Resolution Capital Core Plus Prp Sec II (IOF0044AU) Report & Performance

The S&P/ASX 300 A-REIT Total Return Index produced a total return of 3.9% for the month ended 31 July 2023, outperforming the Australian equities market (S&P/ASX 300 Total Return Index).

After two months of consecutive rate rises the Reserve Bank of Australia (RBA) held the cash rate at 4.1% in July.

Sentiment regarding future interest rate rises shifted downward with the consumer price index (CPI) numbers for July coming in below market expectations.

Within A-REITs, the specialist and retail sectors outperformed whilst the industrial and residential sectors underperformed.

It was a relatively quiet month in terms of news flow ahead of the August reporting season. Outperforming A-REITs included agricultural REIT Rural Funds (RFF). RFF rebounded in July after a year of underperformance on the back of balance sheet concerns. Moreover, the REIT declared its final FY23 distribution in-line with guidance. The Portfolio’s underweight position detracted from relative performance.

Underperforming A-REITs included pub landlord Hotel Property Investment (HPI). During the month the Victorian Government announced its intention to implement a number of electronic gambling machine reforms. HPI has limited Victoria exposure, but other states could follow suit. The Portfolio’s overweight position detracted from relative performance.

Property fund manager Charter Hall Group (CHC) announced redemption deferrals for investors in its unlisted Charter Hall Direct PFA Fund (PFA). CHC stated: “we will only sell assets for prices that reflect fair value and given the lower sales volumes in the office investment markets, sales have proved challenging.” Three notable transactions occurred in July, with retail landlord Unibail-Rodamco-Westfield (URW) selling its stake in Westfield Mission Valley Shopping Centre in California for $290m. The deal reflects a 12% discount to the most recent valuation, an 8.5% cap rate and ~$249 per square foot. The deal pricing likely reflects a reasonable discount considering the competitive retail landscape in the area, with the higher quality, upscale Fashion Valley mall within walking distance.

Charter Hall Retail REIT (CQR) announced the sale of its 50% interest in the Brickworks Marketplace shopping centre in South Australia for $85 million. The sale price represents a 6.1% premium to the December 2022 book valuation.

Meanwhile, Stockland Group (SGP) expanded it lend lease communities development pipeline through the purchase of five lend lease community projects for $210m from the Living Gems Group. Three of the projects are currently under construction with the remaining two due to start construction within the next twelve months.

The S&P/ASX 300 A-REIT Total Return Index produced a total return of -0.1% for the month ended 30 June 2023, underperforming the Australian equities market (S&P/ASX 300 Total Return Index).

To curb elevated inflation the Reserve Bank of Australia (RBA) hiked interest rates in June by 0.25% to 4.1%. The RBA has increased rates at 12 of 13 meetings since May 2022 to the highest level since 2012.

Within A-REITs, industrial and diversified sectors outperformed whilst the retail and office sectors underperformed. Outperforming A-REITs included fund manager Home Consortium (HMC) and office/self-storage landlord Abacus (ABP). HMC announced it had raised $350m in institutional capital for a new unlisted retail property fund. The Portfolio’s underweight position detracted from relative performance. ABP raised $225m of equity for its proposed new externally managed self-storage REIT tentatively named Abacus Storage King (ASK). Pricing of the new REIT reflected a 10% discount to Net Tangible Assets and the Portfolio participated in the raising. The Portfolio’s overweight position in ABP contributed to relative performance.

Underperforming A-REITs included retail landlord Region Group (RGN) and diversified landlord Charter Hall Long WALE REIT (CLW). RGN and CLW were amongst several A-REITs to announce preliminary June 2023 appraisal property valuations. RGN’s book value was marked down 1.7% whilst CLW’s was down 5.8%. The Portfolio’s overweight position in RGN detracted from relative performance whilst the underweight position in CLW contributed positively.

Broadly, appraised based property values have started to fall reflecting the pressure of higher interest rates and most importantly actual transactional evidence after a period limited activity. However, in aggregate A-REIT property values only fell ~3% over the six month period as capitalisation rates expanded by ~25 basis points, partially offset by higher income growth.

Appraised devaluations were most pronounced in office (down 4-8%) whilst non-discretionary retail was down 1.5- 4.0%. Industrial, self-storage and childcare values were flat with rent growth offsetting cap rate expansion. Mall landlords have yet to report.

Some notable transactions took place this month. Office landlord Dexus (DXS) sold an A-grade office building at 44 Market St, Sydney for $393m reflecting a 17% discount to book value, 6.6% cap rate and ~$12,800/sqm. The asset has a short 3-year lease expiry and is only 85% occupied. DXS also sold a business park asset in Victoria for $306m at a 7% premium to book value, bringing total FY23 divestments to ~$1.5bn. DXS has a large development pipeline to fund. The Portfolio’s underweight position contributed to relative performance.

