Listed property trusts were once the sector that could do no wrong but following the Credit Crunch and the ensuing Global Financial Crisis the sector literally came apart at the seams.
Today, having lost fifty percent of its assets under management in 12 months, Australia’s recovering listed property trust (LPT) sector – otherwise known as REITs – are readying for a comeback.
But it won’t be a smooth journey back up – so investors need to know the LPTs to target and avoid.
You can’t be too cautious either: bank-forced sell-offs led to the downfall of majors like Babcock & Brown and the two Allco-owned companies, Rubicon Asset Management and Record Funds Management. There’s growing fear that other highly geared smaller cap LPTs – currently breaching loan-to-value ratios – may also collapse as tight debt markets make refinancing problematic.
On a promising note, however, the sector managed to bounce back from last year’s lows, with a 13 percent jump in the three months to May. This suggests that while conditions remain tough, they’re improving for stocks that successfully managed to survive via capital raisings to reduce debt or finance huge major dollar write-downs.
Since September 2008 over $15 billion has been coughed-up from investors in LPT’s, including majors like Westfield Group (WDC) and Valad Property Group (VPG). And while Mirvac (MGR) and GPT Group (GPT) have each made two separate raisings, Goodman has gone ‘cap-in-hand’ to the market three times.
But returns in this sector are on the up: The SG Hiscock Listed Property Composite put on 23 percent in the three months to May. And based on Rainmaker data, the top 40 Australian LPTs returned around 10 percent over three months, while the (unlisted) MLC (NCIT) Property Securities Trust returned over 39 percent.
According to Shane Oliver head of investment strategy with AMP Capital Investors, much of the renewed investor sentiment towards LPTs can be attributed to significant efforts to reduce gearing. In addition to reducing the need for asset sales that were hanging over the whole non-residential property market, Oliver says a reduction in weighted average gearing – from 36 percent to around 31 percent – has alleviated downward pressure on valuations.
Equally compelling, he says despite the recent rally, LPTs are still trading on significant discounts to net asset value (NAV). While distributions are still being cut, he expects them to settle around 10 percent at current share prices. This compares with an average 7.1 percent yield now offered by directly held Australian non-residential property and a 4-5 percent gross yield offered by directly held residential property.
“Given that they’re offering underlying distribution yields of around 10 percent and are trading at levels last seen 25 years ago – and so have largely factored-in the likely fall in underlying property values – they (LPTs) are judged to offer pretty attractive returns for the next five to 10 years,” says Oliver.
So given the degree of equity raisings, asset sales/stgaluations, distribution cuts, reduced corporate overheads, write-downs – and bearish results that have left investors somewhat befuddled – which LPTs should they contemplate buying and which ones should they avoid?
Given that the top seven LPTs, which comprise around 90 percent of the sector, have gone to the market to deleverage gearing levels rather than sell assets, Dinesh Pillutla head of property for Aegis says the focus has transferred from capital structure issues to property fundamentals like vacancy rates, operating efficiency and good management.
Pillutla says the primary investor focus is now on what constitutes a sustainable yield. And within this market, Pillutla advises investors to steer clear of over-geared LPTs and focus on quality stocks offering 7-10 percent (yield).
He says the key now is to understand the composition and sustainability of the distribution and where it comes from. “That means looking for quality rental income as opposed to distributions that rely on top-ups from one-off abnormals,” says Pillutla.
Based on these dynamics his four favoured stocks include: CFS Retail Property Trust (CFX), Commonwealth Office Property Fund (CPA), Westfield Group for a longer term, and on a more speculative note, Australand Property Group (ALZ) based on its exposure to an upturn in the residential property cycle. “While there’s more risk than cash here, there is sufficient return to justify the exposure,” says Pillutla.
According to Peter Cashmore property analyst with Citi, the message that resonated from (LPT) managers during reporting season signalled a new era in which the focus is squarely on domestic assets, liquidity and an unwillingness to pay out above what they earn. And given that they tend to be more highly leveraged, he expects to see a continued sell-down of offshore assets, especially by smaller LPTs unable to find alternative funding. “Recent moves by Commonwealth Office Property Fund and Dexus (DXS) to declare earnings on an FFO – or ‘funds from operations’ per security basis – suggests a return by LPTs back to a simpler edict: ‘If we don’t earn it – we don’t pay it out’,” says Cashmore.
While yields may be less appealing within LPTs wired to retail, he says they look to have less downside risk than those exposed to more bearish industrial, and more notably office sectors. Total vacancy rates across Australia’s office market, rose sharply from 5.9 percent to 8.3 percent in the past six months.
In light of recent distribution cuts, Cashmore is impressed by CFS Retail Property Trust’s decision to flat-line, rather than cut its distribution profile, plus its healthy capital position and strong management.
Unsurprisingly, Westfield Group – the world’s biggest shopping centre owner which currently represents 43.3 percent of the assets in the LPT Index – remains Citi’s preferred retail exposure. Following the improvement in the quality of the portfolio through stgelopment and acquisition, the broker continues to view the stock as representing good value relative to Australian REITs.
Citi claims a lower cap rate for Westfield could be warranted given its estimated 45 percent Australian asset base which will likely continue to outperform, offsetting its higher proportion of non income producing assets. “We believe Westfield (FY 10e yield 7.1 percent) is well placed in current tight credit markets, evident in the success of their $700 million bond raising and positive feedback from the current $1.25 billion bank loan refinancing,” Citi says.
On the flipside, with a 20 percent fall in asset values likely to see it breach covenants, ING Industrial (IIF) is one of Citi’s top underweight picks, along with Goodman Group (GMG), and Mirvac Group (MGR). And while Citi expects Goodman’s large equity capital raisings to significantly dilute earnings, the broker rates Mirvac a sell based on its dividend cut, reflecting the extent to which it must operate prudently in an unrelenting capital constrained environment.
While many LPTs are trading at significant discounts to NAV for good reason, Michael Este who runs LMW Invest’s funds, says those gratuitously hurt by negative market sentiment represent good ‘value-plays’. Given their healthy balance sheets, the quality of their property assets and sound management, he says these include Dexus, and the Commonwealth Office Property Fund; and potentially Stockland (SGP) and Mirvac on the back of a recovering residential market. “Overlay the big hit taken by Dexus since revaluing its entire property portfolio as at June 30, with an 18 percent discount to NAV, and this signals that there’s value here,” says Este.
Given that only a handful of the 60-plus LPTs on the All Ordinaries Index are what Este regards as investment grade, he suggests investors favour the larger stocks over their smaller counterparts, especially those that have cut or stopped distributions completely, and/or breached gearing their covenants.
Top Overweight & Underweight Picks for the REIT Sector (Alphabetical order)
|Top Picks – To Buy|
|Stock||Current Price||Target Price||Yield FY10e|
|DXS – Dexus Property Group||0.755||0.90||10.4%|
|IOF – ING Office Fund||0.555||0.64||8.1%|
|WDC – Westfield Group||12.50||12.15||7.1%|
|Top Underweight Picks – To Avoid|
|Stock||Current Price||Target Price||Yield FY10e|
|GMG – Goodman Group||0.595||0.40||13.7%|
|IIF – ING Industrial Fund||0.47||0.05||0.0%|
|MGR – Mirvac Group||1.415||0.96||6.3%|
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