By Tony Rasman
24 September 2009
Real Estate Investment Trusts, savaged by the global financial crisis, are slowly starting to find favour again with the experts as they work their way towards reconstruction.
Between March and June of this year, the listed Australian property sector recovered 42 per cent from its March low.
The REITs sector hit its peak in February 2007, and finally bottomed early this year - a total peak to trough fall of 76 per cent, says UBS director and portfolio manager of property securities, Mr David Curtis.
But Australian REITs are also dependent on recovery in other key markets, such as the US and the UK.
Moody's/REAL Commercial Property Price Indices reported all property fell 1 per cent in June this year in the US, and values on commercial property prices are now 35.5 per cent below the peak seen in October, 2007.
Australian REITs are dominated by Westfield, Stockland Group, GPT, CFX, Dexus and Mirvac.
Despite the slower recovery in other markets, key players in Australia have de-leveraged and are better placed than some other REITs.
Analysts say that the global financial crisis has created a two-class listed property sector split into the haves and have-nots.
The major players (the haves), such as Westfield, Stockland and GPT, do not need to raise equity, and even if property values fall 10 per cent, all of these groups are in sound position with lower debt to asset ratios, David Curtis at UBS points out.
The have-nots are in debt crisis and de-leveraging mode, and if they haven't fallen over already (think Allco), are generally shaky.
On a more positive note, there are signs that the credit markets are thawing out with major REITS successfully raising or rolling over corporate debt, he adds.
But with the prospect of less earnings growth over the next few years, property values will need to come down further.
Mr Curtis says a good barometer is the recent revaluations of two Colonial trusts, including the Commonwealth Office Property Trust (CPA ) which re-valued its portfolio to June 30 with a 9.5 per cent fall of book value in the three months to June 30 2009.
By comparison, the Colonial First State Retail Trust (CFX), which owns shopping centres, reported asset revaluations are down by only 5 per cent in the three months to June 30, 2009.
The weighted average cap rate (yield of their assets) of both portfolios remains low (CPA is now 7.7 per cent, CFX is now 6.45 per cent).
Mr Curtis believes that yields need to push up (and therefore values should come down) a little further to achieve required level of returns and to account for the increased cost of capital.
Office Market blues
Meanwhile, commercial real estate (offices, shopping centres and industrial assets), as measured by the PCA/IPD index, returned 13.3 per cent in the year to June, 2008.
There's no doubt a gap exists between the listed and direct property market.
Now the office market and commercial space is in the firing line.
"The market was strong 18 months ago when space was at a premium, and companies were expanding and requiring more space," Paul
Healy of BlackRock Investments explained.
"Valuers had that optimism in forecasts with rents rising but with the onset of the economic downturn, demand for space is falling."
"This is part of the second leg of the economic downturn with no growth in rents and property values affected," he said.
But Healy says the vacancy levels between six and eight per cent are "not as catastrophic" and well below the 26 per cent levels in Melbourne or 29 per cent in Perth during the 1991 recession.
And when the economy turns around, there will be a shortage of space in four years because of the current policy of banks not to lend to developers, he adds.
The Sydney and Melbourne office markets have been the hardest hit, particularly in the financial services sector.
"The lower $30 million end of the retail market is quite strong with centres, which provide basics of essential shopping, proving quite resilient."
Healy says the Industrial property market has fared the worst with falling asset values, particularly in the $10 million range secondary market.
Economic recovery in sight
A glimmer of hope emerges with the release of the latest Australian GDP figures, showing a small rise of 0.6 per cent in the March-June quarter.
Jones Lang LaSalle reports that the commercial property market is one year into a downturn that began in March 2008, and is likely to continue into 2010 with capital values stabilising.
The last property downturn lasted three years from September 1990 to December 1993.
Healy says that when the economic recovery comes, we can expect an upward pressure on rents.
In the listed property sector, Curtis says investors can expect between eight and 12 per cent returns over the next 12 months, made up from seven to nine per cent returns from real estate and between one and three per cent in capital growth.
"There are still problems in the unlisted property sector with property syndicates and funds which could blow up, and the REIT sector would suffer collateral damage," Mr Curtis said.
There is evidence that the office markets will weather this downturn better than the last recession, and in the listed property sector, good value still resides in specific stocks, he adds.
