Citi backs ASX-listed REITs as markets price in four rate cuts by 2025

Australian real estate stocks are positioned for further upside as the looming interest rate cuts could boost property valuations and stimulate demand across key sectors, according to Citi.

The investment bank expects retail and residential properties to benefit most from the changing rate environment, while industrial assets maintain their appeal despite elevated supply concerns. The office sector, however, continues to lag behind other property types despite some signs of stabilisation.

Rate Cuts to Drive Affordability Improvements

Citi economists are now expecting four rate cuts by the end of 2025, potentially bringing the cash rate below 3% by 2026. This shift addresses persistent affordability challenges, particularly in the residential market where house prices have consistently outpaced income growth since late 2020.

The rate environment is expected to particularly benefit first-home buyers, who could see lower mortgage costs combined with new government support policies. Historical precedent from 2013-14, when similar rate cuts occurred, showed housing transaction volumes increasing by more than 20%, though price growth may be more moderate this time due to current affordability constraints.

Retail Sector Shows Strong Fundamentals

Australia's retail real estate market is showcasing robust supply-demand dynamics, with vacancy rates continuing to decline through the first quarter of 2025. Construction of new retail space remained subdued at just 13,140 square meters during the quarter, while population growth of 1.8% year-on-year — driven by overseas migration of 379,800 people over the trailing 12 months — is supporting underlying demand

Transaction activity in retail properties surged 158% compared to the first quarter of 2024, reaching $1.6 billion. This represents a 75% increase over the 10-year average for first-quarter activity. Cap rates have begun declining across all retail sub-sectors, supporting asset valuations as rental income shows stable improvement.

Industrial Market Maintains Appeal Despite Supply Concerns

The industrial and logistics sector continues to attract investor interest, with rents growing 7% year-on-year nationally during the first quarter. Brisbane and Melbourne led growth at 9% and 8% respectively, while Sydney and Perth maintained solid 6% increases.

Vacancy rates remain below 5% across most cities despite some increase from historic lows in 2022-23. However, supply is expected to accelerate significantly, with more than 3.5 million square meters of industrial space projected for completion in 2026, compared to 2 million square meters expected in 2025.

Residential Developers Face Improving Conditions

Construction cost growth has slowed dramatically to below post-COVID averages, creating a better environment for development margins. The residential market is expected to benefit from both lower rates and government stimulus targeting first-home buyers.

Among residential developers, companies with higher exposure to first-home buyers and affordable housing are positioned to benefit most from the anticipated upturn in demand, particularly as affordability pressures begin to ease.

Office Sector Stabilises But Lacks Catalyst

While office vacancies have stabilised across most cities, they remain elevated at 15.3% in Sydney and 18.6% in Melbourne — well above long-term averages of 8.5% and 10.1% respectively. Prime grade properties continue to show strong demand, but high incentives and capital expenditure requirements remain headwinds for cash flow generation.

Transaction volumes stayed low at $1.4 billion during the first quarter, though investor demand is expected to improve as interest rates fall and the bid-offer spread narrows on selective transactions.

Investment Outlook and Stock Picks

Citi maintains a preference for higher-growth real estate stocks positioned to benefit from the rate-cutting cycle, with Goodman Group (ASX: GMG) remaining the firm's top pick based on long-term data center demand and growth prospects.

The investment bank lifted Scentre Group (ASX: SCG) to its third-ranked position ahead of results season, citing strong retail fundamentals, historically high occupancy rates, landlord negotiating power over tenants, and falling debt costs as key drivers.

In the residential space, Citi prefers Stockland (ASX: SGP) over Mirvac Group (MGR), noting SGP's higher exposure to first-home buyers and affordable housing products that should benefit more directly from rate cuts and government stimulus. The firm expects SGP's earnings to see greater upside from the residential cycle recovery.

For industrial exposure beyond GMG, Citi highlights GPT Group (ASX: GPT) and Stockland as continuing to produce attractive income growth from their industrial portfolios. Charter Hall (ASX: CHC) and GPT are favored among diversified players with high sensitivity to interest rate cuts, particularly given their improving funds management businesses.

In the specialised sectors, Ingenia Communities (ASX: INA) remains the top pick for land lease exposure, while National Storage REIT (ASX: NSR) leads self-storage recommendations. Both sectors are expected to benefit from structural demographic trends including Australia's aging population.

The firm has upgraded several stocks on relative valuation grounds following recent underperformance, including Lifestyle Communities, Charter Hall Long WALE REIT, and Lendlease.

Despite some stabilisation in office fundamentals, Citi remains cautious on the sector relative to retail, industrial, self-storage, residential, and data centers, though GPT remains their key value pick in the office-exposed space.