Real estate portfolios will need to adjust with inflation

In times of rising inflation, investors in Australian real estate investment trusts (AREITs) will need to consider the impact it will have on company valuations and specific property sub-sectors.

AREIT portfolio manager at SG Hiscock and Company, Grant Berry, said higher inflation was likely because of a number of factors, including a global drive to diversify supply chains, a deteriorating globalisation tailwind and a rise of fiscal policy as a result of COVID-19.

“As part of this, we are focused on investment opportunities in REITs that have quality underlying property assets, attractive valuations, rent-sourced income and diversification, while avoiding those with equity characteristics and high multiples,” Berry says.

Investors also needed to review whether they were genuinely exposed to real estate assets, particularly as Sydney and Melbourne re-open, said Berry.

“Not all AREITs are equal, with some having significantly less exposure to real estate than the name suggests,” Berry said.

“Increasingly, a number of companies that are classified as REITs are generating the majority of their earnings from activities such as funds management (through management and performance fees) along with development, rather than from owning real assets.

“This means investors may be taking on a very different type of risk profile than they realise while paying a higher multiple for it.”

Berry said REITs with rental income-based yields suffered most during the COVID-19 lockdowns but those who bought them last year had been rewarded with recovering distributions and security prices.

He encouraged investors to take advantage of opportunities in the retail sector as economies opened back up.

In the office sector, Berry said business conditions would be the key driver of tenant demand despite the rise in flexible working arrangements since COVID-19.

He used Perth’s Property Council of Australia Vacancy Rate which showed a 3.6% decrease to 16.9% - the lowest level in six years despite the pandemic.

“This highlights that changing ‘people occupancy’ levels do not automatically correlate to corresponding building vacancy levels as the office may have peak and off-peak demand days,” Berry said.

“For the past five years we have observed a ‘flight to quality’ in the office space and we expect this trend to become more pronounced. Softer leasing conditions in Sydney and Melbourne put tenants in a stronger position to strike favourable deals with landlords and the demand for higher quality space as we emerge from lockdown will accelerate this trend.

“Investors will therefore need to be selective to deliver the optimal outcome.”

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