Offices on the nose as REITs take a $6b hit

“It does look like there is a bit further downside to office values, but not much,” said Pengana Capital fund manager Amy Pham.

Ms Pham noted that the office REITs were trading at 20 per cent plus discounts to book value, not far off the discounts achieved on sales like 1 Margaret Street. “This is what the market is factoring in,” she said.

Andrew Parsons, chief investment officer at Resolution Capital, said office valuations remained challenging, and internal rates of return (similar to total returns) inferred from most valuations would not be achieved.

“The good thing is that REITs are 1693388455 priced accordingly.”

Speaking after Dexus recorded a $1.2 billion or 6.9 per cent write-down across its office-heavy portfolio earlier this month, chief executive Darren Steinberg said he anticipated “further pressure on the valuations of real assets”.

In the retail sector, big mall landlords Scentre and Vicinity also took valuation hits, but these were comparatively small – falls of 0.6 per cent and 1.6 per cent were recorded respectively year-on-year.

Mall owners also surprised the market with their earnings resilience as they reported positive releasing spreads and growth in net operating income.

“The mall isn’t dead, it has been dealing with the onslaught of e-commerce but is reasserting its place as vital social infrastructure and a profitable way to sell goods and services,” Mr Parsons said.

Riding high on surging industrial rents, Goodman Group bucked the trend of write-downs with a $264 million valuation gain, while childcare centre landlords Arena REIT and Charter Hall Social Infrastucture Trust and self-storage specialist National Storage REIT stayed in the black.

“Underlying fundamentals continue to perform well across retail, industrial and specialty REITs in particular, with growth in net operating income offsetting some of the shifts in cap rates” said JP Morgan equity analysts Richard Jones, Solomon Zhang and Adam West.

Ms Pham said fund managers were “a lot more optimistic” about earnings growth than the “quite conservative guidance” provided by the REITs for FY24, which implies a 4.2 per cent year-on-year fall in earnings per share.

With inflation falling – CPI fell to 4.9 per cent  in July  – and interest rates peaking, Ms Pham predicted “good growth going forward” for REITs.

“Mirvac and Stockland have been quite conservative … and even sectors like discretionary retail are going to show that the market is quite resilient,” Ms Pham said.

“The office market has a bit of downside to go, but things are looking up,” she said.

Grant McCasker, head of Australian real estate research at UBS, said residential, in particular apartments (where Mirvac has exposure), had shown signs of improvement while the health of shopping centre portfolios was “better than expected heading into a consumer downturn”.

In its A-REITs note, JP Morgan’s analysts said one of the big surprises this reporting season were the “violent share price reactions” to results announcements as investors quickly rewarded rosier growth forecasts and punished those where earnings will come under pressure from higher debt costs.

“An average 3.1 per cent price move [up or down] on results day, marked one of the most volatile reporting season reactions we can recall for more than 10 years,” the analysts said.

Among the outperformers was Goodman Group, which rose 5.7 per on the day it released its full-year results and more than 14 per cent over the following week.

The JP Morgan analysts said investors were bullish on Goodman’s ability to sustain growth via its data centres exposure.

On the other hand, trusts like Charter Hall Long WALE REIT, which offered weak earnings guidance and whose cost of debt is expected to rise, got hammered, falling over 14 per cent in the fortnight after its results.

Mr Parsons said many REITs had been caught short by “interest hedging mistakes”.

“Rising interest rates were always going to impact earnings and distributions. But the situation was exacerbated by exposure to floating rate debt,” he said.

Mr Parsons said many REITs had about 40 per cent of their debt on floating or variable rates to “juice earning” believing rates would not go up and had been caught short.