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This article appeared in the January 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Why a solid recovery performance should continue in the listed property sector in 2013.
By Ken Howard, RBS Morgans
Property trusts performed very strongly in 2012, with the A-REITs sector outperforming the ASX 200 index by around 9 per cent for the year ended November 30, 2012.
Arguably the performance can be attributed to three broad categories:
- Property trusts were cheap 12 months ago. This time last year many property trusts were actually trading at a discount to net tangible assets (NTA) with little or no value assigned to any funds management or development operations contained within the trust, for example, Westfield Group. (Most property trusts on the Australian sharemarket are in fact stapled securities, typically one unit in a trust stapled to one share in a company.)
- Property trusts have added value over the past 12 months. Many of the trusts have been able to do simple things to add value, such as buying back shares on market at a discount to NTA (as GPT Group has), or completing their post-GFC restructuring, Centro Retail Australia for example.
- Progressive interest rate cuts. These have lifted investor demand for investments promising predictable income, not just property trusts but utility and infrastructure shares such as Telstra and Transurban.
Most investors would agree that the low interest rates environment is likely to persist for some years, which supports the notion that A-REITs will remain in demand over 2013. Paradoxically, low interest rates are symptomatic of soft economic conditions, which is another way of saying tenants of the property trust could very well be struggling.
Equally, I am sure the 2012 performance of the A-REITs sector added some positive tailwinds for the sector heading into 2013, but investors should be cautious about prices over-shooting value.
The sharemarket changes its mind every day and although some short-term trends persist for months or longer, they do not go on forever and invariably prices return to intrinsic value, and often on their way to the opposite extreme.
As a generalisation, it would not be unusual for the price of an A-REIT to have a 20 per cent trading range from low to high over a year, even though the NTA is unlikely to move by more than a couple of per cent.
Take GPT as an example
- The stapled securities closed at $3.16 on December 9, 2011 and the NTA for June 30, 2011 was reported as $3.64, so the shares were trading at a 15 per cent discount to NTA.
- On December 7, 2012 the stapled securities closed at $3.60 and the NTA for June 30, 2012 was reported as $3.65, a 1.4 per cent discount to NTA.
- Over the period, the share price increased by 14 per cent but the NTA only increased by 0.27 per cent.
- The distribution for the 2011 financial year was $0.178 and the distribution forecast for the 2012 financial year was $0.191, an increase of 7 per cent. (The GPT financial year ends on December 31 and the final distribution for the 2012 financial year had yet to be declared).
- GPT's share price has had a greater than 20 per cent trading range each calendar year for the past seven years, and greater than 10 per cent every year for the past 26 years.
Here are three factors to look for in the A-REIT sector in 2013.
1. Lower discounts to NTA
The big discounts to NTA are likely to be a thing of the past, at least for now. While this will disappoint some buyers, owners can at least take some comfort that the price they can achieve on the sharemarket is "fair and reasonable", that is fair and reasonable for buyers and sellers. Over time there should be a reasonably close correlation between the prices achieved in the unlisted property market (actual transactions in physical real estate) and the prices achieved on the sharemarket.
(At the risk of stating the obvious, valuations and therefore the NTA, are typically reflective of transactions in the unlisted/direct property market rather than of transactions on the sharemarket. Importantly, creditors (that is banks) actually take a charge over the physical asset so they are more interested in what they can sell the asset for in the direct property market rather than how the asset is valued on the sharemarket.)
Most of the larger transactions in the unlisted property space have been undertaken by large international pension funds. These funds typically have long timeframes that extend beyond the next sharemarket fad and while they do not have the proverbial crystal ball, they will endeavour to balance the merits of bonds, property and shares and everything inbetween.
It is my guess that many investors - particularly those looking to generate long-term income streams - will be disheartened by the rate of return on cash and bonds, and that this theme will lead to a sustained increase in the allocation towards property investments and therefore firmer prices for A-REITs.
2. Sector consolidation
Some of Australia's largest property developers hold substantial portfolios of commercial real estate and in an environment where the outlook for construction is subdued; it is likely that companies such as Stockland and Mirvac will continue to trade at relatively larger discounts to NTA. However, there is always the prospect of a catalyst, such as the recently announced non-binding proposal by GPT to acquire Australand's commercial real estate portfolio.
Both Stockland and Mirvac start 2013 with new CEOs, who will no doubt review the overall strategy and balance sheet of the respective businesses, so perhaps there will be further moves on this front to realise shareholder value. Strategically I can understand that if you are going to build a "planned community" then you may very well want to hold the local shopping centre (which you have built) at least until most of the expansion opportunities have been realised.
3. More debt and higher risk-taking
I suspect the trend towards "risk reduction" ceased in 2012. At the height of the GFC, A-REITs were all following the same business model, to reduce risk and restore investor confidence by selling "non-core" holdings, typically international properties, reduce debt (in many cases by issuing additional units), and simplifying the business by unwinding off-balance-sheet structures and funds management operations.
A return to the excesses of 2007 is probably many years away but I am sure investors will see gearing levels and transaction activity rise during 2013. On the surface it will be promoted as adding value, but put simply, risks will be increasing and the higher level of risk will be supporting higher returns.
To illustrate, if you could buy a property on a rental yield of 8 per cent and borrow at 6 per cent, and you had 100 per cent equity and 0 per cent debt, your return would be 8 per cent. But at 50 per cent equity, 50 per cent debt, your return would be 10 per cent. It seems obvious that 10 per cent is better then 8 per cent but what are the risks of going from debt-free to 50 per cent debt?
In summary, 2013 should be a good year for A-REITs, even though they are unlikely to outperform the way they did during 2012, and any outperformance is likely to come from an increase in risk instead of the elimination of a valuation discount.
About the author
Ken Howard is a stockbroker and financial planner. He has worked with RBS Morgans since 2001 and been in the financial services industry since 1996. He has adopted a fundamental approach to investing, looking for value and quality in long-term investments.
His strategy is biased towards investments with a long history of paying dividends and distributions. For more about higher-yielding shares in 2013, phone 07-3334 4856 or email.
Learn about the features, benefits and risks of A-REITs in this video.
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