I. Sector Landscape and Outlook
Australia is known for its large structures and iconic sites with a deep history in architecture. Australia, being a member of the UNESCO World Heritage Committee, inscribed with the 19 most popular sites on the World Heritage List that includes the Sydney Opera House, Uluru-Kata Tjuta, Kakadu, the Royal Exhibition Building in Melbourne, the Great Barrier Reef, amongst others. Rising home prices, loose monetary policy, and increased infrastructure spending by the government drives the Real Estate and Construction sector. Australia is the most urbanized nation with high population density in Sydney and Melbourne, contributing to the Gross Value Added of ~$164 billion in 2019-20, according to the Australian Trade and Investment Commission.
The pandemic saw a spurt in demand for residential properties in non-metros and regional Australia. The majority of Australians preferred detached properties as opposed to high-rise apartments. With restrictions on migrant population and closure of businesses saw a record rise in office vacancy rates and oversupply in rentals market. However, the residential property market outperformed with robust price gains benefited from the government grants and support programs such as the Homebuilder scheme, etc.
The Real Estate and Construction sector recovered from the pandemic, with approvals for building construction touched a new high in March 2021, reaching 23,176 units. This was closer to the highest levels seen in November 2017. Private sector houses (for individuals) remained resilient during the COVID-19. It had posted a 47.7% growth in March 2021 over the prior year. New South Wales, Victoria, and Queensland showed a strong pull, with approvals increased by 26.9%, 24.7%, and 12.1%, respectively, compared to the preceding month. Record low-interest rates, the Homebuilder scheme, and stamp duty concessions saw a spike in building approvals. In addition, there was a pent-up demand during the pandemic, which supported the offtake in subsequent periods.
Figure 1. Building Approvals Gained Strong Momentum:
Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group
Home prices in Australia are soaring to new highs. Many analysts have opined that the housing market is nearing a bubble. The Residential Property Index, representing the weighted average index of eight cities in Australia, rose 3.0% in December 2020 quarter (on a QoQ basis), according to The Australian Bureau of Statistics. Home prices in Sydney and Melbourne outpaced the previous peaks set in 2017 and 2020, respectively. As regional Australia gained traction following the work-from-home syndrome, home prices in many smaller cities scaled new highs. Detached property prices have outgrown unit prices. Besides the government aid and low mortgage rates, the spurt in home prices was solely due to low inventory levels.
Figure 2. Low Inventories Riding the Property Prices:
Data Source: Housing Data, Chart Created by Kalkine Group
Prices of homes in capital cities climbed to new highs in recent months. Sydney is the most expensive city in Australia. Price gains were skewed towards houses than units. The premium market in Sydney showed strong growth. Melbourne took the second spot, with home values rose at the average monthly pace of 0.4% over the past decade, according to the data by National Australia Bank (with inference from the data by CoreLogic). Suburbs like Mornington Peninsula outpaced the inner areas. The data from the Reserve Bank of Australia showed auction volumes in Sydney and Melbourne remained the highest in recent months. Housing prices in Canberra has been growing at the fastest clip driven by detached houses. At Brisbane, tighter selling conditions prevail. With 17 days of the average sales cycle, Perth boasts the fastest rate of sales across the capital cities. Detailed below are the mean prices of eight states in Australia for the December 2020 quarter.
Figure 3. Sydney and Melbourne Remained the Most Expensive Capital Cities:
Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group
The rental market in Australia is strengthened with falling vacancy rates, particularly for houses. The border closure impacted net overseas migration, affecting Sydney and Melbourne. Rentals have increased in most part of the country, and vacancy rates reached their lowest level in a decade, according to data by the Reserve Bank of Australia. The moratorium on rental evictions have ended in March 2021, and it may influence rental vacancy rates going forward.
The office vacancy rate hit the highest record in over the last 20 years, according to The Property Council of Australia. The office vacancy rate in Melbourne reached 8.2% in January 2021. Perth and Darwin hold the nation’s highest vacancy rate of 20%. On contrary, demand for ‘A’-grade’ office space in Melbourne’s central business district is on the rise. In a report by Cushman & Wakefield, investment activity in the commercial real estate market rebounded in Q1 2021 to reach $4.5 billion. Low-interest rates attracted investors with investment in the office sector accounted for 60% of transaction volume. Offshore buyers have shown increased interest in the Australian commercial property market. Offshore buying accounted for 40% of total transaction volume. Singapore posted the largest source of capital.
Index Performance:
The ASX 200 Real Estate Index (Industry Group) has generated 10-year returns of ~61.84% as compared to ~49.16% by the ASX 200 Index. Accommodative monetary policy stance by the Reserve Bank, increasing home prices, rapid urbanization, and increasing household wealth are the factors that drive the sector performance.
