Opinions Divided On The Best Property Exposures

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By Chris Shaw

One of the hardest hit sectors in the global financial crisis was the property or Real Estate Investment Trust (REIT) sector, as tighter capital markets meant companies were in a struggle to refinance upcoming debt maturities and to deal with a turnaround in conditions in their markets as the global economy slowed.

But according to Bank of America Merrill Lynch the recent debt issue by Westfield ((WDC)) is proof debt markets are again opening up, a fact recognised by investors given it has been the leveraged REITs that have been the sector’s better performers in recent months.

As conditions improve, brokers have been looking for how best to play the sector going forward, a process GSJB Were suggests has been made more difficult by the fact recent earnings results were impacted by the huge number of capital raisings undertaken in the sector over the last financial year given this had a corresponding dilutionary effect on earnings per share (EPS), dividends per share (DPS) and net tangible asset (NTA) values.

Given this, the broker tried to focus on outlook statements from the companies as they reported but here it suggests guidance was somewhat disappointing, reflecting expectations of higher interest rates, a weaker outlook for offshore assets and further dilution from expected asset sales as debt levels are brought further under control.

A look at results for the sector in general showed those companies with largely domestic operations in particular were able to deliver positive net operating income (NOI), which is the difference between total revenue and operating expenses, an outcome helped by solid market rent reviews during the year.

The other factor in favour of the REITs with primarily an Australian exposure in the broker’s view is their interest cover ratios are relatively solid, so by taking a more cyclical view of the sector it suggests those trusts exposed to the residential sector, such as Stockland ((SGP)) and Mirvac ((MGR)) as well as any opportunities that present themselves in the office sector, may be the best way to play things from an investor perspective. Another group the broker likes is Dexus ((DXS)).

This puts the broker at odds with Macquarie, who rates Dexus as Underperform along with Commonwealth Property Office ((CPA)) and Macquarie Office ((MOF)). The broker is not as positive on the outlook for the office sector as on its numbers the top line for companies in the office market is likely to come under pressure as market rents may fall and rental incentives are increasing.

As well it expects Dexus to be one of the REITs trying to sell offshore assets this year along with the likes of Macquarie Office and ING Office ((IOF)), a move it sees as likely to further dilute earnings per share. A further reversion in capitalisation rates is also expected, while on Macquarie’s numbers as much as $6 billion in debt will need to be re-priced between now and FY11, which means an increase in debt costs for a number of companies in the sector.

Given such an outlook the broker prefers those stocks with a greater degree of upside earnings leverage and cyclicality, meaning its Outperform ratings are for Westfield, Stockland, Mirvac and Goodman Group ((GMG)) while ING Office scores a Neutral rating.

JP Morgan has been a little more specific in its latest focus on the property sector, keeping its attention on the regional shopping mall sector given the proposed sale of the Lakeside Joondalup Mall in Perth is the first true open market transaction for such a mall in Australia in several years.

In looking at the likely sale price, which it estimates at around $450 million, the broker suggests it implies the sector isn’t showing the same level of stress as other sectors of the market, which in turn suggests a shallower cycle than it had previously forecast. With a floor likely to be achieved sometime close to the end of 2009 the broker suggests the larger mall exposures are the best way to play the market, which means Westfield, GPT ((GPT)) and CFS Retail Property Trust ((CFX)).

Of the three, the broker likes both Westfield and CFS Retail, rating them as Overweight, while it is Underweight on GPT despite the stock currently trading at a 15% discount to net tangible assets (NTA) at present. Westfield on a similar measure is at a 13% premium, while CFS Retail is at a discount to NTA of around 7%.

For Citi the best relative value across the propery sector is in Abacus Property Group ((ABP)), ING Office and Westfield, while its top underweights are Goodman Group, Macquarie DDR ((MDT)) and Mirvac. For Abacus the broker likes the modest gearing position and the de-risked balance sheet following a recent rights issue, while it expects the solid management team will deliver on its growth strategy over time.

A similarly strong balance sheet is one attraction with respect to ING Office, while the broker also notes the company’s tie-in with ING gives it access to a solid pipeline of offshore product. With respect to Westfield the broker simply sees the stock as good value relative to its REIT peers.

On the flipside the broker suggests the current environment will present Goodman Group with further risks to real estate values, while funding could still be an issue even though much has been done to address the company’s refinancing and liquidity challenges. Macquarie DDR remains close to breaching debt covenants and in the broker’s view asset sales will be difficult to achieve. With the group still exposed to “big box” retail property in the US Citi suggests an Underweight rating is appropriate. 

Contrasting GSJB Were’s positive view on Mirvac, Citi suggests the group’s expoure to the challenging residential property development market will limit potential upside in the coming year. As well, while some acquisitions are possible as the group attempts to lift asset quality the fact long-term non-residential development work has been suspended until conditions turn more favourable also works against outperformance in its view.

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