There has been a definitive shift in the market from growth to value-based tangible assets and, for owners of existing assets, conditions look favourable for the coming period. At the same time, however, the impact of factors such as rising inflation need to be carefully considered.
We have been spending a lot of time thinking about inflation and its implications. The general consensus is inflation will continue rising in Australia, and it is already considerably higher in the US, hitting a 40-year high.
This is partly driven by supply chain issues, and it is likely that when this abates, some of the pressure will come off. Nonetheless, we expect inflation to be higher in the decade ahead than the preceding decade. Longer-term inflation expectations – over the next 10 years – are further exacerbated by geopolitical concerns globally.
However, retail-based AREITs are arguably one of the more protected investments against geopolitical risks such as the Russia-Ukraine crisis, as well as against rising inflation. Australia is sheltered in that the situation won’t prevent consumers from frequenting shopping centres or how they go about their daily lives.
It will, however, increase already stretched cost pressures of potentially building new assets, so property developers and builders are more exposed. This is only compounded by supply chain shortages for building materials such as bricks and timber. As a result, development orientated AREITs and particularly those on high multiples could derate.
On the other hand, the rising costs to build assets is good for existing owners of built form assets.
Lease structures are also important to provide the ability to grow rents in line with, or better than, inflation. Long-term leases with low fixed increases should therefore become less favourable.
We are also less enthusiastic towards a number of the high multiple growth-orientated groups within the AREIT sector in a rising yield environment.
Interest rates
In addition, there are a couple of elements investors need to consider with respect to rates. Should rates go up in the short term and debt is well hedged, then it shouldn’t have much of an impact on AREITs. However, if longer term rates rise because there’s an increasing risk premium, that will have a subsequent impact on stock valuations. Albeit if they rise because inflationary expectations are building, that should feed cash flow growth and arguably have a minimal impact on valuations.
Broader business and consumer conditions will continue to have a major role to play in how the office and retail property sectors perform.
Retail sector
Now out of lockdown, many retail assets are supporting tenant sales above pre-pandemic levels. While online sales growth is expected to outpace sales growth from physical retail, both are growing. Physical retail has responded with improved click and collect and longer-term mixed-use development opportunities.
There is growing appetite for people to go out, enjoy experiences and, with supply chain pressures potentially lifting prices, they are likely to shop with more intent and notably, the average purchases per visit have been rising.
Office sector
Critically, after a sustained period of lockdowns and working from home, net absorption (tenant demand) in the office sector is now heading in the right direction.
Changing people occupancy levels doesn’t automatically mean a rise in the official building vacancy levels, as the office may have peak and off-peak demand days. Tuesdays to Thursdays seem to be the more frequent days for the office.
We favour the Perth CBD market driven by the commodity boom, improving vacancy rates (albeit from high levels) and rental growth prospects.
While we are operating in an environment of elevated uncertainty, it is setting the scene for a continuation of higher inflation. This should favour quality developed real estate.
Grant Berry, director and portfolio manager at SG Hiscock & Company.
