Australian interest rate movements and A-REITs performance: an analysis by industry sector

Abstract

Investment managers have traditionally resorted to the Australian real estate investment trusts (A-REITs) as a means to growing portfolio return. The A-REITs have been popular for yielding some of the best returns until 2007, when the global financial market (GFC) collapse led to major fall in values. Since the GFC, with low interest rates the A-REITs have performed well compared to the broader stock and bond markets. Given low expectations of additional monetary easing, future rising interest rate environment can significantly impact A-REIT performance mainly in industry sectors with greater reliance on debt funding. Thus, this research explores the sensitivity of A-REITs performance to changes in short- and long-term interest rates across five sectors: diversified, industrial, retail, office and specialised (non-core) funds. The analysis covers a 21-year period (1995–2016) using the capital asset pricing model. In doing so, the research allows comparison of A-REITs performance at sub-sector level and over different market cycles. Findings indicate that both the diversified and retail sector exhibit strong relationship to market risk, short- and long-term interest rates. Rising short-term interest rates contribute to positive returns while rising long-term interest rates result in lower returns. However, the impacts of movements in interest rates on industrial, specialised (non-core) and office sectors were not well explained by the asset pricing model. This could be due to the relatively small sample size of these funds. Overall, the results suggests that gearing levels and by extension costs of debt, do play a significant role in the returns generating process. The paper offers a well-defined practical implication by suggesting that investors may hedge against interest rate risk by selecting A-REITs sub-sector funds with less leverage and large market capitalisation.

Keywords:

• REITs
• interest rate
• property investments
• bonds
• capital asset pricing
• leverage

Acknowledgement

The authors would like to acknowledge the contribution of Mr. Mario Saccoccio, Melbourne-based property professional, for his ongoing industry involvement with the research. We acknowledge research funding contributions from School Property, Construction and Project Management at RMIT University. In addition, we acknowledge contributions made by research supervisor, Professor Dr. David Higgins (Birmingham City University).

Notes

1. Calculated as the percentage of total debt to market capitalisation.

2. The cash rate was 1.50% at the time of this writing.

3. Adjusted for dividend payments, stock splits and so forth.

4. Defined as (Long-Term Debt + Short-Term Debt & Current Portion of Long-Term Debt) / (Total Capital + Short-Term Debt & Current Portion of Long-Term Debt).

5. This is implemented in Matlab software via the 'spline' function. The method involves fitting a third order polynomial around existing data points to interpolate unobserved values between these data points.

6. The Scentre group was created in June 2014 when the Westfield Group separated its United States and European businesses from its operations in Australia and New Zealand.

7. .

8. The pre-GFC period consists of observations between August 1996 and August 2007. The GFC period consists of observations between September 2007 and August 2009 and the post-GFC period consists of observations from September 2009 onwards.