The S&P/ASX 300 A-REIT Accumulation Index posted a very solid gain of 6.4 per cent, outperforming the broader equity market which fell by 2.6 per cent.
The quarter was dominated by the reporting season, with virtually all companies reporting either half-year or full-year results.
In most cases, for property and infrastructure stocks, reported figures were strong and outlook statements upbeat.
Retail was the best performing property sub-sector, up 8.9 per cent with strong positive contributions from all index constituents while the Industrial sub-sector was also strong, up 6.1 per cent with a solid first-half result from Goodman Group driving its share price up 6.4 per cent.
Office property stocks gained 4.8 per cent, with Dexus Property Group and Investa Office Fund up 5.9 per cent and 4.8 per cent respectively.
During the quarter, Dexus’ proposal to merge with Investa was rejected by Investa unitholders.
Sydney and Melbourne office conditions improving
Positive income growth from office portfolios was delivered, with positive fixed increases in existing leases offsetting the drag to earnings of the increased levels of incentives being required to retain or sign new tenants when leases expire.
While there appears to have been some moderation to the level of incentives required, with Sydney falling from low 30 per cent to high 20 per cent, the impact remains significant.
The Dexus portfolio, for example, recorded a small drop in net effective rent, while GPT’s office portfolio benefitted from a significant improvement in occupancy as newly signed leases in the MLC Centre start to contribute to income.
We take comfort from the key markets of Melbourne and Sydney showing positive net absorption over the past six months.
Perth and Brisbane markets are expected to remain difficult for some time, with valuations of Perth assets in particular seeing double-digit percentage falls in several cases.
Residential markets are strong
The overall picture across most developers remains very robust, with each of Mirvac, Stockland and Lend Lease recording record levels of pre-sales, thereby providing strong visibility in earnings for the next few years.
In all cases, activity has been brought forward to cater to strong levels of demand. Mirvac, for example, has a record $2.6 billion of exchanged pre-sales contracts on which it will deliver over the next three years.
Lend Lease, with a more geographically diversified portfolio, has pre-sold residential revenue of over $5 billion.
Settlement risk, now a key focus of investors, is currently minimal, with both Mirvac and Lend Lease reporting settlement problems below historical averages at less than 1 per cent of contracts.
Specialty sales growth improving
Our belief is that a strong property sector needs a robust retail sales environment given that retail property is by far the largest segment of the property market.
And as the specialty tenants pay the majority of the rent in retail, speciality sales growth is a key factor.
Specialty sales grew by 6.5 per cent, 5.3 per cent, 4.1 per cent and 6.9 per cent in the retail portfolios of GPT Group, Scentre Group, Stockland Group and Mirvac Group respectively.
While recent growth has been strong, it has still lagged rental growth over the typical five-year term of most specialty leases and the impact of this is felt at lease renewal, with negative releasing spreads.
However, in all cases the magnitude of these negative releasing spreads has reduced, to be typically in the 2-3 per cent range.
Cap rates compressed further, lifting NTA backing
With only one or two very stock-specific exceptions, core property stocks delivered net tangible asset (NTA) uplifts, continuing the theme we have seen across several recent reporting periods.
Office stocks led the way, where we have seen far more transactional activity in the direct markets, allowing valuers to sharpen their cap rates.
NTA uplifts for Dexus, Investa and Cromwell Property Group were 8.5 per cent, 9.9 per cent and 12.3 per cent respectively.
Offsetting the positive effect of property revaluations lifting NTAs was negative mark to market of interest rate derivatives, given lower interest rates.
With the listed property sector now yielding just under 5 per cent for the financial year ending June 2016 and with bond yields around 2.5 per cent, the yield premium of the sector continues to reside above its long-term average of 1.9 per cent.
Over the medium term, A-REIT earnings streams are relatively secure given the contracted nature of rental income and long average lease terms.
Further, financial leverage is low, with gearing across the sector of approximately 30 per cent (debt to total assets) making the sector a relatively low risk investment choice.
Stuart Cartledge is the investment manager of the Cromwell Phoenix Core Listed Property Fund.
