The book value of Centuria Office REIT (ASX: COF) experienced a significant portfolio drop at the half year. This doesn’t bode well for the valuations of its peers suffering from a higher cost of debt and weaker demand – courtesy of entrenched hybrid work patterns.
Having completed external valuations on 12 of its 22 investment properties as at 31 December 2023 – representing around 49% of the portfolio by value – Centuria Office REIT posted a like-for-like decrease of around $124m on the previous portfolio’s book value, a decline of 5.6%.
In line with Centuria’s valuation policy, the remaining valuations (51% of portfolio value) will be undertaken as director’s valuations with the HY24 results. Valuations and changes to Net Tangible Assets (NTA) remain subject to audit and could be revised up or down.
Centuria Office’s recent revaluation follows a 6% markdown by its peer, ASX-listed Dexus (ASX: DXS), last December which follows a 7.7% portfolio markdown experienced by the REIT six months earlier.
Then there’s Abacus Group (ASX: ABG) which recently forewarned the market to expect a 6.5% drop in the previous book value for the six months to 31 December 2023, when the group’s HY24 results are released 27 February 2024.
Further pain in-store for office
With hybrid work patterns now looking more entrenched than many expected, Colliers suspects REITs with commercial assets are only halfway through the current downward revaluation cycle.
While Sydney’s prime CBD office towers fell by up to 15% in value by the end of 2023, Colliers data suggests it has significantly further to fall in 2024.
At the apex of its fall, somewhere during the third quarter of 2024, Colliers expects prime Sydney office values to have fallen by as much as 27.5% from their June 2022 peak.
Not unlike the GFC, which took 21 months to go from peak to trough, Dwight Hillier, Colliers managing director for valuations and advisory, services suspects current revelations are on a similar trajectory.
Given the inability of the landlords to raise rents to offset pressure on valuations, Hillier expects the office sector to remain the most exposed commerical property asset class this year.
Valuers are looking for transactional evidence to make the decisions on valuations and to make bolder changes. There’s only been a 12.5-basis-point expansion each quarter since December 2022.
Yield expansion correction
Based on Colliers’ numbers, yields will have jumped 137.5 basis points – pushing prime office yields to just under 6% – by the time the market bottoms out later this year.
“Valuers are looking for transactional evidence to make the decisions on valuations and to make bolder changes. There’s only been a 12.5-basis-point expansion each quarter since December 2022,” Hillier told the AFR.
“It’s been death by a thousand cuts. But what we could see in 2024, potentially in the first quarter, is a more significant yield expansion correction. It might be 25 basis points or 50 basis points, who knows.”
Hillier expects the potential sale of a half stake in the $800m tower at 255 George Street in Sydney – held in a wholesale fund that Mirvac took over from AMP Capital – to provide a crucial benchmark on pricing later this year.
Despite the revaluation hit being experienced by REITs with commercial assets, Australian super funds have – within a recent survey conducted by the AFR – poo-popped any suggestion they will have to slash valuations of their hefty real estate portfolios again this year.
All funds surveyed share the view that further valuation write-downs will not be required, and defended their valuation processes after APRA’s warnings that they need to improve.
These calls look especially big when some of the index providers, like the MSCI Index, through most of last year, was like a sellers strike where people weren’t putting properties on the market – so it’s really hard to test what valuations are doing.
Are super funds immune to further writedowns?
Given that the unlisted property [index] – which accounts for around two-thirds of the not-for-profit super fund’s property holdings – has been looking pretty grim, Alex Dunnin director of research at Rainmaker Information says super fund optimism appears counterintuitive.
With a lot of office blocks continuing to be remarkably quiet, he says fund managers coming out and saying valuation plummets are over seems like a big call to make.
“These calls look especially big when some of the index providers, like the MSCI Index, through most of last year, was like a sellers strike where people weren’t putting properties on the market – so it’s really hard to test what valuations are doing,” Dunnin told Propj.
“When things have gone on the market, they’ve sold at quite significant discounts, and that reinforces why – if fund’s CIOs’ are saying – no, no, we’re coming to the end of the down-cycle – they must be seeing something other people aren’t.”
Positive returns mask property woes
Dunnin notes the returns super funds are declaring in their property investment options are still negative.
But what’s saving super funds right now, adds Dunnin, is equity returns most of which have been driven by the energy or technology sector spikes.
As a result, he expects super funds to finish the calendar year with returns in their default options of 8-10%.
“While this result looks good, it’s hiding what’s going on underneath the surface within the property sector,” says Dunnin.
“While super funds can’t hold off [revaluing their assets] indefinitely, provisions brought in by the regulator last year weren’t very prescriptive in terms of what they had to do.”
But Dunnin also reminds the market that some super funds are getting so big that they can by nature absorb losses just by the magnitude of their cash flow.