We expect further devaluations will eventuate with more transactional evidence over 2023 as the market has had time to absorb and adjust to higher interest rates and more challenging economic conditions. A-REIT stock prices already reflect significant devaluations suggesting ~15%.

The S&P/ASX 300 A-REIT Total Return Index produced a total return of -1.8% for the month ended 31 May 2023, outperforming the Australian equities market (S&P/ASX 300 Total Return Index). The portfolio underperformed the index.

After pausing in April, the Reserve Bank of Australia (RBA) unexpectedly hiked interest rates in May by 0.25% to 3.85%. Later in the month the unemployment rate rose from 3.5% to 3.7% but the monthly inflation indicator came in above expectations.

Within A-REITs, office and industrial outperformed while the diversified and retail sectors underperformed. Whilst house prices rose for a third consecutive month, residential developers generally underperformed after recent strong performance amid the renewed prospect of higher interest rates.

Outperforming A-REITs included fund manager Home Consortium (HMC), which announced progress in capital raising efforts for new healthcare and retail funds, and office landlord Dexus (DXS) which provided a quarterly update in which office occupancy increased by 0.1% to 95.4% and tenant incentives moderated. The Portfolio’s underweight positioning in both stocks detracted from relative performance.

Underperforming A-REITs included retail landlords Vicinity Centres (VCX) and Scentre Group (SCG). VCX upgraded FY23 earnings guidance to the top end of the prior range, which represents 11% growth, aided by recovering ancillary income. For the first time since 2018 leasing spreads turned positive. VCX also announced the sale of a 50% stake in its Broadmeadows regional mall at a ~4% premium to book value. Proceeds will fund developments.

Weighing on retail sentiment was likely several discretionary retailers (i.e. tenants) reporting slowing sales. The portfolio’s overweight positioning in both stocks detracted from relative performance.

Operating conditions remain favourable for industrial landlords with market rental growth buoyed by low current vacancy and tenant demand exceeding supply. Rent growth is offsetting capitalisation rate expansion, supporting valuations.

Goodman Group (GMG) upgraded FY23 earnings growth guidance from 13.5% to 15%. Although development work in progress fell 7% the $7bn p.a. production rate remained stable. Development margins are attractive and GMG is doing more development on balance sheet. Higher returning data centres now constitute 30% of the pipeline. Other landlords including GPT (GPT) and Centuria Industrial REIT (CIP) also reported accelerating double digit industrial releasing spreads. Underweight positioning in GMG, predicated on relative valuation, detracted from relative performance, whilst underweight positioning in GPT contributed.

Self-storage and office landlord Abacus (ABP) announced revaluations ahead of its proposed creation of an externally managed storage A-REIT. Self-storage values rose 2.6% whilst office/retail fell 5%.

The S&P/ASX 300 A-REIT Total Return Index produced a total return of 5.2% for the month ended 30 April 2023, reversing last month’s losses, and outperformed the Australian equities market by 3.4% (S&P/ASX 300 Total Return Index). The Portfolio underperformed the index. During the month the Reserve Bank of Australia (RBA) kept interest rates on hold. This was the first pause after nine consecutive increases.

Australian housing values appear to have bottomed out. After falling 9.1% between May 2022 and February 2023 CoreLogic’s national Home Value Index increased by half a percent in April, following a 0.6% lift in March.

The RBA interest rate pause, combined with recovering housing prices, made residential exposed A-REITs the top performers within the index, with Mirvac Group (MGR), Stockland (SGP) and Ingenia Communities all producing double digit total returns during the month.

The second-best performing sector was retail, whilst industrial lagged this month. Two residential exposed A-REITs provided quarterly updates. First, MGR reduced its FY23 EPS guidance by 5% due to delays in residential settlements and development profits being pushed into the next year. It also announced progress in capital initiatives by finding two new investors for its Build to Rent segment and partners for new office and industrial development.

The S&P/ASX 300 A-REIT Total Return Index produced a total return of -6.8% for the month ended 31 March 2023, underperforming the Australian equities market by 6.6% (S&P/ASX 300 Total Return Index). During the month the Reserve Bank of Australia (RBA) raised interest rates by 0.25% to 3.60% but suggested a pause is likely near term. The failure of Silicon Valley Bank in the U.S., and the bail-out of Credit Suisse by UBS in Europe, highlighted the fragility of banks with weak capital structures and concentrated asset exposures. What this means for the broader market including REITs is likely tighter lending conditions and reduced credit availability for sectors with weak operating fundamentals such as office. Within A-REITs, industrial outperformed whilst retail was in line with the benchmark and the diversified, fund managers and office sectors underperformed.

Defensive, lower leveraged A-REITs generally outperformed. The best performing A-REITs included residential developer and diversified landlord Stockland (SGP) and self-storage REIT National Storage (NSR). Stockland likely benefitted from the RBA nearing a pause in hiking interest rates and early signs of a stabilising residential property market.

