<html><body>
GUEST OBSERVATION
Australia has been an attractive destination for international investors attracted by the higher yields prevailing. Quantitative easing in the US, Japan and now Europe has meant yields globally are low. International investors attracted by Australian yields have contributed to the higher housing prices in Australia.
In Australia, capital appreciation of residential property will be constrained over the next several years reflecting housing affordability constraints, concerns about unemployment and reduced international investment capital flows.
Quantitative easing in the US ended in 2014 and interest rate increases are now foreshadowed later in 2015, which will reduce the relative attraction of Australian investments.
In Chart 1 is shown the rate of appreciation in Australian residential property over 15 years to 31 December 2014.
Chart 1 – Residential property appreciation
<img src="/images/2015/04/27/atch-april-27-one.jpg" alt="">
Source: REIA (2015), Atchison Consultants (2015) 
The rate of appreciation peaked in June 2014.
Housing affordability levels indicate prospectively weaker demand for residential property. In Chart 2 is shown the growth in housing debt to income over the past seven years to 31 December 2014, over the period of major falls in interest rates.
Chart 2– Housing Debt to Income
<img src="/images/2015/04/27/atch-april-27-two.jpg" alt="">
ABS (2015) Atchison Consultants (2015)
Housing debt has risen significantly since mid 2012.  The ratio of housing debt to income is at a record high of 140.3% of income at 31 December 2014.  The drive from lower interest rates increasing debt levels, which in turn will finance residential property purchases, will be tested.
A study by the HIA pointed to an increase in house price to income ratio, further highlighting housing affordability concerns.
The Australian economy is in transition from the mining boom reflected in an increase in unemployment levels over the last two years.  Despite this rise in unemployment, house prices have increased.  This has been driven by purchases by foreign investors, primarily from Asia.
Slower Australian economic activity indicates that the unemployment rate may rise and consequently demand for residential property may be lower.
Binesh Seetanah is an analyst at <a href="https://atchison.com.au/" target="_blank">Atchison Consultants</a>.
</body></html>

bseetanah-MkzVfc9t4h

Subdued capital growth in residential property market: Binesh Seetanah

<html><body>
GUEST OBSERVATION
Lessons learnt by management about gearing in the GFC are being applied now as AREITs acquire assets with debt on accretive terms. Yields on property are higher than interest rates on loans, so that return on equity is enhanced.
Gearing can change the characteristics of an investment significantly and in the worst case, force the sale of the underlying assets when prices are depressed. AREITs can enhance returns for investors through gearing, when they are generating total returns that are greater than the interest rate on debt.
Gearing increases downside risks. A major contributor to the AREIT sector fall of close to 70% between 2007 and 2009 was excessive gearing including paying distributions from unrealised profits funded by debt.  Valuations of property assets fell during the GFC and loan covenants were tightened by banks, causing breaches of loan covenants prompting banks to call for loan repayments. AREITs were forced to sell assets at distressed prices and raise capital at significant discounts to NTA.
Chart one illustrates the gearing levels of GPT Group (GPT), Federation Centres (FDC), Mirvac Group (MGR) and the sector over seven years to 31 December 2013.
Chart one – AREIT sector – Gearing Levels 
 <img src="/images/2014/05/29/binesh%20may%2029%20one.png" alt="">
* Previously Centro Retail Australia (CER)
Source: Company financials, UBS, Atchison Consultants (2014)
As shown in Chart one, the three AREITs have all reduced their gearing levels since the GFC. AREITs have re-focused on the fundamentals of property ownership and management and recapitalised through equity raisings resulting in lower gearing levels.
Over the twelve month period to 31 December 2013, AREITs have undertaken bond issuances mainly in overseas markets in order to finance property acquisitions or refinance existing debts. Mirvac Group has increased its gearing level by 5% over the period from 31% to 36% financing property acquisitions. Gearing below 40% does not place any strain on bank loan covenants.
A total of $5.8 billion of debt has been raised over the year to 31 December 2013. This reflects the prevailing low interest rate environment and consequently attractive financing conditions for new property acquisitions. Currently, interest rates on debt of 4.6% are below yields of 5.5% to 8% on property assets in the market.
In the current low interest environment, AREITs will continue acquiring assets at yields above loan interest rates, which is accretive for returns on assets for investors. Provided that levels of debt are judiciously managed, AREITs have the potential to enhance return on equity for investors whilst minimising the potential for breaching loan covenants.
Binesh Seetanah is an analyst at <a href="https://atchison.com.au/" target="_blank">Atchison Consultants</a>.
</body></html>

