Risk is a constant theme for investors and is never more front of mind than amid a once-in-a-generation bull market.

• Investors wary of market rally ending
• But risk pricing indicates benign outlook
• Low institutional complacency a good sign

THE S&P 500 has not had a 5 per cent fall since before last year’s US presidential elections, soaring by more than a third since those lows.

In Australia, the S&P/ASX200 is up by a quarter over the same time frame.

Conventional wisdom says the longer markets rise, the more risk of correction must be building in the system.

But this time around the conventional wisdom looks wanting, according to Tom Ciszewski, a volatility analyst with Pendal’s Bonds, Income and Defensive Strategies team.

Risk measures and positioning can often be a contrarian indicator says Ciszewski.

When investors are hedging themselves it often can be supportive of further bullish performance. On the other hand low hedging and bearish positioning can be a sign of complacency and a relative market top.

“The way derivative risk and implied volatility is priced right now in equities globally, it’s actually pricing in for a pretty benign environment,” he says.

Ciszewski says investors should keep a close watch on how big institutions position themselves in derivatives markets as they protect their portfolios against the risk downturn.

Perhaps paradoxically, Ciszewski’s confidence is founded on the fact that institutions have been buying downside protection as the market rises.

This is because in the past over-confidence and complacency among institutional investors is an indicator that markets may be close to topping out.

“You’re always looking for when and how things will blow up. What is the next downturn going to be and how will we make money during it?” says Ciszewski.

“But right now, there’s very little complacency. The institutions are giving up a little upside to buy more downside,” he says.

Measuring institutional sentiment

One way to measure institutional sentiment is the ratio of put and call options being traded.

A high put/call ratio indicates more people are buying puts than are buying calls. It’s an indicator that investors are protecting themselves against potential market falls.

The SPX put/call ratio, which measures options on the S&P500, has risen over the past year to above two. That indicates twice as many put options as call options are trading on some days.

Ciszewski says institutions may be buying downside protection simply because they have had a strong year of gains and feel they can afford to protect themselves, or it could be they see genuine risk on the horizon. 

Corroborating the high level of put buying and lack of complacency by institutional investors is the current level of SPX Index option skew.  The implied volatility of downside strike puts versus upside strike calls is at multi-year highs.

“Either way, it has this kind of circular effect and allows the market to continue to grind higher.”

When will the outlook change?

So, what will change the benign outlook? And what risks should investors be keeping an eye out for?

Ciszewski says inflation is the biggest potential threat, saying that if markets are wrong and the inflation showing up now around the world is not transitory, that could end the equities rally.

The other risk is if the COVID pandemic manages to outmanoeuvre vaccines and triggers new lockdowns and border closures.

Right now, neither scenario looks likely, he says.

Institutional investors are confident inflation is a temporary effect of reopening.

And markets are looking through the COVID pandemic to a time when life returns to normal.

“There’s more American cases of COVID this Labor Day than there were last Labor Day,” says Ciszewski.

“It doesn’t mean they’re going to lock down. We all have to be careful about merely reading the headlines.”

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About Tom Ciszewski and Pendal’s Income and Fixed Interest boutique

Thomas Ciszewski manages Pendal’s volatility fund, implements defensive derivative structures and develops multi-asset class strategies. He has 24 years of experience in managing derivative portfolios and producing positive uncorrelated returns for investors.

Pendal’s BIDS boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s Income and Fixed Interest strategies here

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About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager

George’s investment management career spans over 30 years with Pendal and its predecessor firms. He is responsible for management of credit, fixed interest and short term income portfolios, including Pendal’s highly regarded Sustainable Australian Fixed Interest Fund, Short Term Income Securities Fund and Credit Impact Trust.

George holds a wealth of experience in portfolio management and credit analysis. He has also worked across numerous fixed income, credit and money market portfolios in portfolio management, credit analysis and dealing roles for 27 years. Prior to this George worked in an accounting role for three years.

In 2019 George was awarded the Alpha Manager status by Money Management’s parent, FE fundinfo, in recognition of his career-long performance in the asset management industry. George was one out of 11 Australia-based investment professionals included in this list of esteemed professionals across multiple asset classes, after being assessed on his ability to create risk-adjusted alpha (outperformance) over his entire track record.

