Property valuations are declining, leading REIT landlords to contemplate asset sales in order to avoid breaching their debt covenants. However, selling assets in the current market could result in lower valuations.
The results of the Charter Hall Long WALE REIT on Tuesday highlighted two key messages for investors. Firstly, not all commercial property is performing equally. While the total portfolio value of the REIT decreased by 5 percent to $6.8 billion, different property types experienced varying declines. Office property values took the biggest hit, dropping by 9.1 percent, while industrial/logistics property remained stable, and retail property fell by 5.3 percent.
The decline in office property values is leading to discussions of potential asset sales in the future. Sheds and warehouses are outperforming shopping centres, while offices are experiencing valuation decreases due to rising interest rates and remote work practices.
Landlords are facing a delicate balancing act over the next year as they try to minimize property valuation cuts while staying within their debt covenants. The manager of Charter Hall Long WALE REIT, Avi Anger, addressed concerns about the REIT’s gearing levels, which currently sit at 42.3 percent. If there were further valuation cuts, the gearing level could rise to around 48 percent, close to the REIT’s 50 percent covenant.
Anger reassured investors that the REIT maintains healthy buffers and significant valuation declines would be necessary for the covenant to be breached. However, he also mentioned that the REIT is considering asset sales to reduce debt. This strategy would provide additional breathing space, although selling properties in a challenging market poses the risk of locking in lower values.
REITs are in a difficult position as they strive to stay within their covenants while property values decline. Asset sales are seen as a solution, but in an unfavorable market, the gap between buyers and sellers is significant, potentially leading to lower sale prices. These lower prices can have a cascading effect on the overall portfolio and the broader market, as property values are determined based on recent transactions.
Australian REIT giants like Charter Hall have previously weathered similar conditions, including during the Global Financial Crisis (GFC). The experience gained from managing through challenging environments should provide some resilience. However, the current environment remains tough, and with rate cuts not anticipated in the near future, the challenges for REIT landlords are unlikely to ease quickly.