LPT stumble triggers row
As previously noted in IPE Real Estate May/June, the listed property trust (LPT) sector in Australia has had a remarkable run in the last couple of years, but has stumbled heavily in 2005. Discussion at the recent PCA Capital Markets Summit was dominated by this share price meltdown. Although the managers and developers present were all fairly confident that the LPT sector would continue to provide an attractive yield, there was nonetheless a good deal of blood-letting over how the industry had allowed itself to be exposed in this way.
The background to this heated debate was the share price collapse of major builders, including Multiplex, Leightons and Lend Lease. The $3.3bn Multiplex Group, running way over budget on the new Wembley Stadium, saw its three-month share price fall 32%. Mirvac Group dropped a bombshell by announcing a profits downgrade of 12%, which sent its share price tumbling. These high-profile shocks affected sentiment for almost the entire listed trust sector, which was the cause of much of the ill-feeling.
JP Morgan’s Tim Church said to the PCA Summit: “This share price collapse is an aberration. The overall LPT sector is going to provide a good return on investment over the long term.” He pointed out, as others did, that following the restructuring of the sector and the introduction of more operational risk to listed portfolios, “the LPT sector is no longer a pure property fundamentals sector”.
Australia is one of the few countries that has no cap on development and trading activities within listed trusts. Owen Thomas of Morgan Stanley pointed out that even before the share collapse, there was some dispute about the correct status/structure of the sector, given the contrast between traditional listed trusts, and the newer hybrids. However, Andrew Parsons of Resolution Capital (formerly Lend Lease Real Estate Solutions) said he didn’t recall anyone complaining when the shares were soaring. “I don’t recall anyone coming out with statements to the effect that 30% returns are unsustainable.”
Parsons was critical of the over-reaction to the performance of just two stocks, Mirvac and Multiplex. He also bemoaned the lack of clarity in defining what is an LPT in the new environment of stapled trusts and consolidated portfolios. He said the lack of a positive take on what has happened “is opening us up to those who want to take their money out of the sector. Let’s put it in perspective. It’s a normal development downturn.”
Bob Kelly of Eureka Funds Management said he couldn’t understand why the listed sector hasn’t tried to tailor itself to the investor’s taste: “I think there’s a reluctance to alter the model.” He also sounded a note of doom for the sector: “I’d be willing to bet we’ll be here in a year’s time with more than two LPTs in trouble. We have imported a lot more risk into the market. There’s a lot less accountability in wholesale and there’s still too much deal-driven and fee-driven activity.”
Nonetheless, this is a fund sector that has produced profits for investors in 22 of the last 25 years. There aren’t many asset classes that can make that boast.
A lively discussion ensued on the topic of ‘Customers & Gamekeepers’ Anton Tagliaferro of Investors Mutual, representing customers, talked of the “ridiculous structure of LPTs deriving 40% to 60% of their income from development. The ASX has to take some responsibility for allowing this.”
His point was that there had been no control exercised over where the LPT sector had ended up after the consolidation process. “The model we have is not sustainable. You have killed the golden goose. And someone has to explain to investors about the poor performance of their listed property holdings.”
Consultant Barry Brakey of Pinnacle Property Group said: “Most super funds I advise are in property because it’s boring. They allocate 10-15% to property. When their portfolio is reviewed and they discover that the portfolio risk profile has changed significantly, you may find that they choose to go offshore.”
The majority of the conference agreed that the risks in the sector now outweighed the returns. Some disputed whether the consolidation in the sector has increased risks for investors. But when you take in the increased gearing, which has risen on average from 5% to 45% in the last five years, risks will certainly have increased there. All agreed it will be a battle over the next year to regain credibility.
Barry Brakey asked how this disconnect came about. His theory is that “we too blindly go along with the index, which does disconnect from the fundamentals. Also, I think there is a relatively low level of research expertise in property (despite the existence of at least three specialist firms in the sector). And there is no consistency of approach. The calculation of the internal rate of return differs from one research house to the next.
Tagliaferro agreed that stapling in itself was not the problem, it is the tolerance of boosting the fund with development profits. “It’s an absolute scandal that managers are able to predict profits three or four years out in the current environment for building.”
Kim Wright of UBS commented from her group’s research that only 9% of earnings on average are derived from development, so while the focus is on the high level of active risk deployed by Multiplex and Mirvac, the industry average tells a different story.
Church predicted further changes in the sector with some consolidated LPTs splitting up again. He used the example of Stockland, which pulled out of its proposed deal with GPT last year: “I would say Stockland’s decision to back away from the GPT deal was a good move. Stockland will be able to produce much better earnings growth on its own.
Brakey’ s recommendations to clients have reflected the valuations for some time: “We had already chosen to go light on LPTs, reducing our exposure. But I would add that I have faith in their ability to adjust. The market will adjust and the product will evolve.”
He believes investors will be scrutinising LPT management more closely in future. He says “it is important to have management teams with property experience and other skill sets. Many externally managed trusts have strong support in non-property areas internalised/stapled entities need to ensure a similar level of non-property support is in place.”
Church concluded that for LPTs, traditional property fundamentals remain critical. Over the past five years, both Australian and international cap rates have trended downwards, resulting in increases in asset values. With the potential for cap rates to rise, asset values may continue to experience downward pressure, potentially offset by rising rents. As such, Church says LPTs must avoid overpaying for properties in the current low cap rate environment, ensure a quality tenant base, to provide strength in rental income and be flexible in leasing arrangements, to attract and retain tenants. Overall, he says, “old style management will be a good way for the sector to go in the next 12 months”.