At face value it’s hard to be bullish about listed property trusts (LPTs) – also known as REITs – within a rising interest rate environment that grants investors relatively risk-free returns of 7 percent-plus on term deposits. With distributions still at the lower end of the range, REITs - expected to deliver an average gross return of around 9 percent this year – have struggled to attract the sort of new money they did pre-GFC when returns were 20 percent-plus.
But according to Winston Sammut managing director of Maxim Asset Management Ltd, there are sufficient drivers at play in 2011 to reward investors - who back the right stocks - with attractive double-digit returns. Year to date, the sector has been playing catch-up having delivered a price return of 3.59 percent – compared with 1.71 percent posted by the S&P/ASX 200.
Since exiting the GFC in considerably better shape, most stocks within the sector now have the ability to increase yields - nudging distributions back towards historical highs of between 80 to 90 percent. They’re also better positioned to deploy buy backs to help close lingering discounts to NTA – indicatively between 10 and 33 percent. REITs that have already flagged their interest in on-market unit buy backs include Commonwealth Property Office Fund (CPA), GPT Group (GPT), Mirvac (MGR), and Charter Hall Retail (CQR).
Among the REITs most likely to deliver double-digit returns, adds Sammut will be those primed for takeover within this year’s expectant flurry of corporate activity. Having repaired their balance sheets, and refocused on the core business of collecting rent, conditions are now considerably more favourable for corporate activity this year.
Ratings agency Moody’s has upgraded its outlook for REITs this year, and expects M&A activity to be a ‘net-positive’ as long as acquisitions aren’t disproportionately funded by debt. Gearings levels for the sector are back around 30 percent, and excluding Westfield Group (WDC) would be considerably lower.
Large trusts already mooted for takeover include Dexus Property Group (DXS), GPT Group (GPT), ING Office Fund (IOF), Charter Hall Office (CQO) and Charter Hall Retail (CQR), and Mirvac Group (MGR) - the worst-performing large listed trust last year. At the smaller end of the REIT’s market, Sammut says Queensland-based FKP Property Group (FKP) also looks ripe for takeover by Stockland which has acquired a 16 percent stake.
But Steve Hiscock managing director of boutique investment manager SG Hiscock & Company argues that the sector doesn’t need to rely on corporate activity to attract retail investors. Based on his forecasted internal rate of return (IRR) of around 10 percent - comprising a 6 percent starting yield and 4 percent capital growth – he says the sector looks better than cash from an asset allocation sense. “The sector is going to again become what is was over the past 20 years – a good proxy on quality office, industrial and retail real estate,” says Hiscock.
He’s also expecting further upside from valuation upgrades and rental increases. “Assuming discounts to net asset values (NAVs) close following future re-ratings, it’s possible for total returns at the top of the sector to hit 15 percent,” says Hiscock.
He reminds investors that today’s 6 percent starting yield – based on a payout ratio of 70 percent - isn’t the same as it was in 2007 when the payout ratio was 100 percent. “In reality, there’s an underlying earnings yield of 7-8 percent, but REITs are now using some of it to fund attractively valued acquisitions,” says Hiscock. “Underlying earnings growth is starting to flow through to unit holders, and for investors this is an optimistic sign.”
He says while yields may not go all the way back to historical levels, the fact that they’re now much more sustainable should be encouraging to investors. “Not one single investor in our Property Income Fund has complained about the level of yield,” says Hiscock. “They realise that it’s more important to get the total return story right, and a 5-6 percent income yield is particularly attractive, especially given capital growth of 4 percent.”
With office vacancies in all capital cities declining as companies look to increase staff, office remains Hiscock’s sweet-spot within the sector, especially in Sydney and Melbourne where rent rises are in the order of 10 percent. While high quality retail is Hiscock’s second favoured subsector, ahead of industrial, he warns investors of being over-exposed while consumer confidence remains so fragile.
Winston Sammut, Managing director, Maxim Asset Management Ltd
Rather than purely chasing yield, investors should be trying to ascertain where the value will be extracted within the next 18 months and beyond - especially on the back of corporate activity.
Stock picks
1) Stockland (SGP):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Stockland's strategy of concentrating on the three Rs of property retirement, retail and residential investments – has paid off with the residential sector performing particularly well, notably in Sydney and Melbourne. Earnings per share were up 8.5 percent and the purchase of Aevum helped to boost income. It has a good pipeline of projects, a strong balance sheet and long dated debt. Trading close to NTA, target $4, gross yield 6.2 percent.
2) GPT Group (GPT):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Reported a net profit of $707.3 million in the year to December 31, which compared to a loss of $1.07 billion in the previous corresponding period, and has raised the idea of future buy-backs. Trading at a 15-20 percent discount to NTA, gross yield 5.25 percent.
3) Cedar Woods (CWP):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
A doubling of its first half profit to $24.2 million reflects the improved profitability of CWP’s projects in Perth and Melbourne. It also reflects the robust demand for the company's projects during 2010, which will continue to bolster earnings in 2011. With a diverse portfolio of projects, the necessary approvals in place and ample funding, management says CWP is well placed to comfortably exceed its 10 percent annual growth target in coming years. Trading at a 30 percent discount to NTA, gross yield 5.5 percent or 7.5 percent fully franked.
