The A-REIT leader: Goodman's transformation from warehouses to data centres

Real estate is one of the most important sectors in the Australian economy, with home ownership deeply embedded in the fabric of the Great Australian Dream.

Unfortunately for first-time home buyers, Australia's housing market has witnessed its 19th consecutive increase of 0.5% in August 2024, pushing the national median home price up to $802,357, as reported by the CoreLogic monthly Home Value Index (HVI).

As escalating home prices continue to pose significant challenges to home ownership, particularly for urban dwellers and Millennials, investing in real estate is emerging as a popular alternative, providing a viable avenue for financial growth.

In this article, we'll take a close look at $Goodman Group (GMG.AU)$ , the largest property group listed on the Australian Securities Exchange (ASX). Notably, it stands out among numerous companies outside the tech sector that are evolving their business models to capitalise on the advantages of artificial intelligence (AI), a trend that is evident in the performance of its shares.

What is Goodman's business model?

$Goodman Group (GMG.AU)$ is an Australia-based global leader in industrial property and digital infrastructure, operating in key consumer markets across Australia, New Zealand, Asia, Europe and the Americas.

Founded in 1989 as a private property trust focused on industrial properties, Goodman has since evolved into the largest Australian Real Estate Investment Trust (A-REIT), boasting a market capitalisation exceeding $60 billion.

In simple terms, A-REITs are holding companies that own and operate income-generating property assets such as office towers, shopping malls, industrial facilities, as well as hotels and cinemas. Similar to managed funds, they represent pooled investments that are overseen by professional managers.

Aiming to“making space for greatness”, Goodman employs an integrated business model known as Goodman's Own Develop Manage model. This approach allows the company to own and maintain high-quality properties in key global cities, develop essential infrastructure and manage the investment portfolio to the highest standards. The model emphasises the effective establishment of transactions before any construction begins, significantly mitigating risks associated with its projects.

A typical Goodman project involves acquiring a development site, securing tenants through lease agreements and attracting investors to finance the development and purchase the completed project. Goodman usually retains a minority ownership stake and continues to manage the properties post-completion, generating revenue from development fees, leasing fees, management and performance fees, as well as a portion of the rental income.

Goodman's customers span a diverse array of industries including e-commerce, logistics, retail, consumer goods, automotive, food production, pharmaceutical, life sciences, healthcare and technology. To support its customers in achieving their goals, the company creates spaces in desirable locations and provide them with exceptional service.

What makes Goodman stand out?

While Goodman stands as the largest A-REIT, representing nearly 40% of the S&P/ASX 200 A-REIT index, it is remarkable that its valuation in recent years has increasingly resembled that of a tech stock rather than a traditional property investment.

Several factors position it favourably against its domestic peers:

● Data centre ambitions

The rapid expansion of the data centre sector, fuelled by the megatrend of generative AI and cloud computing, is resulting in a noticeable surge in demand for data storage and commercial real estate activity worldwide.

As providers of essential infrastructure for the digital economy, Goodman has been developing its data centre capability since 2005 and its strategic shift towards AI and data centres has been carefully planned. The company is significantly increasing its investments in this rapidly expanding sector, with data centre projects representing 40% of its $13.0 billion development pipeline as at June 30, 2024. This proportion is expected to exceed 50% in the coming years as the company transitions from planning to construction.

Data centres are typically higher-value, large and complex development projects that align with Goodman's strategy of undertaking fewer, yet more substantial, projects. Although these projects carry greater risks and longer completion times, they offer significantly higher yields, typically exceeding 9%, compared to those generated from conventional industrial estates.

Looking ahead, data centres are anticipated to be a major catalyst for Goodman's growth. The company's competitive edge stems from its access to secured power at its sites and its established track record in development and program delivery.

● Global property portfolio

Goodman's focus on industrial property and global operation give it a competitive advantage over other A-REITs.

The company has a huge global property portfolio worth $78.7 billion as at 30 June 2024. This portfolio includes logistics and distribution centres, warehouses, light industrial, multi-storey industrial, business parks and data centres. The company does not engage in commodity real estate; instead, it concentrates on unique assets located in constrained land areas, where land is constrained, enabling it to assist clients in enhancing productivity growth.

In contrast to other A-REITs, which typically operate within Australia, Goodman's global operations are substantial, contributing to 64% of its earnings in FY2024. The international diversification positions Goodman to expand its business more effectively in the coming years, potentially enhancing its overall value.

● Low gearing

Rather than relying on significant bank debt, Goodman seeks investment partners for site development and secures potential tenants before commencing construction.

The majority of the company's current projects are either undertaken in partnership or have been pre-sold to partners and third parties. This approach has led to a remarkably low gearing level of 8.4% (22.7% on a look-through basis) and a robust interest coverage ratio of 44.0x as at June 30, 2024—among the lowest in the global property sector. In contrast, many comparable companies operate with gearing levels ranging from 30% to 100%, providing Goodman with a significant advantage in an environment of rising inflation and interest rates.

The bottom line

Goodman is placing greater emphasis on data centres instead of traditional industrial warehouses. Investors have been wagering that ownership of these data centres will lead to substantial profits, resulting in significant gains in Goodman's share value.

Real estate is highly sensitive to fluctuations in interest rate. As a proactive real estate manager, Goodman has the ability to grow its assets under management and create value through the acquisition and development of diverse properties, as well as by implementing effective strategies once those assets are operational.

Nonetheless, despite its strategic positioning, Goodman cannot shield itself from the effects of rising interest rates on property values, especially given the inherent volatility present within its portfolio.