George obtained a Master’s degree in Business (Finance), a Bachelor’s degree in Business (Accounting & Finance) and a Graduate Diploma in Applied Finance and Investment.

 

Debate about inflation as transitory or structural misses the point. It’s about building a portfolio that’s robust to a range of outcomes, says Pendal’s Michael Blayney.

• Portfolio construction must allow for all inflation scenarios
• A dynamic approach to investing may be required
• Liquid alternatives, property, infrastructure may be solutions

THE MAJOR global economic debate right now is whether the recent jump in prices in the US, Europe and other parts of the world including Australia, is transitory or structural.

Central banks remain convinced it’s transitory, though a few around the globe have taken steps to taper bond-buying programs. More than 25 central banks — mostly in emerging markets — have raised interest rates so far this year.

It remains to be seen whether we look back on the “inflation is transitory” line as we do now on the Fed’s “sub prime is likely contained” line in 2007.

“You can go through both sides of the argument, but in portfolio construction, that’s not the main point,” says Michael Blayney, head of Pendal’s multi-asset team.

“As an investor you are faced with a huge amount of uncertainty as to the inflation outlook … and it’s about building a portfolio that’s robust to a range of outcomes.

“Portfolio construction has to link back to a client’s objectives and make sure it can handle different scenarios.”

The difference now, compared to the global financial crisis in 2007-08, is the amount of money in the system thanks to government spending, support payments and money creation, Blayney says.

Back then monetary policy was loosened — just as it is today — but fiscal policy was much tighter.

“There’s an awful lot of money sitting in people’s bank accounts — I’d say an unprecedented amount. It’s hard to imagine it’s never going to get spent. Also, fiscal policies are considerably looser around the world. And we’re starting to see price pressures.

“Last week’s US employment data disappointed with fewer new jobs being created last month, but wages still rose. You also have businesses wanting to de-globalise and bring supply chains closer, which might mean having to accept higher prices.

A portfolio construction approach to inflation

“If you think about all these things, it might mean you sit in the structural camp or the transitory camp. But what you need to think about is balancing portfolio construction risks over range of scenarios,” Blayney says.

Bonds don’t do as well as a portfolio diversifier in an environment where you see unexpected increases in inflation, he says. And if authorities need to tighten monetary policy you could very conceivably see a period where equities and bonds suffer together.

“When the inflation genie gets out of the bottle, traditional bonds become more of a problematic asset, at least initially. It means you have to be dynamic in your asset allocation.

“For example, if bonds sell off a bit because of inflation that might be a good entry point. Once inflation is priced in, it allows you to buy bonds at higher yields. Of course, it means you have to be comfortable not always holding lots of bonds in your portfolio.”

Alternate asset strategies

“You can hold cash, but that’s yielding virtually zero (which is around -2% real). So, you need to look at alternate asset strategies,” Blayney says.

At their broadest, such strategies included everything that isn’t bonds or equities. These strategies can also get access to inflation-linked assets such as commodities and other “inflation-hedging” strategies that are difficult for investors to implement directly themselves.

“There’s liquid alternatives strategies, which rely very much on the manager’s skill and more dynamic management of the fund,” he says. “They tend to be more active and use a lot of relative value type trades with the goal of providing diversification and returns.”

Liquid alternatives involve assets that are easy to buy and sell (liquid) and typically exhibit a lower correlation with traditional stock and bond investments.

Infrastructure and property are other options.

While both are sensitive to rising bond yields they are real assets. Underlying cash flows for many of these assets are linked in some way to inflation through rents (in the case of property), power prices (in renewable energy) or other long-term, contracted inflation-linked revenue streams.

“If you’re worried about sustained, long-term inflation, property, infrastructure and listed alternatives are all good assets to have in your portfolio,” Blayney says.

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About Pendal’s multi-asset capabilities

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

These include Australian and international shares, property securities, fixed interest, cash investments and alternatives.

In March 2024, Perpetual Group brought together the Pendal and Perpetual multi-asset teams under the leadership of Michael O’Dea.

The newly expanded nine-strong team will manage more than $6 billion in AUM and create a platform with the scale and resources to deliver leading multi-asset solutions for clients.  

Michael is a highly experienced investor with more than 23 years industry experience, including almost a decade leading the team at Perpetual.

Find out more about Pendal’s multi asset funds

Contact a Pendal account manager here

Significant Features: The Pendal Imputation Fund is an actively managed portfolio of Australian shares.