Potential green shoots include monthly positive price growth and robust auction clearance rates, albeit the supply of listings is low. The Portfolio’s underweight position detracted from relative performance. NSR completed a $325m equity raising constituting ~11% of shares on issue. NSR will use the proceeds to fund acquisitions, developments and de-lever the balance sheet which is well placed. Operationally, revenue growth continues to decelerate as expected from an exceptionally high level. FY23 earnings growth guidance of 8.5% was reaffirmed.

The Portfolio participated in the raising and the overweight position contributed to relative performance. A large and complex deal occurred this month involving property fund manager HMC Capital (HMC) and its externally managed HealthCo Healthcare & Wellness REIT (HCW). HMC and HCW both raised equity to fund the acquisition of a $1.2bn portfolio of 11 hospitals leased to Healthscope. The portfolio was acquired on a 5.1% cap rate.

The S&P/ASX 300 A-REIT Total Return Index produced a total return of -0.4% for the month ended 28 February 2023, outperforming the Australian equities market by 2.1% (S&P/ASX 300 Total Return Index).

Within A-REITs, office outperformed whilst retail was in line with the benchmark and the diversified and industrial sectors underperformed.

The best performing A-REITs included National Storage REIT (NSR), diversified GPT Group (GPT) and childcare landlord Arena REIT (ARF). A key underperformer was land lease developer Ingenia Communities (INA) which downgraded earnings guidance due to delayed development settlements stemming from wet weather and labour shortages. The Portfolio’s overweight positions in NSR and ARF contributed to relative February was dominated by earnings releases. Key themes to emerge from A-REIT results include:

• Earnings guidance was largely reaffirmed, or previous wide ranges tightened, owing to greater visibility on higher debt costs. Broadly, passive A-REIT earnings growth will be negative in FY23 due to higher debt costs overwhelming rent growth, and many face further headwinds into FY24.

• Comparable rent growth is strongest for industrial, self-storage, childcare and A-REITs with a high proportion of inflationlinked lease escalators. • Balance sheet leverage remains moderate, with some exceptions. Interest rate hedging continues to be lifted, crystallising a higher cost of debt.

• Despite higher interest rates, appraised property devaluations were only modest at Dec-22 (single digit) given limited transactional evidence. Office was worst hit. Rent growth has partially offset mild capitalisation rate expansion, especially in industrial. Many A-REITs expect further devaluations to eventuate. Hence, some are targeting divestments to de-lever or fund developments.

• Capital partnering initiatives remain a focus.

• Retail was robust across malls and grocery-anchored shopping centres. Occupancy is high, leasing spreads are positive (grocery-anchored) or negative but improved (malls), tenant sales above 2019 levels and rent to sales ratios sustainable. Most expect tenant sales to slow over 2023 as higher interest rates cause consumption to slow. Vicinity Centres (VCX) was one of the few A-REITs to upgrade FY23 earnings guidance, which like some other retail landlords, was aided by the reversal of previous provisioning for COVID unpaid rent.

• Office remains challenged and the outlook cautious. Landlords lack pricing power as market vacancy is elevated (~13-15%) and tenant incentives high (~30%). A-REIT occupancy remains at 90-95%, but some like GPT saw this drop. Leasing activity has lifted but smaller tenants remain more active. Bifurcation remains a theme with newer, higher quality buildings with superior amenity outperforming. Physical office attendance remains at only ~60% of pre-COVID levels. Notably, several AREITs, including Dexus (DXS) and Mirvac (MGR), have deferred office developments due to soft market conditions. Both groups also continue to try to sell office buildings.

• Industrial operating conditions remain favourable. Market vacancy is very low (<1%), tenant demand strong and supply moderate. Consequently, A-REIT portfolios are essentially fully occupied with comparable rent growth of ~4% supported by leasing spreads on new lease deals of 10-20% above in place rents. Several A-REITs including Stockland (SGP), GPT and MGR continue to grow industrial exposure via development. • Residential development faces headwinds. Sales in masterplanned communities and apartment developments have fallen 40-50% from recent periods as buyers remain cautious in light of rising interest rates. Land lease volumes have been more resilient. Prices are expected to continue to fall as affordability remains stretched. Wet weather and labour shortages have delayed settlements into FY24 and defaults are expected to rise. Margins remain elevated given previous price growth exceeded construction cost inflation. • Self storage rent growth is decelerating to ~5-7% after an exceptionally strong few years. Rate growth is offsetting occupancy loss. Supply is moderate. NSR and Abacus Property Group (ABP) continue to grow via development. National Storage upgraded earnings growth guidance from at least 5% to at least 8.5%. ABP has proposed to spin off its $3bn storage portfolio to create an externally managed storage REIT. • Fund managers reported slowing transaction activity and equity inflows. This combined with potential property devaluations present headwinds to earnings growth.performance whilst positioning in GPT and INA detracted.