This article appeared in the December 2011 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.
Understand the key themes creating value in the A-REITS sector.
By Ken Howard, RBS Morgans
After a volatile period throughout the global financial crisis, followed by significant and dilutive capital raisings, most Australian Real Estate Investment Trusts (A-REITs) now offer stable balance sheets; lower gearing levels and simpler business models/structures.
Many A-REITs, with the exception of a few that include Westfield Group and Goodman Group; continue to trade at large discounts to their net tangible assets (NTA). Looking towards 2012, we expect merger and acquisition (M&A) activity and capital management initiatives to remain key themes.
(Editor's note: Don't miss the ASX investor webinar on the A-REIT sector. The first webinar saw Michael Cameron, CEO of GPT Group, and Ken Howard, give their views on the office market. The second saw Andrew Wilkinson, Managing Director of ALE Property Group, and Ken Howard, give their views on the leisure sector. A third webinar on retail property was held in late November.)
M&A activity still a key theme
The A-REIT sector continues to consolidate, with recent M&A activity including the ING Industrial Fund (IIF) moving into the hands of a Goodman Group (GMG) related entity, and Valad Property Group (VPG) delisting in August 2011 following the $806-million takeover by affiliates of the US equity giant Blackstone Group. This was the second purchase by Blackstone and followed their acquisition of Centro's US shopping centres for more than $3 billion in 2007.
Not surprisingly, the attraction has been the large discounts to NTA.
In August 2011, a Macquarie-led consortium made a $1.74-billion bid for Charter Hall Office REIT (CQO). The current offer is $2.43 per unit for the Australian assets (excluding proceeds from the sale of the trust's US properties). The bidding consortium includes the Charter Hall Group, the Government of Singapore Investment Corporation and Canada's Public Sector Pension Investment Board. At November 2011, due diligence continues and the independent directors have advised unit holders to take no action.
More recently, Centro Properties Group (CNP), Centro Retail Trust (CER) and numerous unlisted entities look likely to merge, creating one of Australia's biggest shopping centre groups. The restructure cleared a critical hurdle at a CER meeting on 22 November when hybrid lenders supported the deal. The restructure still needs to clear further hurdles in the near term, but if successful the new entity will be known as Centro Retail Australia and will manage $7 billion of retail shopping centres across Australia.
Many A-REITs still trading at large discounts to NTA
An often-used default method of comparison for listed property companies is the discount/premium to NTA (total assets excluding intangible assets, less total liabilities).
A-REITs continuing to trade at significant discounts include: Abacus Property Group (ABP), Centro Retail Group (CER), Challenger Diversified Group (CDI), Charter Hall Group (CHC), Dexus Property Group (DXS), Westfield Retail Trust (WRT) and Commonwealth Property Office Fund (CPA).
The discounts are even larger within the developer/manager space, including groups such as Australand Property Group (ALZ), FKP Property Group (FKP), Mirvac Group (MGR), Sunland Group (SDG) and Devine (DVN).
As mentioned, exceptions include Westfield Group (WDC) and Goodman Group (GMG), given they are trading at plus 10 per cent premiums. This is largely because of the potential upside from their significant development operations.
On-market share buy-backs
A-REITs announcing capital management initiatives has been a key theme throughout 2011 and we expect this to continue into 2012. In particular, many A-REITs have undertaken buy-backs to assist in narrowing the gap between their share price and NTA. Challenger Diversified Property Group (CDI), Charter Hall Retail REIT (CQR), GPT Group (GPT), Investa Office Fund (IOF) and Stockland (SGP) have all begun on-market buy-backs totalling around $1 billion in value.
The increase in capital management also reflects the more stable balance sheets following large capital raising undertaken over recent years, as well as a substantial improvement in the environment to access funding from banks.
Funding available for those with quality portfolios
Currently, average gearing for the A-REIT sector is around 30 per cent. Gearing (debt to equity) levels have reduced substantially since 2007 as a result of many groups deleveraging at the height of the GFC through capital raisings that diluted the share price (through much more share issuance). However, more recently groups have looked to simplify business models and/or recycle capital via asset sales, both domestically and offshore.
Access to bank debt - new funding and debt refinancing - has also improved, particularly for groups that have good-quality property portfolios underpinned by solid cash flows. While senior debt margins increased from a low of around 50 basis points in early 2007 to more than 300 basis points in early 2009, we believe margins are now sitting around the 200 to 250 basis points range. The ability for bank lending margins to tighten further will depend on the cost of borrowings and preferred levels of exposure to the property market by major banks.
Distribution yields average around 7 per cent
Current A-REIT yields generally range from around 6 per cent to 8.5 per cent. Most groups have clear distribution policies (e.g. what payout ratio will be applied) which are agreed upon by the board and then communicated to investors. Since the GFC, distributions have stabilised and looking at consensus forecasts for the year ahead, we expect most A-REITs to post some distribution growth.
About the author
Ken Howard is a stockbroker and financial planner. He has worked with RBS Morgans since 2001 and in the financial services industry since 1996. He has adopted a fundamental approach to investing, looking for value and quality in long-term investments. The strategy is biased towards investments with a long history of paying dividends and distributions. To find out more on the outlook for A-REITs in 2012 call Ken Howard on 07-3334 4856 or email Ken.
Ken Howard LLB BEcon CFA GAICD is an Authorised Representative of RBS Morgans. RBS Morgans Limited (ABN 49 010 669 726 AFSL 235410) is a Participant of the ASX Group and a Professional Partner of the Financial Planning Association of Australia.
Investors who are new to A-REITs should watch the ASX A-REIT video which features ASX business development manager Jonathan Morgan.
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