Market Outlook

Continued soft inflation and employment data in the US has changed market leadership as expectations for several Federal Reserve Fed Fund rate cuts has led to a strong rotation from large cap tech into lagging sectors including REITs which are seen as beneficiaries of lower rates. We believe equity markets may have overreacted to the BOJ’s hawkish hike (more below) and to concerns that the Fed may be responding too late to the slowing US economy. The overall backdrop appears favourable for the REIT sector as the major headwind of higher for longer rate expectations is no longer a market concern as both short- and long-term rates have been falling in recent days. Unlike small cap companies that may be impacted by an economic slowdown, REITs’ defensive earnings coupled with falling funding costs should start to attract generalist investors who have ignored the sector for the past few years.

Japan

BOJ Governor Ueda raised short term interest rates to 25bps from 0-.1% and at the same time halved the amount of JGBs that the bank will purchase as part of its QE policy reduction. Both moves were highly anticipated and there was little reaction after the moves with both REITs and Developers moving slightly higher along with the JPY. However, the sector did see heavily selling pressure as did the equity market after Ueda’s press conference where the Governor expressed the bank’s intention to continue raising rates and indicated that rates could go above 50bps as the neutral rate, in his opinion, was still not achieved. This hawkish hike was uncharacteristic for this Central Bank which has been extremely cautious given the weak domestic demand picture. The Central Bank appears to be expecting its second component of inflation (wage increases leading to strong consumption) to start to drive prices higher and even cited the weak JPY as a reason for concern despite the strong JPY move prior to the meeting. We believe that Ueda’s hawkish tone may have been directed more at the forex markets and politicians as there is unclear evidence of strong domestic factors behind Japan’s current CPI. In fact, ex food and energy CPI is running well below the 2% target. The initial reaction to Ueda’s press conference was a selloff in equities including Developers and a spike in short term rates. However, since then JGB rates have falling sharply across the curve and both 2 year and 10-year JGB yields are below the level they were at prior to the Central bank moves. JREITs, while down slightly since the announcement, have performed much better relatively and are up in USD terms since the move. Bank stocks, beneficiaries of higher rates moved up initially after Ueda’s comments, but then lost almost 25% in two days as rate expectations have changed with global macro conditions continuing to moderate. In the current environment, we think both JREITs and Developers will outperform the equity market as the JPY strength is driven more by expectations of Fed cuts than BOJ hikes and believe generalist investors will look to defensive domestic industries for outperformance. Logistics and Residential offer defensive growth. Results for the large cap developers will be announced in August and we expect continued strength in residential sales and improving office leasing. For most of the companies that announce earnings, this will be the first quarter of their fiscal year, so it is unlikely that they will revise higher their guidance even if results exceed expectations.

Australia

The RBA announced no change to policy rate in its August 6 meeting and pushed back on expectations for a near-term OCR cut given persistently high inflation caused by high labour costs. The Board assumes CPI will only moderate by 2026. While they have commented that the Board is not ruling anything out, implying that a hike is also a possibility, markets were pricing in a 33bps cut by December 2024 and 90 bps by August 2025. Given the RBA’s past forecasts, the market is taking a more optimistic view that rates will drop earlier than indicated by the Board. Full year results and next year’s guidance starts in earnest at the beginning of August for the AREIT sector. We expect Goodman Group to show solid results including decent guidance due to strong contribution from its growing Data Center developments. Cyclically challenged REITs (Residential, Office, and Diversified) will offer conservative guidance as most companies will assume base rates remain elevated. Given the recent move lower in rates in Australia with two-year rates falling sharply, there is a potential that this guidance may prove to be too conservative. For example, CIP, an Industrial REIT that has already reported and presented forward guidance, is assuming a 4.6% base rate while market pricing is already implying a 33bps cut by this December and 90bps reduction by August 2025. Current BBSW rate is 4.41%. Recent reporting seasons in Australia were disappointing and led to extreme price moves, but we suspect this reporting season may have less excitement as companies now will appear conservative in their guidance. Diversified REITs, Mirvac and Stockland, will meet expectations, but guidance may be cautious for both. For Mirvac, continued sluggish demand for apartments may tamper down earnings growth expectations while for Stockland the ongoing settlement delay of its communities purchase from Lendlease due to an ongoing ACCC review will likely impact their ability to accurately forecast their growth. Nonetheless, given valuations are at trough levels and earnings bottoming we remain bullish on both and think any correction would be a buying opportunity.

Hong Kong

Expectations going into results are extremely low especially after Hang Lung Properties’ DPS cut by 1/3rd due to weak sales particularly in China. Recent drop in HIBOR will help earnings going forward but we suspect first half numbers will not show much improvement in interest costs while some leakage to Shenzhen is having some impact even on non-discretionary retail. Luxury retail has also been impacted by leakage but more to Japan than to the mainland. Given the recent jump in the JPY and likely price adjustments from the global luxury brands, we expect this leakage to naturally normalize. We expect some recovery in HK retail spend as we have hit “peak leakage,” and we expect a sharp decline in HIBOR to help sentiment for residential while lowering interest costs almost immediately for the HK REIT sector which as large exposure to floating rates. In fact, during the sharp selloff on August 5, HK counters bucked the trend due to expectations of lower US rates, strong weekend residential sales, and short covering. We attended Link REIT’s HK and Shenzhen asset tour (see separate note) and noticed weak attendance from buyside firms as interest in the market is at extremely low levels despite cheap valuations.

Singapore

SREIT results were in line with expectations and dividend growth has been stunted by higher interest costs. Given the outlook for rates globally, rates in Singapore will follow as the MAS does not set interest rate policy directly. We believe that the rotation from Banks into SREITs will continue and expect the sector to be led by the large cap names that tend to benefit the most from rotational buying. In a sign that funding costs are starting to ease, we have seen several SREITs re-finance their perpetual debt securities by issuing new ones with favourable terms.

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