Australia - land of opportunity?
Australian Listed Property Trusts had a remarkable year in 2004. The return for the sector as measured by the S&P ASX 200LPT Accumulation Index, was 32.18%. The majority of that total (23.64%) was clearly capital growth. This occurred at a time when capital returns on residential property (currently yielding under 4%) have generally been flat in the main centres.
The main drivers of this performance have been the merging of the largest LPTs. Consolidation has halved the number of trusts and the market is now absorbing a new wave of trust launches, including globally focused portfolios. The ASX's listed property trust index contracted to just 25 trusts at the end of 2004 from a peak of 51 in January 2001.
Paul Pavlidis, head of listed securities at Property Investment Research (PIR) in Melbourne, says: “The sector consolidation has resulted in the majority of funds being managed by the top five players. It means there is a much smaller menu for investors. The shift away from externally managed structures to the internally managed stapled variety has also fundamentally altered the nature of these investments. It has introduced a greater element of risk, not as a factor of the property portfolio, but that your return is tied to the other activities of the stapled group.”
Stapled securities provide investors with exposure to a funds management and/or property development company in addition to a real estate portfolio. Stockland Trust Group (SGP) was one of the first to adopt the stapled security structure in the mid 1980s. As a result, SGP has often traded at a considerable premium to its peer group.
The stapling of Mirvac, then Centro and the conversion of Westpac Property Trust to a stapled entity, have been key events in the emerging changeover to stapled securities in the LPT sector. Ultimately, this restructuring activity has changed the face of the LPT sector.
PIR’s John Welch states: “As more stapled securities arise, we must face the inevitable variety of risks that come with those staples if we wish to continue to have liquid property in our portfolios. These risks include higher volatility of earnings from development related activities as well as the potentially higher stock price volatility that can come with larger market capitalisation stocks. The flipside is that distributions have the potential so show more significant growth with the exposure to higher growth industries.”
That change has been good for many, especially in 2004 when returns went through the roof
Now, though, investor’s risk tolerance is being put to the test. Investors looking for a stable and secure yield have lost their traditional vehicles. This will be a pivotal period for LPTs as investors realise that they will not be seeing 30% annual returns very often. But there is unlikely to be too much of a backlash. After all, investors have been behind a lot of the changes that have taken place.
For property securities fund managers, the recent downturn will have made them reflect on the increased risks. Some are likely to revert to a more traditional high yield portfolio as the market moves away from its high growth phase. Paul Pavlidis comments: “The stapled structures have received a lot of support and they have outperformed, because people have largely ignored externally managed trusts. But investors will re-connect with externally managed trusts once they come to terms with the difference and realise that they just want the yield.”
The consolidation of the LPT index means managers will be pushed to outperform with such a concentration of portfolios. Westfield represents more than 30% of the index ($27bn out of a total $82bn). And it is set to get bigger since, despite its dominance, it has been cleared to acquire three additional entities from General Property Trust (GPT). So portfolio managers will welcome the emergence of the new LPTs. Since July 2004, seven new LPTs have listed on the ASX, with an initial total market capitalisation of over $1billion.
Opportunities are increasingly being sought overseas, and the growth of LPTs with global remits is gaining support among the asset consultants. Russell recently cut its domestic property exposure for balanced portfolios in favour of greater global exposure. Global property is being increasingly heavily promoted because of its favourable yield characteristics, and lower volatility than listed equity investments but with significant income potential. As an illustration, Asia is one of the few places where you can find investment grade property at a yield of 7% to 8%, which is debt funded at 2% to 3%.
The end of the domestic housing boom has produced a string of damaging announcements for building companies. Share prices for major builders, including Multiplex, Leightons and Lend Lease, have fallen hard in recent months. The $3.3 billion Multiplex Group saw its three-month share price fall 32%, half of that fall occurring in one day.
Mirvac Group shares lost 5% in April, prompted by comment from Merrill Lynch about residential market weakness and the lack of clarity in the earnings outlook. Mirvac then dropped a bombshell by announcing a profits downgrade of 12%, which sent the share price tumbling further. Managing director Greg Paramor said the squeeze was due to deferred residential sales, increased development costs and a decision by the group to hold onto projects previously earmarked for sale. Sales and settlements have been deferred at several sites. Paramor says Mirvac will return to its policy of only recognising profit on pre-sale contracts on their completion.
Pavlidis says these events have spooked the market and the trusts deemed to be high up the risk scale have been the ones to suffer the most. He believes the market has over-reacted. “At present prices, the market is not placing any value on their development and construction activities.”
The long-running saga of how General Property Trust will be consolidated is on-going. Its proposed $1bn joint venture with Babcock & Brown follows the failure last year of a deal with Stockland Group. Pavlidis liked the look of the Stockland deal but is less sure of the merits of the venture with B&B: “It’s a fantastic deal for Babcock & Brown. It introduces a number of risks for GPT that will mean it’s a different beast. That is something we have to study more closely,” he says.
Babcock & Brown said the terms of the deal were consistent with the joint venture details announced in March and would pursue real estate investment, trading and development opportunities worldwide. It also intends to establish an Australian real estate funds management business managing both listed and wholesale products. The agreement is subject to approval of GPT's management internalisation proposal, which will be voted on in early June.
Merill Lynch is forecasting a 9.8% return for the LPT sector over the next 12 months which contrasts with the consensus view at PIR, which is that returns of 3-6% are more likely in 2005.
Despite the very definite feeling that the boom is over, property is seen as a good solid investment with low volatility and stable income returns. LPTs in particular still have money pouring in due to their liquidity. Industry analysts predict a shift from residential to indirect investment in non-residential property through LPTs and office syndicates in preparation for an office market upswing commencing late 2005 – early 2006.