AREITs applying the gearing lessons learnt in the GFC

<html><body>
The issues surrounding liquidity of property investments were highlighted in the credit crisis. Sale of securities was the only source of capital raising as bank lending froze and prospective buyers of property assets could not finance acquisitions.
Property investors who seek a liquid property investment access can purchase listed property securities on the ASX or through a managed fund. Alternatively, investors wanting to invest in property that do not require daily liquidity can gain exposure through the direct purchase of an asset or through purchase of units in unlisted property funds or syndicates.
Liquidity associated with listed property securities can provide a range of benefits to investors. Liquidity gives investors the flexibility to invest or divest from their property investments and invest elsewhere as opportunities arise in other investments. Liquidity assists investors in rebalancing their portfolios.
Return premium – compensation for illiquidity
Direct property is characterised by limited flexibility and liquidity. Investors’ expectations from investments in direct property are that these investments would generate higher returns than listed property to compensate for illiquidity. Investors in direct property typically have longer investment horizons.
An assessment of whether direct property investments generate higher returns to compensate for illiquidity relative to listed property securities, over 28 years to September 30, 2013 has been undertaken.
Chart one below shows growth in returns from an initial investment of $100 made in September 1985 in listed property and direct property.
Chart one – Growth in investment – Listed property vs direct property
<img src="/images/stories/2014/02/17/binesh_feb_17.png" alt="binesh_feb_17" width="470" height="260">
Source: S&amp;P/ASX, PCA/IPD
From Chart one, over a 28 year period to 30 September 2013, from an initial investment of $100, an investment in direct property would have generated a higher return than listed property. Direct property generated 9.9% and listed property generated 8.9% per annum.
Liquidity is valued by the market and can be determined and quantified through turnover, size and transaction costs. Analysis concludes that the required return premium for illiquidity ranges between 0.7% per annum and 1.0% per annum.
Over 28 years to September 30, 2013, a return premium of 1.0% per annum over listed property has been paid to direct property investors for the illiquid characteristics of direct property. Over the long term, direct property investors have adequately compensated for illiquidity.
Current environment
Total returns in the range of 10.0% - 11.0% per annum are expected for listed property over the next twelve months. Comparatively, total returns in the range of 8.5% - 9.5% per annum are expected for direct property over the next twelve months. Therefore a return premium, as a reward for illiquidity, from an investment in direct property is not expected.
Binesh Seetanah is an analyst at <a href="https://atchison.com.au/" target="_blank" rel="nofollow">Atchison Consultants</a>.
          
</body></html>

Liquidity in property investments - direct v listed

<html><body>
Net asset value (NAV) and net tangible assets (NTA) are two common valuation metrics of Australian real estate investment trusts (AREITs). NTA is the balance sheet or book value of the underlying properties held within an AREIT. NAV is an analytical valuation of an AREIT based on the expected net cash flows from the property assets and profits generated from activities unrelated to income generation within the AREIT structure. These activities include operational businesses, such as funds management or property development.  
The degree that an AREIT is trading at a premium or discount to NAV and/or NTA, serves as a yardstick for assessment of the whether the AREIT is undervalued or overvalued.    
Rental income AREITs v AREITs with operational businesses  
A rental income AREIT, such as Westfield Retail Trust (WRT), derives the vast majority of its revenue from rental income. This compares with Westfield Group (WDC), which generates rental income and undertakes operational businesses such as construction, funds management, property asset management, leasing and marketing activities.  
Chart one illustrates the premium/discount to NAV and to NTA that these AREITs have traded at over three years to October 31, 2013.  
Chart one – Premium/Discount to NAV and NTA comparison
<img src="/images/stories/2013/12/04/binesh_dec_4_chart_one.png" alt="binesh_dec_4_chart_one" width="470" height="185"> 
 
*Inception – 13 December 2010
Source: UBS, Atchison Consultants  
WDC has been trading at substantial premiums to NTA since September 2011 which is attributable to the expected profits generated from the operational businesses within the group.  
However, WDC has been trading closer to its NAV, which accounts for expected market value of the assets of the properties and profits from operational businesses.  
Pricing relative to NTA and NAV  
The premium/discount to NAV and to NTA that the sector is valued at as at 31 October 2013 is shown in Chart two
 
