Morgan Stanley: ASX 200 REITs to trend higher over the next 12 months

The expected decline in global interest rates and bond yields has set the scene for real estate valuations to trend positively over the next 12-18 months, according to Morgan Stanley.

"We think it is realistic to expect that in a downward rate environment, companies will start trading above NTA, or in the least, closer to NTA than the past two years," the analysts said in a note on Thursday.

Net tangible assets (NTA) is a valuation metric used to assess the value of a company's physical assets after deducting liabilities. It is particularly relevant for real estate companies, where tangible assets (e.g. property) make up the majority of the company's value.

Twelve months ago, the real estate stocks were trading at an average discount of 20-25% to NTAs, indicating poor investor confidence in property markets and rising interest rates.

Historically, REIT valuations have traded close to 1.0x NTAs. However, "they rarely trade in-line for any extended period, but rather above, or below. We think we could be heading into a period of above average NTAs," says Morgan Stanley.

Falling yields, higher NTAs

Using GPT Group (ASX: GPT) as an example, the analysts noted that:

• GPT has averaged a share price/NTAs of 0.95x over the past decade

• Its range within one standard deviation is quite wide, at 0.78x and 1.12x

• The spread indicates that when interest rates are expected to move down, the market would coincidentally anticipate cap rates to compress and asset values to increase in the future

• This anticipation and periods of lower rates results in stocks trading at a premium to NTAs

The below chart compares GPT Group's share price/NTA against the Australian 10-year bond yield (inverse). The chart reiterates:

• GPT and the broader REIT sector rarely trades near a 1.0x price/NTA

• It either trades at a premium or discount

• During periods of falling bond yields and interest rates (2013-2019), GPT generally traded between 1-1.3x its price/NTA

• GPT has not traded at a price/NTA of more than 1x since 2019 amid rising bond yields and the global hiking cycle

Source: Morgan Stanley Research

State of Play for ASX REITs

The analysts raised their target prices for REITs across the board, highlighting GPT Group (ASX: GPT), Scentre Group (ASX: SCG) and Charter Hall (ASX: CHC) as top picks for investors seeking to capitalise on the rate cut theme.

However, it's important to note that many real estate stocks have already seen significant gains of 30-50% since bond yields and inflation trends peaked in November 2023. While Morgan Stanley may see risks skewed to the upside, a large portion of this move may already be priced in.

Overweight Rated Stocks

Price as at 30 September 2024 close | Source: Morgan Stanley Research

Equal-weight Rated Stocks

Price as at 30 September 2024 close | Source: Morgan Stanley Research

Under-weight Rated Stocks

Price as at 30 September 2024 close | Source: Morgan Stanley Research