4) FKP Property Group (FKP):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Focused on its residential projects, including Point Cook in Melbourne and its large retirement business, FPK reported an underlying profit of $54.6 million for the half-year to December 31, up 14 percent. Shareholder Stockland’s (13 percent) looks to be an obvious acquirer in any future corporate activity. Trades at a 32 percent discount to NTA, gross yield under 3 percent.
5) Abacus Property Group (ABP):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Plans to purchase a greater number of large, high quality properties and increase its distributions to shareholders. Trades at a 20 percent discount to NTA, gross yield 7.4 percent.
6) Aspen Group (APZ):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Despite sharply lower profits following a $6.9 million asset writedown in the first half, APZ still expects to deliver 14 percent growth in operating profit before tax for the full year. The timing of residential lot settlements is also expected to drive higher funds management income. Resolution of board control issues will appease investor uncertainty. Trades at one of the biggest discounts to NTA on the market – at 30 percent, but offers a gross yield of 9.0 percent.
Dinesh Pillutla, Managing Director, Property Investment Research
Reporting season clearly showed that asset values have stabilised since the GFC with most REITs reporting modest gains. This provides comfort that NTAs are now realistic and that there’s good opportunity for the discounts to narrow across the whole sector. Most managers optimistically expect good rent growth in their portfolios which supports Pillutla’s view of rising distribution yields, despite rising debt costs. Organic growth through rising property income and improving operating efficiencies support a positive medium term outlook.
1) Bunnings Warehouse Property Trust (BWP):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
At the operational level, the first half result came in as expected, with rent growth flowing through to the bottom line (adjusted NPAT of $26M). Pillutla like BWP’s organic income growth potential, its long ‘WALE’, and the possible upside from developments and acquisitions. While there is the high cost of debt, it appears to have peaked. In light of this, he says the recent decline in BWP’s share price presents a more appealing entry level. Forecasted full year 2012 dps of 13.7c equates to a gross yield of 7.7 percent. Trades with 10 percent of $1.88 NTA.
2) Charter Hall Group (CHC):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Reported a first half 2011 operating result of $30.8 million. While full year 2011 appears to be a year of consolidating the Macquarie platform, Pillutla says acquisitions to support active earnings in full year 2012 could be the main catalyst for re-rating. NTA was $2.21 and gearing a modest 7 percent, currently trading at $2.42.
3) Charter Hall Office (CQO):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Appeals to Pillutla as a more speculative asset play. Given that there weren’t too many surprises in the first half adjusted net profit, he says the real issue is now value – with the easy money having already been made. His DCF valuation and full year 2011 forecast dividend yield is in the low 6 percent range, which suggests the stock is trading around fair value. What rescues CQO from a neutral call is the sell-down of the US portfolio which he says offers an obvious, immediate catalyst to close the 20 percent gap to NTA of $4.
4) Charter Hall Retail (CQR):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
A reasonable adjusted net profit of $42 million provided some encouraging net operating income (NOI) growth in CQR’s remaining “core” portfolio. While CQR has had a decent run, Pillutla says the recent pullback has restored a bit of the stock’s margin of safety. He feels that there is still some upside to CQR’s share price and earnings, particularly from acquisitions or developments – with asset yields well over the cost of debt. Trading at a 15 percent discount to NTA of $3.69. Forecasted full year 2011 yield is 7 percent.
Michael Doble, CEO, Real Estate Securities, APN Property Group
With the former ‘debt-story’ no longer a sector issue, some REITs have been left with lazy balance sheets. While NOI hasn’t been strong, falling incentives and lower vacancy rates will translate to higher income for REITs exposed to office. Increases in both payout ratios and earnings growth should help to close discounts to NTA and this outcome should attract investors back into the sector. REITs ‘actively’ managing their assets should outperform, and those with significant discounts to NTA are more likely to attract M&A activity.
1) Carindale Property Trust (CDP):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Offers a yield of between 6.5 and 7 percent with massive capital upside expected to come from a $125 million redevelopment in Canberra and $300 million expansion of its Carindale centre in Brisbane - adding between 60c and $1 to NTA. Currently trades at a 23 percent discount to NTA of $5.54. Doble expects deep pockets of value to trigger a re-rating.
2) Challenger Diversified Property Group (GCI):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
In addition to strong performance metrics, GCI has a manageable lease expiry profile, and replenished balance sheet to support growth opportunities. Offers a gross yield of 8.4 percent, and trades on an 11 percent discount to NTA of $0.66.
3) Cromwell Property Group (CMW):
Chart: Share price over the year to 18/03/2011 versus ASX200 (XJO)
Reported a six-fold increase to first half 2011 profit on higher rental income and recoverable outgoings after acquiring Qantas' global headquarters building – which saw rental income and recoverable earnings jump 16 percent.
With great active management and good steady earnings growth, CMW offers a 9-10 percent gross yield, and trades at a slight premium to NTA of $0.71.
Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.
