The ASX REITs you should be watching as the Fed cuts and bond yields fall

UBS says Australian real estate stocks could benefit from the resurgence in US rate cut expectations.

According to CME's FedWatch tool, traders are pricing in a 90% chance that the Fed will cut interest rates by 25 bps in September. That's up from the 70.2% likelihood a week ago.

"US rate cut expectations have gone from "if" to how many – we have 25 bps at September, November and December," says UBS. While Australian rate cuts are not expected until 2025, local real estate stocks may benefit from a shift in the US yield curve.

An Odd Correlation

The lack of correlation between US bond yields and Australian REITs has taken place across a number of periods since 2000. UBS attributes this lack of correlation due to:

• Differing interest rate cycles and economic drivers between Australia and the US

• Crisis periods such as the GFC and COVID break down the correlation

• Debt levels in REITs at various stages throughout history place pressure on fundamentals

"However, for the last 4-5 years we have witnessed a period of rising rates and underperformance of REITs relative to equities," the report said.

"We expect as US interest rates fall improving the yield curve dynamics this may result in global REIT outperformance including Australian REITs."

Periods such as 2000-02, 2014-16 and 2018-19 demonstrated periods of falling yields and a strong correlation with Australian REIT performance.

ASX 200 A-REIT (blue) vs. US 10-year yield (yellow) | Source: TradingView

Stocks to watch

UBS says historical regression analysis suggests the outperformance of local REITs starts zero to four months prior to the first RBA rate cut. Economists currently expect the RBA to make its first rate cut in February 2025 while markets think it will be closer to July 2025.

UBS highlighted the following stocks based on its backtesting of total returns of the REITs sector, against changes to the Australian 10-year government bond yield.

• Residential stocks Stockland (ASX: SGP) and Mirvac (ASX: MGR)

• Retail real estate stocks Scentre Group (ASX: SCG), BWP Trust (ASX: BWP) and Charter Hall Retail REIT (ASX: CQR)

• Industrial Goodman Group (ASX: GMG)

• Higher beta value stocks such as GPT Group (ASX: GPT) and Charter Hall (ASX: CHC)

The analysts said that Stockland is currently trading at a price-to-earnings ratio of 13 and expected to deliver a 3-year EPS compound average growth rate of 7%.

Scentre Group was also viewed as a name with a moderate valuation and a solid near-term earnings growth trajectory. "Trading at a 14-times PE, we expect continued net operating growth momentum ... with a circa 4% 3-year EPS CAGR," says UBS.

On a separate note

Among the many pieces of analyst research I've encountered, one insight has particularly resonated with me: Morgan Stanley's finding that Charter Hall exhibits the strongest and most correlation with Australian 10-year bond yields.

"Charter Hall is by far the most linked to bond yields. Its P/E multiple has a -0.77 correlation vs. Australian 10 year bond yields, and -0.68 vs. US 10 year Treasury yields. Dexus is the second most linked at -0.66/-0.44. This means that as bond yields decline, the multiples of these two stocks generally re-rate upwards," the report said.

Charter Hall shares are up 12.9% in the past week, making it the second best performing A-REIT stock.

Top performing ASX 200 REITs

Data as at 11:30 am on Wednesday, 17 July (Source: Market Index)