Once upon a time Australian Real Estate Investment Trusts (A-REIT) were a favorite place for investors looking for high yield. And then along came the GFC. Many A-REITS leveraged themselves to the hilt and when the credit markets tightened, many found themselves in serious strife.
However, in the last few years the sector has picked itself off the floor and once again investing in A-REITs – which used to be called Listed Property Trusts - has become fairly profitable. As opposed to fixed income investments, with an A-REIT you have the potential to benefit from both yield and capital appreciation. You also can buy and sell an A-REIT in the same way you trade BHP or any other ASX listed stock.
There are two types of A-REITS – stand alones and stapled securities. Both types manage and/or own real estate that can vary by location and primary use. Diversified A-REITS may hold assets in residential real estate, retail real estate, industrial and commercial real estate, and hotel and leisure real estate.
A Stand Alone A-REIT property is held in a real estate trust managed by a single entity and investors benefit both from the value of the property and potential rental income. With “stapled securities” you are effectively buying a two for one special. You get a share in a managed fund as well as in an operating company with the two entities “stapled” together. Regardless of structure, some A-REITS contract out the management of properties they own.
Another way to think of the two structures is to differentiate between the passive holding of an asset, and the active management of the asset and development of new assets. With stapled securities, the managed fund passively holds asset ownership while an operating company actively manages the holdings and buys or builds new holdings. For investors, here is the two for one special. First the tax nature of the trust provides either tax free or tax reduced distributions through depreciation allowances and franking credits with the taxable dividends on the shares.
The sector can be very complex to fully understand as one listed A-REIT often manages the property for another. Putting the complexities aside for the moment, you might wonder why anyone with any common sense would invest in property of any kind here when so many are so bearish on the sector.
Here is why. The following one-year share price chart compares two A-REITs, with Westfield Group (WDC) – Australia’s largest A-REIT and one of the largest in the world – managing property for one of Australia’s smallest A-REITs – Carindale Property Trust (CDP):
WDC has over 111 retail shopping centres in its portfolio spread across Australia, New Zealand, the United Kingdom, and the United States. Carindale has a 50% interest in Westfield Carindale shopping centre in Brisbane. Already one of the biggest centres there, expansion to be completed by the end of this quarter will add 120 stores, making this the fifth largest shopping centre in Australia.
The expansion is proceeding in stages and with the first stage recently completed, analysts at JP Morgan raised the target price on CDP from $5.60 to $6.50 pointing out the share price is not taking the additional capacity into account.
Analysts at Deutsche Bank and BA-Merrill Lynch reiterated BUY ratings on WDC and raised their target prices since June of 2012, citing strength in their US Assets. Given concerns about encroaching Internet sales on our brick and mortar retail outlets, the strength of the Australian dollar, and concerns over property markets in all sectors, the share price performance appears to be something less than purely rational; as investing in a downward spiraling sector seems totally irrational.
As evidence of these valid concerns, there is the recent earnings release from another giant A-REIT – the Stockland Group (SGP). Unlike Westfield, Stockland is highly diversified with holdings in residential and retirement properties, retail properties, and office and industrial properties. A one-year share price chart shows impressive performance going into the earnings report and market reaction to that report:
There was little to like in this report. Net profit dropped 35%, down from $754.6 million a year ago to $487 million for the current fiscal year. Although the company attributed the profit decline to “adjustments to financial instruments”, revenues of $2.22 billion were also lower, down 21% for the year.
To complete the dismal picture, management stated the earnings outlook for 2013 will be below the 2012 numbers unless there is substantial improvement in residential real estate in coming months. To get a better picture of the carnage that followed the announcement take a look at the 5-day share price chart:
The outgoing CEO of Stockland called the current residential market the worst he had seen in 20 years, driven by a lack of consumer confidence. Job security, potential changes in interest rates, and falling home prices are keeping potential buyers on the sidelines.
Analyst forecasts for SGP had already been lowered enough that the poor results actually met some revised estimates. Only two major firms – UBS and Credit Suisse – downgraded SGP from BUY and OUTPERFORM to NEUTRAL. Macquarie already had an UNDERPERORM rating on the stock but cut its price target. JP Morgan, BA-Merrill Lynch, and CITI all maintained BUY or OUTPERFORM ratings, citing the 7.4% dividend yield.
