Brokers Line Up A-REITs preferences

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The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

– JP Morgan updates preferences in residential property sector
– Fundamentals in OZ Office market seen as improving
– Current retail risk premium appears overdone

By Chris Shaw

In the view of JP Morgan, Australian house prices will continue to moderate through 2011, with a further fall of around 3-5% expected for the year. This will bring the total decline across 2011 to 5-10%. Volumes are also expected to remain soft given poor sentiment and the weak price outlook.

The news is not all bad however, as JP Morgan's view is income growth should continue to be solid, while population growth is likely to remain at around 1.5% per annum. Given construction of new dwellings is not keeping pace with underlying demand, developer volumes are expected to improve in 2012.

The declines in prices are also improving affordability, which suggests to JP Morgan the current housing slowdown is the result of cyclical and not structural issues. This implies current share prices for companies in the sector have overreacted to market conditions.

To reflect this, JP Morgan has updated its order of preference in the residential property sector. Stockland ((SGP)) is now the preferred exposure, reflecting both 10% recent relative underperformance a currently attractive earnings multiple and the stock trading at a solid discount to net tangible assets (NTA), especially when compared to long-term averages.

Mirvac ((MGR)) is next on JP Morgan's list, as while the stock remains cheap despite having significantly outperformed peers, Stockland simply offers better value. The ranking also reflects a longer-dated earnings recovery for Mirvac, with a return to normalised earnings levels seen as unlikely until FY14.

FKP Property ((FKP)) is cheap, JP Morgan estimating the stock is trading at a discount of 47% to NTA. The issue is the market is not willing to pay for retirement exposure, which sees the stock come in third on the broker's list.

Australand Property ((ALZ)) being overweight Victoria and Underweight Queensland is a positive and JP Morgan sees the stock as similarly cheap relative to peers. While residential earnings should improve by FY13, JP Morgan suggests the potential upside is better in more liquid plays such as Stockland and Mirvac.

Lend Lease ((LLC)) brings up the rear for JP Morgan as following strong relative outperformance year-to-date, the stock simply has a fuller valuation when compared to peers. In rating terms, JP Morgan rates both Lend Lease and Australand as Neutral, while Stockland, Mirvac and FKP score Overweight ratings.

By way of comparison, Sentiment Indicator readings according to the FNArena database stand at 0.8 for FKP, 0.7 for Mirvac and Lend Lease, 0.6 for Stockland and 0.0 for Australand.

Among office plays, Citi continues to recommend Dexus ((DXS)) and Commonwealth Property Office ((CPA)) as preferred exposures to the Australian market. Citi expects an improvement in fundamentals in the Australian office market will provide a boost for stocks in the sector.

Accelerating demand and high barriers to supply should support the Sydney market, while Citi also sees a solid outlook for Perth given resource driven demand. Performance in the Melbourne office market should be more moderate given recent outperformance.

Both Dexus and Commonwealth Property Office appear well placed to benefit from such an improvement, Citi pointing out both stocks are trading at a discount to NTA at current levels and both offer attractive cash flow multiples. 

Citi rates Dexus as a Buy and recently downgraded to a Hold rating on Commonwealth Property Office following a period of relative outperformance. The FNArena database has Sentiment Indicator readings of 0.1 for Dexus and minus 0.3 for Commonwealth Property Office.

Credit Suisse also sees something of a recovery underway for the Australian office sector, noting effective rents have increased and tenant demand was encouraging in the second quarter of 2011 as tenants now appear less inclined to hold out for a better deal. 

Conditions remain patchy however, as some additional supply is due to come online and there has yet to be a significant pick-up in leasing momentum in Credit Suisse's view. 

In the retail sector, Credit Suisse notes June quarter data from real estate group Jones Lang LaSalle indicates rents on new specialty leasing deals in regional sectors continue to increase, though at a lower rate than recent quarters.

Vacancies for specialty stores in regional centres remain close to historical lows, but at the same time tenant demand is still subdued. Retail supply increased in the quarter as projects progressed, Jones Lang LaSalle noting prime yields were unchanged during the quarter.

In the view of Credit Suisse, market conditions suggest the current retail risk premium appears to be overdone, as retail REITs under coverage trade on a weighted-average implied cap rate of 6.7%. This is 30-basis points above book, which compares to the office sector trading 20-basis points below book on an implied cap rate of 7.5%. 

Cap rate is annual net operating income divided by the cost of the property.

For exposure to REITs Credit Suisse continues to prefer the high quality names in the relative sectors, which means Westfield Retail ((WRT)) in the retail sector and Dexus in the office and industrial sector. The FNArena database shows a Sentiment Indicator reading for Westfield Retail of 1.0.

 

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