What’s Next for AREITs? Bond Yields, Valuations & Market Trends
SGH Property Income Fund: December Quarter Update with Grant Berry, Lead Portfolio Manager, SGH Property Income Fund
Market environment: A Quarter of Significant Developments*
The December quarter was an eventful quarter. We had the US election. We also had a lot of data in terms of inflation coming through. The Federal Reserve was cutting rates, but notwithstanding that, we actually saw bond yields rise over the quarter. Nominal 10-year government bond yields in Australia rose from just under 4 percent to finish the quarter at just under 4.4 percent. While Australian inflationary linked bonds, real bond yields as we refer to them, rose from 1.68 percent to finish the quarter at 2.07 percent.
Now 2 percent is historically high in a post GFC context. That rise in real bond yields, as a valuation input, saw weakness in REIT pricing and generally it was in line with what you would expect given the magnitude of that softness in the bond yields.
Now with the REIT pricing recalibrating off that historically high real bond yield of 2 percent, we see many REITs as attractively priced.
SGH Property Income Fund Performance
Moving back to performance, we had strong performance coming through from two of the smaller securities that we hold in the SGH Property Income Fund, being Aspen Group as well as Peet Limited.
While three detractors came from the larger holdings and larger securities, I should say, or securities, being GPT Group, Dexis Property Group, and Stockland.
Valuation Strategy and Investment Approach
Investing in real assets for income
The SGH Property Income Fund is focused on investing in real assets for income. At the end of the quarter, the portfolio was trading at around a 15 percent discount to its net tangible asset backing and around a 20 percent discount to our internally derived net asset value which is based on through the cycle capitalisation rates. What I mean by through the cycle capitalisation rates is that we assume a more steady capitalisation rate over time so that we don’t fall in the trap of seeing securities being cheap, when at a discount to NTA when the NTA itself is very elevated. Or conversely, we don’t we don’t be scared to invest in securities when they’re trading above NTA if the NTAs are very, very depressed. So we take them a through the cycle view.
In terms of the portfolio, what we’ve been doing in the past year, we’ve been steadily moving the portfolio to smaller securities, which is where we see more value. And as I mentioned before, Aspen Group, as well as Peet Limited, are a couple of examples where that’s playing out very positively for the portfolio.
Fund’s Diversification Strategy
Our portfolio, that’s the SGH Property Income Fund, is well diversified. Aa at end of the quarter, we don’t have any individual security over the 10 percent. Now that contrasts markedly to the AREIT sector, which is very concentrated. In fact, we have one security, being Goodman Group, representing over 40 percent of the AREIT Indices.
Key portfolio Adjustments
What we’ve been doing with the portfolio, we’ve been adding to the positions in GPT Property Group. We’ve also been adding to Dexus Industria and we’ve introduced GrowthPoint Australia into the portfolio. GrowthPoint Australia is a group that we’ve been looking at for some time. It’s been attractively priced. What’s made us more enthusiastic is a change with a new fund manager and how he’s pivoting the group. They sold down some industrial assets into a partnership that should drive growth and importantly, also reduces gearing.
In terms of selling side or reducing, we’ve been reducing in Stockland. We like Stockland, it’s a high quality group. But the income yield as a consequence of strong price performance is not as attractive as it was. In fact, GPT, I mentioned earlier, has a higher income yield now, so we’ve used some of the proceeds to buy GPT. We’ve also been reducing Mirvac group as well. Mirvac, the yield is lower and also we’re a little bit more cautious on the quality of the income there as well.
Finally, we’ve been reducing our exposure to Charter Hall Retail. The reason why we’ve been doing that is they’ve been pursuing a takeover for Hotel Property Investments jointly with HostPlus. We’re a bit cautious on that takeover, reason being is that we believe that it adds more complexity to Charter Hall Retail for a number of reasons, as well as increasing the gearing of the entity.
A Long-Term, Income-Focused Strategy
The SGH Property Income Fund, as the name would imply, is about investing for income. So we’re looking to invest in real assets, delivering reliable, stable cash flow, coming primarily from rent.
Secondly, we’re looking for attractive pricing valuations. And at the end of December, the portfolio, as I mentioned earlier, is trading at a discount to its net tangible asset backing and our NAVs. So we’re seeing good value there. Now in terms of the discount to net tangible asset backing, it is after many of the AREITs have seen their NTAs decline, as interest rates were on the ascent.
Finally, we’re taking an active approach to building out the portfolio.
The portfolio is well diversified. We’ve been shifting it more into the smaller entities. Where we are seeing more value. We’re very cognisant of risk, and we’re looking to build out a portfolio that’s going to deliver for the long term.
Sector specific market insights
Retail is continuing to perform along in a very steady fashion.
Office, a bit more nuanced. Melbourne office market does have its challenges, but we are seeing an increased momentum in terms of return to office. Still elevated incentives, it’s the softest office market. Having said that, Brisbane and Perth office markets are strong. Sydney, we’re seeing green shoots emerging and we actually saw strong net absorption there quite recently. That’s take up of space by tenants. So we’re seeing a positive environment there.
Industrial we’re seeing a little bit of softness. The rental growth that we saw in, the past year or two has really come down and vacancy rates, while having been low, are on the ascent, so we’re a bit more cautious there.
Residential, I could be here all day talking about residential, but we all know that Australia has an undersupply of housing. And the supply is really the solution and that’s why we’ve got to focus on the developers that can deliver affordable product. And the best at doing that is really Stockland Group and Peet Limited, which are in our portfolio.
* The text has been edited for clarity.
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