Why it's a golden period for Scentre Group and retail REITs: Morgan Stanley

Scentre Group (ASX: SCG), Australia’s largest shopping mall operator, is set to capitalise on expiring leases signed during the Covid-19 downturn, potentially boosting rental income over the next two years, according to Morgan Stanley.

The favorable conditions could drive a steady 4.5% annual growth in funds from operations (FFO) through 2027, making SCG an attractive pick for investors seeking stable real estate returns.

During 2020 and 2021, SCG inked over 5,000 lease agreements at steep discounts, with leasing spreads dropping 13.1% and 7.6%, respectively. These leases, typically spanning five to seven years, are now approaching renewal.

Leasing spreads refer to the percentage difference between the rent of a new or renewed lease and the rent of the previous lease for the same retail space. They indicate whether a landlord, like Scentre Group, is securing higher or lower rents when leases are renegotiated or new tenants move in.

Positive Leasing Spreads

With retail rents recovering, tenants renewing in 2025 and 2026 could face rent increases of up to 13% compared to peers who secured leases in 2024. About 40-50% of SCG’s specialty leases expiring in the next two years were signed during the 2020-2022 period, when rents were notably lower.

SCG has already shown signs of recovery, posting positive leasing spreads of 3.1% in 2023 and 2.0% in 2024 — the first gains since the company’s formation. This momentum is expected to continue as under-rented leases are renegotiated at higher rates, providing a natural tailwind for revenue growth. Unlike office-focused real estate investment trusts (REITs), SCG’s retail portfolio offers a clearer path to predictable cash flow, analysts note.

Same Thesis for Vicinity

Vicinity Centres (ASX: VCX), a smaller retail REIT, is also positioned to benefit from similar dynamics, though its gains may be less pronounced. VCX faced a 12.7% leasing spread decline in 2021, and upcoming renewals could lift rents by up to 14% for some tenants. However, SCG’s deeper rental discounts during the Covid years suggest a more sustained upside.

Positive view on Scentre Group

Morgan Stanley maintained an Overweight rating on SCG with a $4.34 target price, naming it their top pick among passive REITs.

SCG’s financial metrics enhance its appeal, trading at a modest 1.05x its net tangible assets and offering a 6.2% FFO yield.

Its 5.8% cost of debt aligns with current market rates, positioning SCG to benefit from anticipated interest rate cuts by the RBA. In contrast, VCX and office-heavy REIT Dexus face lower debt costs but may encounter rate-related challenges in 2026.

he company’s conservative strategy—focusing on small-scale mall upgrades rather than large capital projects—minimises disruptions and supports steady earnings. With 12,000 specialty stores across 42 malls, including high-traffic centers like Chermside and Bondi, SCG is well-placed to navigate economic uncertainties while delivering consistent returns.