Real estate falls as bond yields rise

Real estate took the brunt of investor fears over rising interest rates, necessary to curb rising inflation, with the S&P/ASX 200 Real Estate Index (ASX: XRE) and the S&P/ASX200 A-REIT’s Index (ASX: XPJ), the two worst performing sectors at noon, down -2.20% and -2.34% respectively.

Given that the Real estate sector is typically negatively correlated to long-term bond yields, declines experienced today weren’t a complete surprise.

The Australian government 10-year bond yield jumped to 4.09% while the three-year yield were also up at 3.76%, the highest level in a decade.

Sector underperformance

Adding the investor concerns over real estate, which ended August as the worst performing sector (down -3.2%), were the weaker-than-expected FY23 guidance by many REITS during the August reporting season, with rising debt costs resulting in downward revisions to broker earnings forecasts.

Overall, REITs have on a rolling 12-month basis, now underperformed the broader ASX200 -7.67%.

Interestingly, REITs underperformance in August follows the 54bps increase in yield for the Australian 10-year bond on the back of heightened inflation concerns.

Outperformers over the month were:

• Charter Hall Group (ASX: CHC) up 8.1%

• HealthCo Healthcare & Wellness REIT (ASX: HCW) up 4.4%,

• Scentre Group (ASX: SCG) up 4%

Underperformers over the month were:

• Centuria Office REIT (ASX: COF) down -11.6%

• Arena REIT (ASX: ARF) down -11.6%

• Centuria Capital Group (ASX: CNI) -11.4%

Why are REITs so exposed?

Admittedly, some real estate stocks are clearly more capable of weathering a rising interest rate environment than others.

However, the sector at large is more exposed to higher floating debt costs, which in varying degrees impact earnings, especially those with higher gearing levels and low hedging profiles.

Rising construction costs, potentially expanding cap rates, coupled with a major increase in the cost of debt finance may also make project commencement for many REITs increasingly problematic. 

REIT’s leading today’s falls

Only eight of the 76 listed companies in the real estate sector were up in afternoon trade, with smallcap property investor/developer, Axiom Properties (ASX: AXI) up 2% having climbed 8% higher in early morning trade, seemingly on the back of no news.

At the bigger end of town, it was Dexus (ASX: DXS) and Vicinity Centres (ASX: VCX) with the biggest falls today, down -3.67 and -3.37% respectively.

Blue sky

Despite FY23 earnings guidance being lower than expected, some encouraging takeaways following reporting season notes Credit Suisse are:

• Rising sector occupancy over the year

• Retail sales showing signs of improvement, as are Retail re-leasing spreads.

• Office incentives trended higher

• Tailwinds from rising industrial market rents are expected to take some time to cycle through REIT portfolios.