Property rebuilds its value: the listed property sector, savaged in the crash, is back in play

THOUSANDS of small investors are still shocked from the losses they suffered when the listed property sector plumbed new depths last year

The sector remains unloved. Many of the stocks are trading at a discount. The average discount is about 10 per cent to the net asset value of the sector.

According to Deutsche Bank's research team, the Australian real estate investment trust sector was down 0.7 per cent for the three months to early this month, compared with a gain of 6.3 per cent in the broader Australian equities market.

"We struggle to see the A-REIT sector matching broader market returns," the bank's research team wroterecently.

In fact, the benchmark S&P/ASX A-REITs 200 Index has trailed the broader market equivalent, the S&P/ASX 200, since September 2007.

Investors were let down badly by a sector they had long trusted. It was a sector they should have been able to depend on for their regular dividend cheques.

"It is an untrusted sector," says Stuart Cartledge, principal of Phoenix Portfolio, a Melbourne-based fund. "Unfortunately people have tarred every trust with the same brush. It will take time to win back the trust of investors." .

Cartledge's Phoenix Portfolios Listed Property fund has consistently been a top three performer on the Mercer's Index for Australian Real Estate Securities.

The pain was deeper than in past market corrections. The world of big and small investors fell apart when the sector's market value dropped from $130 billion in July 2007 to $38bn in June last year and dividend cheques dried up.

The sector had enjoyed unprecedented growth in the lead-up to the global financial crisis in 2008, bingeing on debt to acquire assets to fatten fee incomes with exponential growth in assets under management.

And to make the figures stack up, creative financial engineering appeared in a sector that was previously conservatively geared. Several trusts borrowed to pay distributions.

The financial earthquake swallowed up the more adventurous vehicles, such as those in the stables of Babcock & Brown or Rubicon, managed by Allco Group.

Many prominent names have disappeared from the sector. Macquarie Group, for instance, known for its financial engineering skills, no longer has its name on listed property trusts. It has sold Macquarie Office, now Charter Hall Office REIT, and Macquarie Countrywide is now Charter Hall Retail REIT.

The better performing Macquarie Leisure Trust was internalised by its management and is trading as Ardent Leisure, while the heavily indebted Macquarie DDR, which owns US assets, is managed by its US management company and was renamed EDT Trust.

The crisis has cleaned up the sector for the investors, removing the hubris and excesses of the boom years.

In the cleansing process those with a sustainable business model were able to recapitalise to the tune of $19bn. They were forced to pay back debt and sell assets, revise their unrealistic payout policy, retreat from foreign markets and, most important, return property trusts to being boring rent collectors.

John Freedman, head of property at UBS, says the sector has reduced its average gearing from 40 per cent plus to between 25 per cent and 27 per cent. He says the sector has done away with financial engineering and focuses on its incomes from its core businesses to pay dividends.

Some trusts such as Stockland have a gearing ratio of 18 per cent and almost $2bn in liquidity. Others such as GPT, which went close to oblivion, have gearing of 25.5 per cent. Goodman Group brought in global institutional investors to provide capital for its growth. Further, A-REITs have adopted the global standard of distribution of a percentage of their incomes and for stapled trusts, which have development and other activities, some choose to pay incomes only from rental income and not development profits.

"What you get now is a more secure, sustainable, and realistic return. This is what property is all about," Freedman says.

The sector distributes 80 per cent to 90 per cent of its incomes, retaining the balance for capital expenditure.

Deutsche Bank has forecast 4.1 per cent weighted average earnings per share growth until 2012-13.

The bank says this will be the tough year for earnings for the sector but earnings will start to pick up from the 2011-12 financial year. On the back of higher earnings, distributions will also pick up.

Deutsche Bank says distributions fell 29.7 per cent in 2008-9 and 32.2 per cent the following year. However, it will be positive from this year.

Many fund managers are happy for trusts to retain earnings, saying this is a far more sustainable approach than paying out 100 per cent in dividends, and sometimes more than that, as they did previously. Freedman says the sector will offer income returns of 6 per cent to 8 per cent, with a further 3 per cent to 4 per cent coming from capital growth.

He adds there could be "a bit of upside" from any mergers and acquisitions.

The share price of the listed retirement village operator Aevum was languishing at about $1.10 for a long time before Stockland made an offer to take out all the units it did not own. After its initial bid, Stockland lifted its offer to $1.77 a unit.

Similarly, the ING trusts -- ING Office, ING Industrial ING Real Estate Entertainment, ING Real Estate Healthcare and ING Real Estate Community Living -- are trading on a takeover premium, fund managers say.

The ING Industrial Trust was trading at under 40c. A Goodman-led consortium is doing due diligence on the trust and will pay a price based on its net tangible asset of 57c per security to take it private. With a lower beta (market return), Freedman says movements in the prices of A-REIT securities are less volatile than general equities, compared with the past few years. He says for every 1 per cent movement in the broader equities market, A-REITs are typically moving about 0.75 per cent. This reflects the low gearing and payout ratios and secure state of the underlying property assets.

Melbourne-based asset allocator Ken Atchison, whose firm advises superannuation funds and some platforms on investment strategy in property, says at the present level investors are getting fair value.

Simon Marais, head of fund manager Orbis Australia, has probably made more money from the sector in the downturn than others because bottom-fishing is his specialty. Marais started buying A-REITs during the crisis. A classic opportunistic investor, he bought some of the worst performers and emerged as a substantial shareholder in many trusts.

In the past few months, he has exited from many when the price of some trusts quadrupled. But he admits some unit prices did not go up at all. He still has substantial holdings in several trusts including Valad Property Group, Mirvac Industrial Trust; APN European Property Group and Australian Education Trust.

Marais says the level of gearing in these trusts has stabilised and property valuation has started to edge up. His investment decision is based on the assets held by the trusts. Even if these trusts were to fail, he says the assets will still be worth something. Further, companies such as Valad have cut off their European operations and own some good income-producing Australian assets. But few investors have the foresight, nerve or available cash of Marais, who manages a $2bn fund, least of all small investors.

There was a lesson learned from the crisis, however: for all its faults the listed sector continues to provide liquidity and it had the ability to bounce back.

Chris Craggs, principal consultant with Australian Finance Group, says: "In hindsight, investors should have stayed with the listed sector.

"If we had put our clients' money into A-REITs from March last year [the trough] we would have seen outstanding returns."

Craggs says some small investors opted for direct property and invested in property syndicates. But he says these investors are in a quandary as their money is frozen in these syndicates.

Since 2008, property syndicates and unlisted trusts have been frozen because inflows have stopped. They have locked in investments valued at about $7bn.

Industry sources say there is no immediate prospect of these unlisted property fund managers getting out of the deadlock, which will not happen until the property market picks up again. Only then can their managers sell assets to raise the cash to meet to meet redemptions.

An additional problem is these trusts usually have secondary grade assets compared with blue-chip office towers or super-prime regional shopping centres in the listed sector.

Some financial planners say ruefully the decision to go to direct property was not a wise one. "Confidence is returning to listed property," says Peter Johnston, executive director of the Association of Independently Owned Financial Planners, which represents 2500 advisers.

"The smart money is starting to enter the market. This tells us that now is the right time to start investing," he says.

Johnston says credit remains tight or unavailable for developers, which means demand is not being fully met. Simplistically, this means higher rents, which will lead to higher values.

When all is considered, property has a place in a balanced portfolio, Craggs says.

Florence Chong From: The Australian November 24, 2010 12:00AM