I. Sector Landscape and Outlook

Australia has one of the most highly urbanized populations and has a real estate industry that thrives on the rising local, tourist and foreign attraction. The residential property market has offered homeowners with significant returns on their investment and has grown on the back of favorable prices and government support. The commercial property market has also performed modestly in the past and has been one of the most lucrative industries to invest in. Australia’s real estate sector witnessed a long period of stability in prices until it was hit by the coronavirus pandemic. The sector was impacted by a decline in the country’s population. COVID-19 has led to a reduction in business construction and household spending, leaving the property market on a wobbly ground. Despite these challenges, recent trends related to business activities, property prices, and constant support from the government demonstrate that there remains significant headroom for the property market to grow once the pandemic subsides.

What is a REIT? A Real Estate Investment Trust (REIT) comprises a bunch of property assets which are listed on the Australian Stock Exchange and primarily generate revenue from rental income on the properties held by the trust. REITs provides investors with access to a diversified property portfolio which provides a benefit of increase in value of the underlying asset and the regular rental income on the properties owned. A REIT may include various types of assets such as hospitals, hotels, offices, apartment buildings, warehouses, etc.

Figure 1. S&P/ASX 200 A-REIT versus S&P/ASX 200 (3-months*)

ABS Residential Property Price Indexes: The Australian Bureau of Statistics recently reported the movement in residential property prices for eight capital cities for the June quarter. On a pcp basis, property prices in all cities witnessed a rise, except Perth and Darwin. Total value of residential dwellings in Australia declined by $98.2 billion and stood at $7,138.2 billion.

Figure 2. Change in Residential Property Prices (July 2020)

Data Source: Australian Bureau of Statistics; Chart Created by Kalkine Group

New Loan Commitments in July 2020: According to the Australian Bureau of Statistics, the value of new loan commitments for housing increased by 8.9% in July 2020. The value of new loan commitments for owner occupier housing increased by 10.7%, while investor housing rose 3.5%. The number of owner occupier first home buyer loan commitments increased by 14.4%.

Figure 3. New Loan Commitments (July 2020, June 2020, and July 2019)

Data Source: Australian Bureau of Statistics; Chart Created by Kalkine Group

First Home Loan Deposit Scheme: The Australian Government recently stated that it will provide additional 10,000 places under the First Home Loan Deposit Scheme for FY 2020-21 to assist in purchasing new home or a newly built home. The First Home Loan Deposit Scheme is the Government’s initiative to support eligible first home buyers purchase their first home sooner and currently has 20 participating lenders across Australia providing support under the scheme. In a recent article, the Commonwealth Bank of Australia stated that the residential property market is proving resilient, especially in regional Australia. Median dwelling value for regional Australia increased by 0.1% over the 3 months to June 2020, with the highest QoQ increase reported in Regional Tasmania.

Figure 4. Median Dwelling Values in Regional Australia (Quarter Ending June 2020)

Data Source: Domain.com.au, CBA; Chart Created by Kalkine Group

JobMaker Digital Business Plan: The Real Estate Institute of Australia stated that the Federal Government’s JobMaker Digital Business Plan will improve the efficiency and productivity in transactions within the property industry. The permanency of electronic transactions outlined in the plan is expected to positively impact the property market making it easier to do business and transact property.

Figure 5. Commercial Property Sales Trend in Australia (2007-08 to 2019-20)

Data Source: CBA; Chart Created by Kalkine Group

Key Risks

COVID-19 Impact on Population Growth: The population growth outlook for Australia is highly uncertain due to the health response to COVID-19. The National Housing Finance and Investment Corporation expects underlying dwelling demand in Australia to decline in the range of 129,000 and 232,000 from 2020 to 2023, mainly due to a decline in population.

Decline in International Student Arrivals: Net Overseas Migration contributes to ~60% of Australia’s population growth, which is currently being impacted by international border closures and travel restrictions. International student arrivals, who form a large portion of NOM mix and provide an economic boost to the country, began to decline due to the pandemic. Henceforth, a decline in arrivals has flow-on effects on underlying housing demand. In July 2020, there was a decline of ~97% in short-term visitor arrivals from top 10 countries in comparison to July 2019.

