Despite a falling official cash rate, the 10-year Australian government bond yield is rising. And higher yield on government bonds relates to higher borrowing rates for the government and often acts as a benchmark for longer term corporate debt.
On Friday we saw most of the property index tumble, showing signs the government bond yield benchmark is beginning to influence the market.
With the long-term government bond rate (essentially our risk free rate) rising, it brings the current dividend yield received on equities into question. It also forces consideration to be given to future growth potential of individual property companies as well as property as a general asset classes.
Since a low of 2.91% on 3 October 2012, the 10-year government yield has risen 76 basis points to 3.67%.
Although the 10-year Australian government bond yield is well under its 10-year average, it is increasing at a time when our official cash rate has been cut to 2.5% in a bid to stimulate economic activity.
With an increasing longer-term bond yield reflecting a steepening yield curve, it essentially means the yield between this benchmark is working towards converging with the ongoing yield on property trusts. This also holds for other investments – think Telstra (TLS) with its static earnings and low growth forecast.
If the return you are receiving on the property trusts remains static in conjunction with the risk, you can now receive an improving return from longer dated bonds with a smaller risk. Without growth in their underlying businesses, REITs could be quick to fall out of favour with investors.
As with any investment, it is a trade-off between risk and return.
What the market will be looking for over reporting season is the ability of property trusts to build on their existing businesses and increase their return to shareholders. In the current climate the best ways for this to be achieved are going to be through funds management or development of new structures.
Accounting for the current economic landscape, not all property trusts are going to give the same returns. Key areas to look at are industrial, then office followed by discretionary retail. If you believe previous rate cuts have done nothing to encourage domestic spending, you probably want to avoid discretionary retail.
Jones Lang LaSalle sees the value of industrial capital stock increasing from $29 billion to $53 billion by 2022. This is in sharp contrast to falling office rental yields in most Australian cities, with Melbourne falling the most, to 6.4% currently (see David Gilmour's A-REITs find favour – but what about those vacancies rates?). Retail spaces also have started the year losing ground, with vacancy rates up to 4% over the first half of this year from 3.5% at the end of last year. CBD markets are the culprits.
Earlier today GPT Group (GPT) reported first-half figures, beating analyst estimates. GPT is cashed up after deciding not to acquire assets from Australand (ALZ), leaving it with flexibility to build on its industrial portfolio, tipped to be the growing sector.
Over the next two weeks we have Stockland (SPG), Goodman Group (GMG), Dexus (DXS) and CFS Retail Property Trust (CFX) also reporting.