Fund Objectives: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the S&P/ASX 300 (TR) Index over the medium to long term.

Self storage is an under-appreciated part of the real estate industry that could be a big winner from Australia’s growing population. JULIA FORREST explains the investment opportunity

• Population and demographics underpin growth
• Built-in inflation protection
• Find out about Pendal Property Securities Fund

SELF-STORAGE is not the first place many investors would think of as a place to stash some cash.

But Aussie equities investors looking for opportunities should take a closer look at the industry, says Pendal PM Julia Forrest.

“The world of self-storage is not something you often hear about, but it’s an asset class we like,” says Forrest, who co-manages property investing in Pendal’s Aussie equities team.

Record high immigration and a downsizing trend towards apartment-living will fuel ongoing strength in the self storage industry, says Pendal’s Julia Forrest.

ASX-listed National Storage REIT (ASX: NSR) — which operates 230 centres across Australia and New Zealand — offers exposure to the sector.

NSR is the biggest active position in Pendal’s property strategy, Forrest says.

The opportunity explained

High inflation and rising interest rates have seen a somewhat muted investor appetite for real estate over the past twelve months.

Office assets are trading as much as 30 per cent below book value and the retail and logistics sectors are both under some pressure.

But self-storage assets are defying that trend, underpinned by strong demographics, low maintenance costs and inbuilt inflation protection, says Forrest.

“Occupancy was supercharged during COVID — and is now returning to normal — but the underlying metrics remain very strong, linked largely to Australia’s strong population growth.”

Self-storage assets were in strong demand during the COVID lockdowns period as young people returned to the family home, expats were forced to return at short notice, and many households had to clear space for working from home.

Now immigration and an ageing population are underpinning the industry’s growth.

Forrest says 70 per cent of self storage clients are individuals looking for somewhere to store their possessions, often prompted by a life event.

The remaining 30 per cent are businesses needing somewhere to store their inventory, building materials, and tools.

Low costs, strong prices

One of self storage’s key attractions is very low maintenance costs compared to other types of real estate.

“It costs very little to maintain — you’re replacing lighting, there’s a minor amount of depreciation. That means you get strong, resilient cash flows.”

As a result, valuations are holding up well as other real estate sectors come under pressure.

Retail real estate faces structural headwinds from the move to online shopping and infinite supply of virtual alternatives to physical store space, says Forrest.

Office is also facing structural change in the way people work and has risks ahead as the economy slows.

“But self storage is not a discretionary purchase — a lot of it is needs based because of those life events, which makes it a little more resilient than the other sectors.

“Self storage is still transacting at book value. Office is 20 to 30 per cent below book value. Retail and even industrial are beginning to see a bit of pressure on book values, but self storage continues to transact at book values.”

Self-storage sites also have the potential for transformation into high value industrial and logistics space, she says.

“Industrial vacancy is incredibly low. For self storage, one of the higher and better uses is as industrial. You don’t get that with office because of zoning.”

Inflation protection

Forrest says self storage offers a level of inflation protection in a portfolio because of the short duration of leases.

“Because you’re leasing month to month, if there is a big inflationary spike you can just lift your rate. You are not locked into a long-term lease. This provides quite a lot of inflationary resilience.”

She says the Australian market is quite immature relative to other markets.

“Self storage space in Australia represents 2.1 square feet per capita. In the US, it’s closer to 6.1 square feet per capita. So, in terms of available space, Australia is relatively under serviced, although the US is a much more mobile market.”

Real estate sentiment shifts

Sentiment towards real estate has shifted markedly in the last few weeks after a tough year amid signs that inflation is coming under control, Forrest says.

“Until very recently, people were very concerned about interest rates and inflation.

“But with a couple of lower CPI readings here and in the US, the market’s pricing of future rate hikes has come way back and that has led to a real estate rally.”

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

Recent results from the listed property sector show shopping malls are enjoying robust trading conditions, says Pendal’s JULIA FORREST

• Retail remains robust
• Normalisation of returns ahead
• Find out about Pendal Property Securities Fund

A SURPRISING rebound for shopping malls was the standout feature of this year’s real estate investment trust reporting season, says Pendal’s Julia Forrest.

Rising interest rates and the expiration of interest hedges meant earnings declined for many Australian REITs, surprising investors in a sector where performance is typically well-flagged.

