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In 2018 the XJO fell 3.23 percent.

Notionally the poor performance on our market is at least partly due to weak domestic property prices. CoreLogic/RP Data, a house price aggregator that has traditionally been very generous with house price growth estimates, put the drop in house prices at 4.8 percent the December 2018; the weakest conditions in the housing market since 2008.

However, in those same twelve months, the XPJ – an index of Australia’s largest REITs (Real Estate Investment Trusts) has actually risen 4.81 percent.

So what gives?

Well, many REITs focus on non-residential property – whose performance is less publicised than the widely followed residential prices, and this may have inadvertently helped REIT performance. Additionally, a weaker outlook for interest rate rises (both in Australia and the US) has also likely been a benefit for the sector.

Investors may also favour the higher yields of REITs, which become relatively more attractive in a lower interest rate environment.

Regardless, it doesn’t mean that the underlying performance of the sector hasn’t been hit by the latest property downturn. For example, last week REIT Vicinity Centre (the fifth largest listed REIT in Australia) reduced the book value of its property portfolio, which was labelled as “symbolically significant” by Citi analyst Adrian Dark, adding that “that conditions are deteriorating faster than even we expected”.

Last Friday ASX listed LandMark White Ltd (LMW), a listed property services firm, downgraded their earnings forecasts for this financial year, blaming “a reduction in valuation instructions from first-tier lenders”.

The NAB commercial property index also hit a two year low late in 2018, with respondents reporting that retail property rents are expected to fall in all states.

With the REIT sector trading at multi-year highs, and underlying conditions not particularly strong, the risks are likely to the downside for the REIT sector.

And the risks are particularly pronounced in the retail subsector. As one investor told the AFR: “Rents have been rising at 4 per cent, wages at 3 per cent and sales in stores have been falling for five years. The economics of the tenants and the mall owners can’t decouple for too long.”

The REIT sector is traditionally seen as a strong defensive sector on the market. However, the causes of current economic downturn weakness in Australia are heavily tied to the underlying assets of REITs, and this could lead to some shock for REIT investors in the years ahead.