Figure 4: The ASX 200 Real Estate Index (Industry Group) outperformed ASX 200 Index in the past ten years by whooping ~12.68%:
Source: Refinitiv (Thomson Reuters) as on the close of 20 May 2021
Key Risks and Challenges:
Falling wage growth and increasing home prices lead to a drop in Home Affordability. According to the data by the Parliament of Australia, loan repayments as a proportion of family income dropped to 34.8% in December 2020 quarter as compared to 35.5% in the previous year. The recent rally in prices may take the housing market closer to a bubble. Economists have warned the weak lending practices and low mortgage rates (as low as 2%) is goofing up the prices artificially. This may blow the banking system saddled with non-performing assets. The expiry of the rental moratorium in Australia is likely to influence the residential rental market with disruption in vacancy rates.
Figure 5. Key Risks in The Real Estate and Construction sector:
Sources: Analysis by Kalkine Group
Outlook:
The Morrison government has extended the HomeBuilder program for additional twelve months and raised the support budget to $2.5 billion. The program provided relief for first time home buyers with a $25,000 to buy a new home or a $15,000 grant for renovating an existing home. Banks are positive about the outlook for the housing market. ANZ Bank is expecting housing prices to rise 17% nationally in 2021. Perth and Sydney are expected to outperform, with housing prices expected to increase by 19% each. Key Executive at The Commonwealth Bank of Australia is expecting property prices to rise 14% over the next two years. New housing loan commitments scaled new highs with 5.5% growth in March 2021 to reach $30.2 billion, according to the data by the Australian Bureau of Statistics. Investor housing loans touched a new level with 12.7% to $7.8 billion. In the 2021-22 budget, the government has allotted $15.2 billion over the next ten years in various projects covering road, rail, and community infrastructure projects in Australia. This will likely to boost engineering and construction activity in the near term.
II Investment theme and stocks under discussion (LEP, VCX, NWH, MGR)
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 the ‘Price/Book Value’ method.
1. ASX: LEP (ALE Property Group)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$883.79 Million)
LEP manages and leases pubs in Australia. It is also engaged in property fund management business. LEP owns a portfolio of over 100 pubs.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 21.50% on 20 May 2021. We believe that the stock might trade at a discount as compared to its peer median Price/Book Value (NTM Trading multiple) given elevated debt levels, aggressive dividend distribution policy, and various pending litigations. For the said purposes, we have taken peers such as Goodman Group (ASX: GMG), Vitalharvest Freehold Trust (ASX: VTH), Home Consortium Ltd. (ASX: HMC), to name a few. Considering the restructuring initiatives, satisfactory performance in H1 FY21, dividend distributions, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $4.420, up by 0.226% on 20 May 2021. The stock has delivered an annualized dividend yield of 4.79%.
2. ASX: VCX (Vicinity Centres)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$6.87 Billion)
VCX property management company engaged in the development of retail properties and shopping centers in Australia.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 21.38% on 20 May 2021. We believe that the stock might trade at a premium compared to its peer average Price/Book Value (NTM Trading multiple) given the rebound in visitation and cash collection from tenants in Q1 FY21 and optimism expressed by the company. For the said purposes, we have taken peers such as Charter Hall Retail REIT (ASX: CQR). Growthpoint Properties Australia Ltd. (ASX: GOZ), Centuria Office REIT (ASX: COF), to name a few. Considering the rebound in operating performance during H1 HY21, strong liquidity, satisfactory debt profile, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.560, up by 3.311% on 20 May 2021. The stock has delivered an annualized dividend yield of 7.11%.
3. ASX: NWH (NRW Holdings Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$721.06 Million)
NWH provides infrastructure and civil services to urban development, mining, and energy sector in Australia.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 26.90% on 20 May 2021. We believe that the stock might trade at a premium as compared to its peer median Price/Book Value (NTM Trading multiple), citing the healthy order backlogs (pipeline of $14.1 billion), and increased budgetary allocations by the government to spur public infrastructure. For the said purposes, we have taken peers such as Monadelphous Group Ltd. (ASX: MND), Service Stream Ltd. (ASX: SSM), Lycopodium Ltd. (ASX: LYL), to name a few. Considering the diversified revenue streams, adequate liquidity, project backlogs, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.670, up by 5.696% on 20 May 2021. The stock has delivered an annualized dividend yield of 4.79%.
4. ASX: MGR (Mirvac Group)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$10.71 Billion)
MGR is a property management and investment company. Through Mirvac Property Trust, it invests and manages office, retail and industrial assets.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 12.26% on 20 May 2021. We believe that the stock might trade at a premium as compared to its peer average Price/Book Value (NTM Trading multiple) as the company upgraded its earnings projections for FY21 considering strong pipeline projects. For the said purposes, we have taken peers such as Charter Hall Social Infrastructure REIT (ASX: CQE), Rural Funds Group (ASX: RFF), Aventus Group (ASX: AVN), to name a few. Considering the developmental pipeline projects, improved EBIT in H1 FY21, solid liquidity, we give a “Hold” recommendation on the stock at the current market price of $2.790, up by 2.573% on 20 May 2021. The stock has delivered an annualized dividend yield of 2.79%.
Note: All the recommendations and the calculations are based on the closing price of 20 May 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.
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