Have ASX REITs hit rock bottom?

Bell Potter says beaten-up real estate stocks are a lot like green bananas – Some people like them but they’re not quite ready yet.

The broker initiated coverage of nine REITs on Wednesday and has demonstrated an early preference for those that have higher interest rate hedging, underlying earnings growth and exposure to defensive sub-sectors like healthcare. 

A ‘Cautious Sector View’

The ASX 200 hit a 12-month low last week and that weakness was led by the rate-sensitive REIT sector. 

To add some perspective, here are the number of ASX 200 stocks that made a fresh 52-week low between October 30 and November 3:

• Real Estate: 0 Highs, 17 Lows

• Financials: 0 Highs, 6 Lows

• Industrials: 0 Highs, 6 Lows

• Materials: : 0 Highs, 5 Lows

• Discretionary: 0 Highs, 5 Lows

• Healthcare: 0 Highs, 4 Lows

• Technology: 0 Highs, 2 Lows

• Staples: 1 High, 1 Low

• Utilities: 0 Highs, 0 Lows

• Energy: 0 Highs, 0 Lows

The ASX 200 found a temporary bottom on October 30 and rallied around 3.3% over the next five sessions. During this time, the S&P/ASX 200 Real Estate Index has had an outsized rally - up 7.7%.

“Despite some big moves in the past week driven by bond yields, REITs have underperformed broader equities on a 12-month basis (-0.3% ASX 200 A-REIT vs. +1.5% ASX 200) and since the cash rate started to rise in May 2022 (-5.1% ASX 200 A-REIT vs. -1.2% ASX 200),” the analysts said.

While all-important bond yields may be peaking, the analysts remain cautious about the overall sector given:

1. Bond market volatility and the recent increase in the long end of the curve create uncertainty for real estate investors

2. Cost of capital will dictate earnings growth and the ability to grow via development, acquisitions or necessitate disposals

3. Challenging 3rd party capital raising environment and dislocation in offshore markets where global investors can realise greater risk-adjusted returns

The State of Play

Bell Potter initiated coverage of 9 REITs, with a preference for founder-led, high-growth businesses or those with material value for mean reversion. The stocks that were assigned Buy ratings include:

• HMC Capital (ASX: HMC) – $5.55 target price

• HealthCo Healthcare & Wellness REIT (ASX: HCW) – $1.75 target price 

• Centuria Capital Group (ASX: CNI) – $1.55 target price 

• GDI Property Group (ASX: GDI) – $0.75 target price

• Dexus Convenience Retail REIT (ASX: DXC) – $2.85 target price

Three stocks received a Hold rating:

• Centuria Industrial REIT (ASX: CIP) – $3.20 target price 

• Centuria Office REIT (ASX: COF) – $1.25 target price 

• Homeco Daily Needs REIT (ASX: HDN) – $1.25 target price

The sole Sell-rated stock is Dexus Industrial REIT (ASX: DXI), with a $2.65 target price

‘Easy to See Value, Hard to See Catalysts’

The REIT sector presents significant value from a historical valuation perspective, according to Bell Potter. The key data points are:

• Material discount to NTAs – Approximately 27% discount 

• High dividend yields – Approximately 7.0%

• Undemanding PE ratios

“Despite the value screen, and acknowledging that we could be closer towards rate cycle peak … we are cautious overall on the sector given as bond markets remain volatile with the recent increase in the long end of the curve,” the analysts said.

Four Key Themes to Watch

#1 Cost of Capital: There is a strong correlation between 10-year bond yields and the REIT sector. The weighted average cost of capital for the sector almost doubled between FY22-23. While the rate of increase is slowing, analysts expect many REITs to face cost of debt headwinds. “Indeed, there are REITs still facing headwinds into FY26e which will mitigate earnings upside risk,” they said.

Source: Bell Potter

#2 Liquidity & 3rd Party Capital: The analysts believe the real estate sector remains liquid for now, but incrementally tougher than 12 months ago. “Global real estate private equity investors are more active offshore, having been the marginal investor and driving the higher volumes in prior years.”

Source: Bell Potter

#3 Sector Consolidation: Cheap valuations could see a pick up in M&A activity. “Any consolidation would be a positive for the sector … however, we anticipate that even with large discounting in other sub-sectors i.e. office, discounted valuation could persist for some time yet.”

Source: Bell Potter

#4 Sub-sector Preferences: The table below summarises the analysts views for sub-sector exposure.

Source: Bell Potter