Falling official interest rates means investors are seeking alternative forms of income, and real estate investment trusts (REITs) offer the opportunity to access reliable income and capital gains, with the current cycle of official interest rate cuts a positive for REITs, according to Grant Berry, portfolio manager at SG Hiscock & Company.

Contributing to this within Australia is the high demand from population growth, coupled with elevated construction costs and economic uncertainty, leading to less supply, which is all supporting returns from REITs, he says.

“While we see increasing downside risks for economic growth in Australia and offshore, there are still supportive tailwinds for the REIT sector. Population growth is robust, and forecast to continue,” says Mr Berry.

“Research from CBRE has forecasted that the Australian population will rise to 32 million by 2035, which represents an increase of 4.5 million people over next 10 years.

“Population growth ultimately drives occupancy demand for property. In Australia, the growth is much greater than most other developed nations, and that growth will help to support the demand for Australian commercial property.

“In particular, greater population numbers will raise the need for hospitals, housing, logistics facilities, and we will also need more retail and office space. The CBRE research shows that with each additional 1 million increase in the population, it will require 4,500,000 square metres for logistics, 800,000 square metres for retail, 800,000 square metres for office and 420,000 new residential dwellings. These are all significant numbers,” he says.

The supply dynamics are also an interesting aspect in that brining on supply is challenging in many subsectors due to land constraints, associated planning or economics due to elevated construction costs. Strong demand and low levels of new supply supports the investment case for existing quality real estate. According to Mr Berry retail spaces are a challenge, and vacancy rates in offices are slowing down supply.

“It is a challenge to supply retail spaces, as the associated planning and costs to build on land in urban locations is proving difficult. In the office space, planning and supply is easier given the vertical nature of office buildings. However, vacancy rates are elevated, and construction costs have risen in the order of 40 per cent in recent years. Hence not much supply there. In the industrial and logistics space, there is more supply and while there are areas that are more challenging, such as infill locations, we did in fact have a record year of supply in 2024.  Which is why we prefer retail and office.  

“On top of all of this, lower quality assets can be withdrawn from the market for alternative uses such as old office buildings converted to residential,” he says.

Further interest rate cuts and government policy are additional tailwinds for the residential subsector. Mr Berry says that a relatively good regulatory environment and corporate governance in Australia is favourable for commercial property investment in Australia from an international perspective with a low Australian dollar a potential attraction.

Meanwhile, falling bond yields and healthy credit spreads make the real estate sector’s dividend payments more appealing; these securities historically paid higher dividend yields than other equity classes, offering an alternative source of potential income, according to Mr Berry.

“Bond yields for valuation metrics, that is nominal bond yields, feed into discount rates and inflation linked bonds (real bonds), which we believe have relevance to capitalisation rates and property yields. Both are currently elevated in a post GFC context. If property is priced with reference to this, it sets up the asset class for good long-term returns.

“Investing in an Australian REIT can help investors diversify, have exposure to high quality assets and lower transaction costs without buying actual property. Investors gain exposure to different property sectors and real estate assets and such diversification is hard to achieve by investing directly in commercial property given the significant costs and scale involved,” Mr Berry says.