Feeling brave? Contrarian investors might find a treasure in the ASX REIT space

The ASX property sector has been smashed. Are there any opportunities in the rubble?

REIT written with images circling it and a man touching it.

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Key points

  • Higher interest rates are increasing interest rate costs for ASX REITs
  • Interest costs are going up
  • Some property business falls may be overly pessimistic

The real estate investment trust (REIT), or ASX REIT, space has been hit hard following all of the interest rate rises.

It makes sense because not only does it increase the cost of debt on the balance sheet (due to higher interest payments) but it also hurts the valuation, in theory. Warren Buffett once said:

The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.

Pain in the property sector

There has been a large decline in share prices of various ASX REITs and property-related businesses.

For example, the Centuria Office REIT (ASX: COF) share price is down 45% since September 2021.

The Charter Hall Retail REIT (ASX: CQR) share price has fallen 18% from April 2022.

The Scentre Group (ASX: SCG) share price is down 16% from February 2023.

The Centuria Capital Group (ASX: CNI) share price has sunk 54% since December 2021.

The Rural Funds Group (ASX: RFF) share price is down 44% from the end of December 2021.

The DEXUS Property Group (ASX: DXS) share price is down 27% from April 2022.

And so on.

Are there ASX REIT opportunities?

Each segment of the property sector is different, facing various circumstances. Some may experience sizeable writedowns of the valuations of their properties, while other valuations may hold up well.

Office properties are facing headwinds relating to more people working at home, though some businesses are ordering their staff back to the office for more days of the week.

Bricks and mortar shopping centres face increasing competition from e-commerce, though shops have benefited from the return of shoppers following COVID-19. But, now they face a possible reduction in foot traffic if households keep tightening their belts.

On the other hand, industrial ASX REITs are benefiting from strong demand from businesses wanting onshore logistics facilities in Australia in metropolitan areas. That's why I like the look of Centuria Industrial REIT (ASX: CIP), which is down 27% from December 2021, its rental growth can offset some of the valuation headwinds.

Rental income and growth can support valuations and distributions. That's why I like the Charter Hall Long WALE REIT (ASX: CLW) after its 22% fall from April 2022 – it has a weighting average lease expiry (WALE) of over 11 years, which shows a lot of rent is locked -in. Plus, it's seeing strong rental growth for the properties which are linked to inflation.

Another interesting option is farmland ASX REIT Rural Funds Group which owns a portfolio of farms across cattle, almonds, macadamias, vineyards and cropping. It's still generating rental income and expecting rental growth, particularly thanks to investing in its farmland. Higher interest rates could be a headwind, but it has hedged a lot of its debt for the next few years.

Property fund managers are also interesting opportunities. While DEXUS is down heavily, its funds under management (FUM) is holding up, which is a positive for management fees. It's also trading at a sizeable discount to its last stated net tangible assets (NTA) but I'm not sure how much the NTA is going to reduce in the next 12 months.

Of the sectors I've mentioned, I'm a fan of industrial and farmland the most, though property managers could do well as well. I think that areas that are continuing to see very good occupancy, good rental income and growth could see stronger property performance.

Motley Fool contributor Tristan Harrison has positions in Rural Funds Group. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Rural Funds Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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