The ASX 200 AREIT Accumulation index rose by 3.15% over the quarter ending 31 March 2014.

S&P ASX 200 AREIT Accumulation

The February reporting season contained few surprises with AREIT's generally reporting in-line with market expectations. Earnings per share (EPS) for the 6 months ending 31 December grew by 3.3% and Net Operating Income was up 2.3%. A modest increase in asset values in the sector led to a 2.5% increase in Net Tangible Asset growth.


The outlook for key sectors is as follows:


The improvement in global and local economic conditions would ordinarily flow through to increased office demand but CBD office vacancies have increased over the year (Sydney CBD 10%, Melbourne 11%, Brisbane 16% and Perth 11%). Brisbane has been impacted by the contraction in the government sector while the downturn in mining services has affected Perth. As a result, generous lease incentives have masked a fall in effective rents (by around 3% in Sydney and as much as 10% in Brisbane and Perth). Nevertheless, investor demand has actually driven an increase in prices for office properties, largely driven by the low interest rate environment. In conclusion, we expect economic conditions to improve office demand somewhat but large vacancy rates will continue to suppress rental growth and capital appreciation.


Vacancy rates have increased slightly but remain very low. Recent strength in retail sales is a positive development as has been the fall in the AUD, which reduces demand for online and imported goods. Overall, the 12 month outlook for the sector remains relatively positive.


Primary demand for industrial property is driven by a need for warehouse facilities for the retail and logistics sector, as well as the manufacturing sector (heavy and light industrial usage). The improved domestic outlook should increase demand by retail and logistics, which should largely offset the ongoing decline in the manufacturing sector. We would expect rents to remain broadly flat until new supply becomes available.


AREITs exposed to residential property and construction should fare well over the next 18 months as low interest rates continue to fuel a housing recovery. With interest rates at record lows and household debt near record highs, we believe this recovery is unsustainable over the medium term.


In conclusion, the outlook for Australian equities remains more favourable than AREITs at this juncture. Nevertheless, the sector is reasonably valued and should remain supported in this low interest rate environment. We recommend investors retain a modest underweight exposure.

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