Figure 6. Short-term Visitor Arrivals in Thousands (July 2019 & July 2020)

Data Source: Australian Bureau of Statistics; Chart Created by Kalkine Group

Increase in Unemployment: During the global financial crisis, international student arrival was heavily impacted by the unemployment rate in Australia. Notably, it took around 4 years for student arrivals to recover to pre-GFC levels. Therefore, previous recessions indicate how COVID-19 can lead to a similar scenario.  

Uncertainty Regarding Renewal of Lease: Generally, Commercial REITs include properties that have long leases, which when expire may not be renewed by the property holder and lead to loss of rental income for the REIT.

Delay in Rent: Loss of business and household income due to the COVID-19 pandemic will directly impact the rental income of REITs, which may bear the risk of delayed or less rental income due to the adverse economic conditions.

Outlook 

The pandemic has increased the uncertainty with respect to the path back to normalization and has posed unprecedented challenges for REITs. However, the property market in Australia has been resilient on the back of its urbanized population. The Commonwealth Bank of Australia expects home buying to improve on the back of low interest rates and revised its house price forecasts for a peak-to-trough decline of -6% as compared to the previously forecasted decline of -10%. The CBA also highlighted that the office sector accounted for 62% of commercial property trading in 2019-20, which demonstrates the long-term investor belief in office property.

Therefore, as the economic conditions improve and property prices begin to recover, trading activity in the property market is expected to gain momentum. Retail properties will be in demand from businesses that serve the day to day requirements and a return to office culture due to limitations of remote working will help in the recovery of office properties. Moreover, the rapid shift to eCommerce will act as a driving force for warehousing and logistic services, hence, benefitting the Industrial REITs. 

II. Investment theme and stocks under discussion (VCX, LLC, SCG and CNI)

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘P/E’ method. 

1. ASX: VCX (Vicinity Centres)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 6.6 Billion)

Vicinity Centres (ASX: VCX) is involved in investment, management, and development of the property. The company is also in the leasing and funds management business.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~23% on 08 October 2020 closing price. For the said purposes, we have taken peers such as Stockland Corporation Ltd (ASX: SGP), Goodman Group (ASX: GMG), GPT Group (ASX: GPT), etc. At the same price, the stock of VCX was offering a dividend yield of ~10.79%.

2. ASX: LLC (Lendlease Group)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 8.15 Billion)

Lendlease Group (ASX: LLC) is an international property and investments group having core expertise in shaping cities and creating strong and connected communities.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~18% on 08 October 2020 closing price. For the said purposes, we have taken peers such as Vicinity Centres (ASX: VCX), Mirvac Group (ASX: MGR), Goodman Group (ASX: GMG), etc. At the same price, the stock of LLC was offering a dividend yield of ~2.81%.

3. ASX: SCG (Scentre Group)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 11.99 Billion)

Scentre Group (ASX: SCG) owns and operates Westfield in Australia and New Zealand with interests in 42 Westfield Living Centres.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~26% on 08 October 2020 closing price. For the said purposes, we have taken peers such as Vicinity Centres (ASX: VCX), Dexus (ASX: DXS), Stockland Corporation Ltd (ASX: SGP), etc. At the same price, the stock of SCG was offering a dividend yield of ~9.78%.

4. ASX: CNI (Centuria Capital Group)

(Recommendation: Hold, Potential Upside: Low Double Digit, Mcap: A$ 1.21 Billion)

Centuria Capital Group (ASX: CNI) is engaged in the marketing of investment products including investment bonds and property investment funds.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~15% on 08 October 2020 closing price. For the said purposes, we have taken peers such as Charter Hall Group (ASX: CHC), Goodman Group (ASX: GMG), Charter Hall Social Infrastructure REIT (ASX: CQE), etc. At the same price, the stock of CNI was offering a dividend yield of ~4.29%.

Note: All the recommendations and the calculations are based on the closing price of 08 October 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

Disclaimer  

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