020 is very unlikely to match the returns of last year, with investors needing to recognise there are increasing risks emerging, particularly at such a late stage in the investment cycle.

“We’ll be continuing to take a fairly conservative approach to valuations pushing up capitalisation rates.

“Our preference will be to have exposure to high quality assets, AREITs with less cyclical factors, and investments trading at discounts that are out of favour. The recent shift towards value, with some reduction in risk behaviour, has seen this approach start to outperform while continuing to deliver good absolute returns,” he said.

While geopolitical issues weighed heavily on global markets last year, it was also an interesting year for the Australian property market and its various subsectors.

In late 2018, the US Federal Reserve pivoted from a more hawkish to dovish position which continued into 2019, while the Reserve Bank of Australia cut interest rates post the Federal Election and continued to be accommodative as the year progressed.

According to Mr Berry, this provided a favourable backdrop for property driven by an appetite for yield.

“For the past two years, we have been at an advanced stage in the property cycle, particularly for commercial office and industrial property sectors. Capitalisation rates (rental yields) are below levels experienced in prior peaks, with the lower bond yield environment extending pricing of property assets.

From a portfolio perspective, we adopt a more conservative through-the-cycle approach in our investment analysis. The reason we do this is to become cautious at advanced stages of the cycle, and opportunistic when prices are attractive,” he said.

Across the broader investment spectrum, including equity markets, there has been a very significant divergence between growth and value companies, and the property sector sits within this broader context of late cycle, higher pricing and a more elevated risk appetite.

2019 has been a relatively good year for the AREIT sector, with strong returns including distributions and, looking ahead, if bond yields stay around current levels, we would expect the sector to be well supported,” Mr Berry said.

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Grant Berry

The volatility in equity markets has led to investors seeking more defensive investment options with Australian real estate investment trusts (AREITs) regarded as a useful alternative, says SG Hiscock & Company’s director and portfolio manager, Grant Berry.  

“REITS, or listed real estate, has the attraction of more predictable income streams than many mainstream equities, thanks to lease agreements that include annual fixed increases, CPI inflation increases and, in some cases, inflation plus increases.

“As an investment option, AREITs reflect the real, tangible nature of real estate. If gearing is low there is the appeal of knowing that there are real assets supporting value. As a result, AREITS have been an attractive option for investors who are seeking stable income as well as capital growth,” he said.

However, Mr Berry said investors need to understand the sources of income for REITs, as well as the assets and balance that support the investment, particularly as the property cycle reaches its later stages.

“While balance sheets are overall very healthy in the current low interest rate environment, given the stage we’re at in the property cycle, some of the drivers of recent growth within AREITs may start to taper off. 

“Investors should be aware that many AREITs undertake other activities such as development and third-party management, which create additional sources of income, but which may be vulnerable in the late stage of the cycle. 

“At the moment, there is considerable pricing dispersion within AREITs and, on our analysis, this is at the widest level since the global financial crisis. Investors therefore need to ensure they fully understand the current risks as well as the opportunities within the sector,” he said.

Mr Berry said the market is ascribing a considerable premium for what are considered higher growth groups, with earnings from development and funds management in particular. 

“This is late cycle behaviour, and warrants caution.

“Across the property sector, some trusts have had more investment support than others – in particular, industrial and office-focused REITs; however, the rental growth is more short-term than long-term, as pricing is very conducive for development, which will lead to increased supply.  

“At the other end of the spectrum, we are also observing high quality and lower risk groups trading at discounts to their asset backing, which we believe provides a real opportunity,” Mr Berry said.

He added that an unprecedented low interest rate environment, low capitalisation rates, e-commerce and the flow of capital are collectively driving the performance of the AREIT sector.

“Looking ahead, improved consumer sentiment, a bottoming-out in residential and the implementation of anticipated tax offsets will serve to improve confidence in retail and residential-exposed AREITs.”

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