A-REITs: Never say never

PORTFOLIO POINT: After a string of capital raisings, Australia’s REITs appear to be protected against further headwinds.

After a period of painful readjustment that saw A-REITs slide an agonising 79%, investors are asking whether the recent deleveraging represents a new beginning. The resumption of attractive distributions has helped to stoke interest in the sector, but has anything fundamentally changed?

The most important development has perhaps not been the endless stream of capital raisings but the appetite of investors for the issuance. Over the past nine months the sector has successfully raised about $14 billion to return the average gearing ratios of the seven largest A-REITS to below 30%, from above 40% just one year ago.

One aspect that remains a constant is Westfield’s domination of the market, accounting for about half the ASX 200 Property Index. Because of its size, and the expectation that it will return to the market at some point to reduce its uncomfortably high gearing of about 53%, we’ll put Westfield to one side for the moment and focus on the remaining six big REITs: Stockland, Mirvac, Commonwealth Office Fund, CFS Retail Trust, Dexus and GPT Group.

The consensus among property analysts is that the “big six” have raised enough capital to protect themselves from further headwinds and create solid buffers with their debt covenants.

The collapse in share prices and investor sentiment has made the equity issued expensive and, in many cases, shareholders are being forced to participate to avoid being thoroughly diluted (see Rights issue a tougher choice than it seems). Though it should be noted that the worst publicity in the sector is related to companies outside the big six, such as Goodman Group where its attempts to raise capital through a heavily dilutive options scheme has raised tensions between investors and chief executive Greg Goodman.

But not everyone feels that way. The head of Australian real estate equities research at Merrill Lynch, John Richmond, is pleased with the attempts to recapitalise the bigger REITS. “You’re winning on two fronts,” he says. “You win because you’re getting a discounted issue price and you win because you’re buying a better company. We’ve not seen anything this year that we thought was not worth participating in.”

nThe Big Six
Company	ASX	Price	Discount to NTA	Market Cap	Gearing Dec 2008	Gearing June 2009	Sector
Commonwealth Property Office	CPA	$0.85	39.70%	$1.5 billion	30.0%	24.6%	Office
Mirvac Group	MGR	$1.14	53.80%	$1.9 billion	34.0%	19.0%	Office, Retail, industrial
Dexus Property Group	DXS	$0.74	44.40%	$3.4 billion	37.3%	37.3%	Industrial, Office, Retail
CFS Retail Property Trust	CFX	$1.63	23.80%	$3.9 billion	25.6%	25.6%	Retail
GPT Group	GPT	$0.52	63.60%	$4.4 billion	46.6%	37.0%	Retail, Industrial, Office, Residential
Stockland	SGP	$3.22	10.30%	$7.2 billion	31.0%	21.5%	Retail, Industrial, Office, Residential

Certainly the ability to raise any cash just nine months out from the credit crunch should be viewed as some kind of victory, regardless of the discount being offered. And yet not all the bad habits of the past have been expunged, with some A-REITS still opting to maintain 100% payout ratios, such as Commonwealth Office Property Fund, and others who went early and chose to blow the freshly raised capital on ill-advised share raiding sorties, such as Stockland.

Still, there is much to be optimistic about. The head of REIT research at Goldman Sachs JBWere, Simon Wheatley, says: “The Armageddon scenario, where a huge amount of commercial real estate would hit the market, has abated”. That view is shared by Shane Oliver, chief economist of AMP Capital. “A-REITS are trading at levels not seen since 1984,” he says. Oliver believes that further falls in property values are priced in and that the sector has finally turned the corner (see attachment).

If you’re thinking about returning to one of the most beaten-up sectors of the market – a sector our commentator Charlie Aitken branded as “listed property time-bombs” (click here) then make sure you stick to quality names because beyond the 'big six’ there are plenty of undercapitalised disasters waiting to happen. In the meantime, according to a note from UBS, there’s value on the three year horizon.