“It was quite a strange reporting season for A-REITs because there were some really outsized moves in response to results which is very unusual,” says Forrest, who co-manages Pendal’s property trust portfolios.

“But the positive surprise was in shopping malls where operating metrics improved.

“Occupancy is pushing towards completely occupied — that’s a long way from where we were two or three years ago.

“There’s genuine demand by tenants for more space and for better space and there’s been no supply for four or five years so you’re seeing competitive tension between tenants.”

Positive leasing spreads

Forrest says the return of positive leasing spreads — where the rent charged for new leases is higher than the rent charged for expiring leases in the same property — has also surprised.

“Scentre Group, which has all the Westfield malls, has not reported positive leasing spreads since 2011. Nobody expected this change.”

This is a positive sign for property owners as it indicates an increase in demand for their property and allows them to generate higher income from the property.

It is also an indicator of a strong rental market and a competitive environment for tenants.

Forrest says several factors are driving this change.

A rising population and wages growth has sent overall retail sales 15 per cent above 2019 levels.

Alongside that is a lack of supply — for nearly five years there has been virtually no new supply of retail space, says Forrest.

“And the retailers themselves are in a better position because they’ve divested their bottom 5 to 10 per cent of stores, the ones that weren’t profitable.

“So, the ones that they have left are more profitable and many of them are still pursuing a growth strategy and opening new stores.”

Forrest says investors have been waiting for signs that interest rates will reduce retail spending.

“You’re beginning to see some deceleration of growth. If you look at the numbers for Scentre Group for July and August, the rate of growth of spending has come off in apparel and in home wares, but it’s still positive.

“But for food and beverage, we’re all still eating out. That’s still really strong.”

Rent reset

Forrest says the reset of rents lower during the COVID shutdown has set the base for a more sustainable outlook for the sector.

“Even if sales decelerate or go backwards, the starting point with rents does give you a bit of a buffer.”

Elsewhere in A-REITS, Forrest says the single standout performer was Goodman Group, which posted earnings growth of 16 per cent, well ahead of expectations of 9 per cent growth.

“They also announced the fact that a fair amount of their development pipeline is going to be data centres.

“Because data centre opportunities come with much bigger development margins, there’s a huge opportunity — $30 to $60 billion over the next five to 10 years. That was very well received by the market.”.

Industrial leasing spreads continue to be strong: “Spreads are still between 15 and 20 per cent. They are beginning to decelerate, but with a vacancy rate below 1 per cent landlords are still in a very strong bargaining position.”

In residential, pre-sales continue to struggle. “It’s coming off a massive base given the amount of stimulus where interest rates were over the last two years, so it’s only natural that the pre-sales numbers continued to struggle,” says Forrest.

“The likes of Stockland are doing smart things — cutting their land sizes to smaller and smaller blocks to keep them affordable. But even so, the numbers that they’re posting look low.

“First home buyers are a reasonable component of the market, and everything comes back to affordability.”

In office, the picture is mixed, she says.

“We are beginning to see a bit of top line growth for the highest quality offices. Office buildings exposed to tenants where everybody’s back at work and have got amenity and high-quality services, they’re doing well.

“But there a very long tail and in aggregate, it’s going sideways.”

Valuations attractive

Overall, Forrest says that with the volatility of the past year behind us, REIT investors are set for a return to more normal performance.

“If you think about FY24 earnings, we would have cycled through pretty much all of the rate hikes so from FY25 onwards, you’re looking more like your standard A-REIT performance.

“A dividend yield of 4.5-5 per cent plus maybe 3 per cent growth for a total return of 7 to 8 per cent.”

She says A-REIT valuations are compelling.

“The sector is pricing cap rates to move another 100 basis points, which implies the market is expecting asset prices to fall maybe another 15 to 18 per cent.

“They are unlikely to fall that far. So, the entry point is interesting.”

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

The world of office space provides plenty of challenges, but also opportunities if you know where to look, argues Pendal’s JULIA FORREST

• WFH and rising interest rates challenge office property
• Some winners to emerge from the sector
• Find out about Pendal Property Securities Fund

OFFICE space is on the mind of many businesses as work-from-home tension between workers and bosses plays out.

Commercial property, and specifically office property in Australia, has had a challenging time since the pandemic.