NAB (National Australia Bank) publishes quarterly surveys for both commercial and residential property. The most recent results for residential property show home prices declined nationally by 2%, with the largest drops in Victoria (2.9%) and New South Wales (2.3%). This 2nd Quarter decline followed a 1.1% decline in Q1. Property professionals surveyed indicated conditions would remain challenging throughout 2012 with another 0.7% possible drop by year end. However, they see conditions improving in 2013. On the positive side, the NAB survey showed the percentage of first time home buyers in the market rising to 22.1% in Q2 following a rise of 18% in Q1.
Commercial property is under pressure as well. Retail property values are forecasted to decline by 1.2% with industrial properties dropping 0.9%. However, the survey sees a 1% increase in office property values over the next year with vacancy rates at between 6 and 7%.
It's easy to dismiss these survey conclusions that the current downtrend will reverse itself in 2013; indeed, real estate professionals have a vested interest in painting a rosy outlook. However, analyst opinion generally agrees with this view with few, if any, calling for a wholesale exit from the A-REIT sector.
Two more A-REITS support the notion that share price performance might be attributable to the operation of the company rather than market conditions.
First there is Aspen Property Group (APZ), with a market cap of $473 million. Their principal exposure is commercial, with residential holdings limited to land and Aspen Village communities for active retirees and tourists. Their major revenue streams are from office, retail, and industrial properties. Here is their one year share price chart:
The share price turned southward after the company announced the sale of a holding in Queensland called the Rocklea Building. Although the property was valued at $8.1 million, Aspen sold it for $7.35 million, explaining the building had been vacant for an extended period and was considered a non-core asset. Management argued that offloading the property at a loss - and cutting short any further capital expenditure on it - was a positive outcome; the market wasn't so jubilant. The share price collapsed at the end of June when the company lowered its FY 2012 guidance.
Australand Property Group (ALZ) is perhaps a better example of the hypothesis that well-run companies are able to thrive in difficult market conditions. Australand is a diversified property group with its main focus on commercial and industrial properties, although it does generate around 25% of its earnings from residential holdings. On 26 July the company announced net profit of $89.7 million, for a 6% year over year increase as well as an outstanding 41% revenue increase to $393 million. Interestingly, commercial and industrial properties fell 26% while their holdings in the purportedly moribund residential sector increased 46% to $38 million. Analysts at BA-Merrill Lynch upgraded the shares to BUY with an increased price target and Macquarie, Citi, and JP Morgan also raised their price targets.
ALZ did this in the face of a difficult environment and management stood by its higher guidance for the coming year, which according to Deutsche Bank, is “defying challenging market conditions.”
All of these companies pay handsome dividends – Australand has a yield of 7.8%; Aspen is at 12.6%; Stockland at 7.5%; Westfield at 4.9%, and Carindale at 5.3%.
Analysts and real estate professionals are not the only ones who see value in our property markets, despite the trying times. According to CBRE – the largest real estate services company on the planet – in the past year 30% of all commercial properties sold in Australia went to foreign buyers.
One of the hallmarks of a great company is the ability to reinvent itself when faced with uncertain conditions or a changing market environment. Our two largest A-REITS – Stockland and Westfield – are doing just that.
Westfield is aggressively pursuing an upscale strategy by shedding lower quality properties and going after higher-end shopping centres. Instead of fleeing the UK the company is increasing its investment in upscale UK outlets over the next few years. Going forward, this strategy will result in higher margins and higher rental rates while simultaneously insulating itself against decreased spending from middle and lower income consumers in economic downturns.
Stockland’s new vision, called the 3-Rs strategy, is bolder. They are divesting themselves of their office and industrial properties and leaving the UK entirely. Sydney’s Central Business District (CPD) is dwindling with only 1% growth over the last decade and the UK is not expected to emerge from their current recession anytime soon.
What are they up to? Despite concerns about residential real estate, they believe in the population growth and retirement potential in Australia and by 2017 they plan to generate 65% of their revenue from Retail properties; 23% from Residential; and 12% from Retirement properties.
The company estimates the approximately $2.9 billion from asset sales will cover their capital investment expenditures without having to take on more debt or resort to a capital raising. They're also targeting increased exposure to areas where population growth is expected to be highest while reducing exposure to neighbourhood and CBD shopping centres.
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