Scentre Group’s Potential for Growth Amid Lease Renewals
Scentre Group (ASX: SCG), the largest shopping centre operator in Australia, is positioned for growth as it prepares to capitalise on expiring leases established during the Covid-19 pandemic. This strategic move could significantly enhance rental income over the next two years, as reported by Morgan Stanley. The firm anticipates a steady annual growth rate of 4.5% in funds from operations (FFO) through to 2027, making SCG an appealing option for investors seeking stable real estate returns.
In the wake of the pandemic, SCG executed over 5,000 lease agreements in 2020 and 2021 at notably reduced rates. Specifically, leasing spreads experienced declines of 13.1% in 2020 and 7.6% in 2021. These leases typically have terms ranging from five to seven years, and many are now nearing the renewal stage.
Understanding Leasing Spreads
Leasing spreads represent the percentage difference between the rental rate of a renewed lease and that of the prior lease for the same space. They serve as an indicator of whether landlords, such as Scentre Group, are achieving improved rental rates through renegotiations or when welcoming new tenants.
Forecasting Rent Increases
As retail rents show signs of recovery, tenants with leases set to expire in 2025 and 2026 may face rent hikes of up to 13%, particularly compared to those renewing in 2024. Approximately 40-50% of SCG’s specialty leases due to expire in the next two years were signed during the 2020-2022 period when rents were significantly lower.
SCG has already demonstrated a recovery in its leasing operations, posting positive leasing spreads of 3.1% in 2023 and 2.0% in 2024 — marking the company’s first notable gains since its establishment. This upward momentum is anticipated to persist as under-valued leases are renegotiated at higher rates, creating a favourable environment for revenue growth. According to analysts, SCG’s retail-focused portfolio presents a more straightforward path to predictable cash flows compared to office-centric real estate investment trusts (REITs).
Comparative Performance of Vicinity Centres
Vicinity Centres (ASX: VCX), a smaller player in the retail REIT market, is also poised to take advantage of these trends, albeit on a lesser scale. With a 12.7% decline in leasing spreads noted in 2021, Vicinity’s upcoming lease renewals might see increases of up to 14% for some tenants. However, SCG’s deeper discounts during the pandemic years suggest more substantial potential for increases.
Scentre Group’s Investment Appeal
Morgan Stanley has given a bullish endorsement to SCG, maintaining an Overweight rating with a target price of $4.34, recognising it as their top pick among passive REITs. The company’s financial health is underlined by its current trading at 1.05 times its net tangible assets and offering a generous FFO yield of 6.2%.
With a debt cost of 5.8% that aligns with current market rates, SCG is strategically positioned to benefit from expected interest rate reductions by the Reserve Bank of Australia (RBA). In contrast, other REITs, such as VCX and Dexus, which have higher exposure to office spaces, may face challenges related to rate increases anticipated for 2026.
Scentre Group adopts a conservative approach focused on incremental upgrades to its smaller malls, minimising disruption and thereby supporting consistent earnings. With a portfolio that includes 12,000 specialty stores across 42 malls, such as the high-traffic Chermside and Bondi locations, SCG is well-equipped to weather economic uncertainties while delivering reliable returns.
In summary, Scentre Group stands at a pivotal moment as it looks to renew many of its leases at higher rental rates, backed by a recovering retail landscape. This, coupled with a conservative growth strategy and attractive financial indicators, positions SCG as a strong candidate for investors within the real estate sector.