The Covid-driven work-from-home phenomenon, along with rising interest rates, have created a very different environment for the sector.

“It’s been very hard to get people back into the office,” says Julia Forrest, who co-manages Pendal’s property securities funds.

“It seems to be more difficult in Melbourne than anywhere else.”

“The physical occupancy in Melbourne is running at about 47 per cent, though recently there have been some big employers mandating staff to be back in the office 50 per cent of the time,” she says.

“That will help.

“Physical occupancy is still pretty low in government because staff have only been mandated to come back into the office one in every five days. That has an impact on retail services and amenities.”

The doubt over the number of days people are spending in the office has made it difficult for government and the private sector to re-sign leases.

It isn’t clear what the demand for space will be in 12 months or two years, let alone five years.

“Up until recently, we have just seen tenants sign short term leases because they’re not confident about what their occupancy needs will be.

“Landlords have been willingly accepting two-year leases, which they haven’t done in the past, and in some cases one-year leases,” Forrest says.

These short-term leases affect long term returns, but also the amount of finance a landlord can get against a property asset. It’s also triggered creativity between landlords and tenants.

“We’ve seen large tenants commit to new buildings and large amounts of space, and they’ve negotiated contraction rights – the ability to hand back floors,” Forrest says.

“That’s not new in itself. What is different is that they have the ability to reduce the amount of space, even before they occupy the building. Until now, there’s never been contraction rights before commencement.”

Opportunities remain

Forrest says there are still opportunities to find good returns in commercial property, citing 555 Collins Street in Melbourne which has just been developed.

It has a good range on tenants, including Amazon, will open close to fully tenanted, and the construction contract was well negotiated, she says.

“Obviously it’s a tenants market, but office landlords are being a bit more creative. I don’t think things are getting worse, but I do think things will stay tough for quite a while,” Forrest says.

Proeprty investors shold also keep an eye on the unemployment rate.

“Normally you see elevated vacancy rates when unemployment is high,” Forrest says.

“The problem is you have vacancy rates high when unemployment is at 50-year lows, so there’s not a whole lot of employment growth coming through that’s going to fill the space.”

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

Investing in listed property can look tricky when bond yields are higher and recession fears abound. But it’s a good time to be an active stock-picker, argues JULIA FORREST

• Assets need pricing power and inflation protection
• Supermarket based retail, self storage and logistics the best
• Find out about Pendal Property Securities Fund

INVESTING in listed property when bond yields are higher – and amid talk of a recession — is tailor-made for active stock pickers, says Pendal’s Julia Forrest.

As bond yields increase, the yield on Real Estate Investment Trusts may appear less attractive by comparison. Higher bond yields also indicate higher rates, which can mean higher finance costs for real-estate developers.

But there are opportunities out there for REITs investors who know where to look.

“You want a portfolio with inflation protection, and you want to own assets that have pricing power,” says Forrest, who has co-managed Pendal’s property trust portfolios for more than a decade.

“We’ve positioned our portfolio so we are over-weight in supermarket-based, shopping centre REITS, because the big supermarkets have reasonable pricing power and demand is fairly resilient.

“We also like mall REITS.

“We have self-storage property in the portfolio which works quite well in this environment.

“They have pricing power. About 40 per cent of tenants are business tenants and they get to sign leases on a monthly basis as opposed to locking themselves in for three to five years.

“That means there is protection against inflation.

“We are also overweight logistics and industrial REITS.

“The landlords have pricing power because the vacancy rate is so incredibly low. They’re ability to charge market rents means you have reasonable earnings growth and protection against inflation.”

Forrest says inflation isn’t going away anytime soon.

“We’re of the mindset that inflation will probably be stickier. We are not going back to this incredibly low inflationary environment,” she says.

Keep an eye on leasing spreads

A metric commonly used by REIT investors is “leasing spreads”. It’s the difference between what a landlord charges on an expiring lease, and what they get on a new lease for the same asset.

During the recent ASX reporting season, industrial REITs were commonly getting leasing spreads of between 15 per cent and 20 per cent.

“The industrial REITs have the widest positive leasing spreads,” Forrest says.

“Over the past five years, retail REITS have had negative leasing spreads as a result of depressed sales. Supermarket based REITS did not go negative, though they were close to flat.

“Mall REIT leasing spreads are no longer negative and as such no longer an earnings headwind.”

