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.