With the prospect of an RBA interest rate tightening cycle beginning as soon as June this year, we look at how the A-REIT sector performs when interest rates are rising.
Since 2000, there have only been 3 RBA rate tightening cycles (99-00, 01-08, 09-10). Across all 3 periods, Australian Real Estate valuations fell as the P/E ratio of the sector contracted on average by -120bps.
In all 3 tightening periods, the P/E ratio contracted most during the pre-tightening period. This makes sense as the market moves ahead in anticipation of higher short-term rates.
In the current cycle, a similar pattern has emerged. Since the A-REIT index peaked in December 2021, the sector's P/E ratio has fallen by almost 200bps, whilst A-REITs have underperformed the broader market by ~14%. All of this occurred before the RBA hiked rates.
If we extend the analysis across more periods, a similar pattern emerges when the Australian 10-year bond rises. The REIT sector tends to underperform the broader equity market as bond yields rise. Once 10-year bond yields have stopped rising, the A-REITs sector P/E typically begins to expand.
We remain market weight in the A-REIT sector while the interest rate backdrop is currently creating headwinds for the sector. We suspect most of the relative underperformance has now passed.
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John is a leading investment strategist with 20 years experience.