The retail REITS have changed tack in recent years, focusing more on services, which are harder to replicate online, and encouraging food and beverage outlets to encourage people to stay longer.

It’s a very positive active leasing strategy for those assets, Forest says.

“We are looking for asset classes that continue to have direct property tailwinds, like industrial, and have pricing power and inflation protection.”

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

Shopping centre owners and fund managers were the stand-out sectors in a strong reporting season for listed property, says Pendal’s JULIA FORREST

• Listed property performed well during ASX reporting season 
• Shopping centres and fund managers stood out 
• Find out about Pendal Property Securities Fund 

IT WAS a strong reporting season for ASX-listed property largely due to a post-pandemic bounce-back, says Pendal’s Julia Forrest. 

Owners of shopping centres, and property fund managers were the stand-out sectors, while office trusts were still struggling. 

Higher interest rates will have negative effects on the sector, but locally many Australian Real Estate Investment Trusts (REITs) have hedged against higher debt costs and offer reasonable value. 

The pandemic — and government regulations instituted in response — hurt revenue and profits in the property sector. But that’s now ended earnings across the sector were up 19 per cent last financial year — or 14 per cent if you exclude fund managers, Forrest says. 

For the owners of big shopping centres, it was a very good earnings season. 

“The malls had the biggest rental abatements during Covid, but they are now not too far off where they were pre-COVID. It is quite extraordinary that they’ve been able to come back to where they were FY19,” Forrest says. 

While things are improving, they aren’t back to ‘normal’. Vicinity Centres, which owns shopping centres across the country, reported 10 to 12 per cent lower foot traffic. 

“Foot traffic is returning on the weekends but not during the week. Having said that, sales have surpassed FY19 because we’re spending 30 per cent more when we do go to shopping centres,” Forrest says. 

“We don’t quite know how much of that is permanent but we are seeing food and beverage coming back in malls. Even cinemas are coming back.” 

The other stand-out sector within property was the fund managers, Forrest says, nominating Goodman Group, which focuses on industrial property, and Charter Hall. Both expect to maintain earnings growth this financial year. 

“It’s a function of assets under management. They have both been acquisitive the last year or two and they have big development pipelines, and they have the tail wind of asset values going up.” 

Industrial property was a particularly strong performer during COVID, as businesses scrambled for space to fulfil e-commerce sales. But unlike many other parts pandemic favourites, industrial remains strong.  

“Rental growth in the US is well over 20 per cent. In Europe its ten to 12 per cent. Australia has the lowest industrial vacancy rate in the world … and growth is around 20 per cent. Supply hasn’t been able to keep up with demand,” Forrest says. 

While fund managers and shopping centres are performing much better than during the pandemic, the outlook for the office sector is less certain. 

“In FY22 it was impacted by lockdowns again,” Forrest says. “It’s just a function of people not returning to work, though there’s a sense that it has started to improve in the past couple of weeks.  

“We got through COVID and the flu season … and maybe people want to be in the office because things are getting more difficult.” 

There has been a preference for better space, but vacancy rates remain high and more supply will hit the market in coming years.    

For investors looking at buying or selling property in a rising interest rate environment, Forrest says there’s three ways to think about interest rates.  

The first is ring interest rates make fixed income alternatives more attractive.

The second is that as rates rise, discount rates increase, and asset values fall. An exception she says is industrial space because demand is so high. And finally, the cost of debt rises.  

Fortunately, many companies in the REITs sector have hedged their debt exposure, so rising rates won’t hit interest costs too hard. 

“And the sector looks reasonable value,” Forrest says. “It’s trading at around 15 times which is a discount to the all-industrials… and excluding the fund managers, it’s at a 16 per cent discount to NTA (net tangible assets).” 

“We’re looking at EPS growth of a bit over three per cent … and an initial yield, excluding fund managers, of around five per cent, so eight per cent isn’t bad.” 

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About Julia Forrest, Pete Davidson and Pendal Property Securities Fund

Julia Forrest has managed Pendal’s property trust portfolios for more than a decade. She has 25 years of experience spanning equities research and advisory, initial public offerings and capital raisings.

Pete Davidson is Pendal’s Head of Listed Property. Over the past 34 years Pete has held financial markets roles spanning portfolio management, advisory and treasury markets. he specialises in the property, retail, insurance and infrastructure sectors.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here