Chart two – AREIT Sector– Premium/Discount to NTA and NAV as at October 31, 2013
 <img src="/images/stories/2013/12/04/binesh_dec_4_chart_two.png" alt="binesh_dec_4_chart_two" width="470" height="250">
Source: UBS  
Over the last 18 months, prices of AREITs have been driven upwards by investors looking for high cash dividend yield investments, within a prevailing low interest rate environment.  
As shown in chart two, as at October 31, 2013, the AREIT sector was trading at premium to NTA of around 23% and at a minimal discount to NAV of 1.5%.  
WDC, which accounts for approximately 25% of the value of the AREIT sector, skews the overall sector’s valuation. The AREIT sector, excluding WDC, was trading at a premium of around 13% and 1.7% to NTA and NAV respectively as at October 31, 2013.  
As shown in chart two, as at October 31, 2013, AREITs such as Westfield Retail Trust (WRT) Investa Office Fund (IOF), Challenger Diversified Trust (CDI) and GPT Group (GPT) have been trading at discounts to both NTA and NAV. These AREITs are undervalued by the market.
 
<hr>
 Binesh Seetanah is an analyst at <a href="https://atchison.com.au/" target="_blank" rel="nofollow">Atchison Consultants</a>.
</body></html>

How to decide if a REIT is undervalued

<html><body>
The June 2013 reporting season has recently been completed, with most AREITs releasing results in-line or slightly better than forecast. A review of the major underperformers and outperformers during the reporting season (31 July 2013 to 30 August 2013) has been undertaken.
AREIT performance over the reporting season 
During the reporting season, the AREIT sector generated a negative return of 0.2%, underperforming the Australian share market by 2.7%. Underperformance of the sector is partly attributable to an increase in long-term government bond yields during the month with long-term bond rates increasing by approximately 0.18% to 0.20%. Chart 1 below shows the total returns of individual AREITs over the reporting season.
Chart 1 – AREITs returns over August 2013
Click to enlarge
<a href="/images/stories/2013/10/08/areit-oct-9-big.gif" title="Click to enlarge" rel="shadowbox"><img src="/images/stories/2013/10/08/areit-oct-9-small.gif"></a>
 
 
Source: IRESS
 
Underperformers
Key underperformers during the reporting period were FKP Property Group whose share price fell by 16.9%, BWP Trust which fell by 5.9%, and GPT Group falling 3.0%.
FKP Property Group reported an impairment of $188m of its held properties and an 11% fall in its NTA just prior to the release of its financial year-end results and was subsequently sold down heavily. Statutory profit, dividend per share and earnings per share fell considerably.
The fall in value of the BWP Trust during the reporting period is mainly attributable to an entitlement equity raising made on August 8, 2013 at a discount of 4% to the prevailing stock price. This raising was completed on August 26, 2013. Financial results were in-line with expectations for the Trust with the exception of an increase in debt which increased finance costs by 6.2% and a fall of 1.2% in distributable profit for the financial year.
GPT financial results were below expectations attributable mainly to downward revaluations of properties held in Dandenong and Charlestown. Statutory profit, which includes exceptional items, was down by 6.7% from 2012 results and was below expectations. Net operating income growth slowed by 0.7% during the first six months of the year. The company’s has revised its earnings per share forecast down by 0.4% for the financial year ending June 30, 2014.
Outperformers
Key outperformers during the reporting period were Cromwell Property Group, whose share price rose by 5.6% and Stockland, which rose by 4.2%.
Cromwell Property Group stock price rose by 2% on the day of its release of the financial results. Results were in-line or slightly above expectations for the financial year. Dividends per share and dividend payout ratio were slightly higher relative to 2012 financial results and in-line with expectations. Operating profit amounted to 7.6 cents per share relative to expectation of 7.5 cents per share, with property investments contributing to 95% of operating earnings (up by 21% from last year). Additional rental income from properties acquired in NSW and Brisbane CBD in May 2013 contributed to a higher operating profit than expected. The company forecast an increase in operating profit of 8.8% and an increase in distributions of 3.4% for the financial year ending 30 June 2014.
There was no significant impact on Stockland’s share price following the announcement of weaker financial year results, as they were in-line with expectations. Stockland reported a fall in earnings per share of 24% during the financial year mainly attributable to a fall of approximately 79% in statutory profit, resulting from the writing down of its residential portfolio by around $355 million during the year. Strong performance relative to the sector during the reporting season can be partly attributable to the company’s positive outlook for the residential property market.
 
<hr>
 Binesh Seetanah is an analyst at <a href="https://atchison.com.au/" target="_blank">Atchison Consultants</a>.
 
 
</body></html>

Binesh Seetanah

Editor's Picks

Have something to contribute?

Developments

New apartments

New townhouses

News