Stockland

The biggest A-REIT after Westfield, Stockland, went to market early and raised $300 million last year towards acquisitions that included aged care provider Aevum and stakes in FKP Property Group and GPT.

As the group’s sales forecasts proved part-fantasy and its strategic stakes went underwater, Stockland returned to the market and raised another $2 billion. However, Stockland’s gearing is the second-lowest of big A-REITs and its diversified assets represent a lower-risk proposal than the sector specialists, hence the marginal discount to net tangible assets (NTA). (In a separate development, it has also just publicly announced its plans to separate its residential business into two units while maintaining behind closed doors that it doesn't intend to demerge them.)

Mirvac

Known mostly for its residential division, Mirvac is a truly diversified company with assets across the entire property spectrum although it should be acknowledged that it is going back to the market for its third capital raising at $1 per security. Mirvac’s residential assets are considered to be vastly undervalued and it is trading at the second-largest discount to NTA behind GPT Group.

Mirvac’s residential expertise puts it in good stead for the recovery, where it is expected to outperform all other asset classes and remains Goldman Sachs JBWere’s preferred A-REIT exposure.

Under new chief executive Nick Collinshaw, Mirvac appears to be the most agile of the big six. A high-quality diversified property play albeit with considerably more risk than Stockland.

Commonwealth Property Office Fund

The fund has attractive yields of better than 10% but whether they can be maintained is uncertain as it relies on the fund sticking to its policy of paying out 100% of profits as distributions as others move towards a more sustainable model. Rising unemployment and its effect on the fund’s office assets could hamper its medium term growth profile, but the company has always maintained an optimal level of gearing while the rest of the sector loaded up with debt. Commonwealth Property Office Fund has been the least-affected of the six by the fallout from the global financial crisis and is trading at just 50% off its highs. A reliable exposure to a volatile sector.

CFS Retail Trust:

The resilience of the Australian retail sector has surprised everyone and for quality exposure to retail outside of Westfield, it’s hard to go past CFS Retail Trust. Investors are expecting retail to be the last sector to fall, which could explain why its performance has trailed the Property Index. The vehicle is only modestly geared, which explains why it only needed to raise $200 million last October and why its share price offers one of the smallest discounts to NTA in the sector. Like Commonwealth Property Office Trust, it also maintains its policy of paying out 100% of profits but at the same time it is a stable performer in a difficult sector. CFS Retail is a punt on a short and shallow recession.

Dexus

With the exception of GPT, Dexus is the most highly geared despite raising $300 million in an institutional placement last December and then tapping shareholders in a two for seven offer that raised another $749 million. Gearing, of course, isn’t such a bad thing when it’s freely available and it opens the potential of blue sky for investors. Its assets are considered high quality and it remains UBS Wealth Management’s preferred exposure to the sector.

GPT Group

GPT Group is the black sheep of listed property. A disastrous European joint venture with Babcock & Brown cost $1.9 billion, forcing the group to raise $3.3 billion over two issues including the highly dilutive one-for-one issue that closed on June 9 (see Rights issue a tougher choice than it seems). Following the departure of Nic Lyons the new management is hoping investors can see the difference between the old GPT and the new GPT. Supporting this thesis is new headroom in the gearing covenant, second only to Bunnings Property Trust across the entire property index, and its sale of $460 million of non-core assets.

As the AREITs attempt to redeem themselves by jettisoning the non-property related income and adopting more transparent corporate structures, there’s one other key feature of the landscape you need to be aware of. With distribution cuts looming on the horizon, you won’t be able to rely on your investment for income. Even as the companies deleverage and return to their core business they remain a capital growth risk play over the short term.

Macro considerations should also form part of your outlook because different vehicles are more suited to 'U’, 'W’ and 'L’ shaped recessions. And don’t expect a return to the halcyon days where AREITs outperformed the entire index year after year. They certainly have some catching up to do but you need to learn how to crawl before you can walk.