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Listed property trusts that increase their borrowings to acquire or develop property assets will increase returns to investors provided they generate returns that outperform interest charges.  
In 2006, the A-REIT sector, as represented by the S&amp;P/ASX 300 A-REIT Index was geared at 37%.
Gearing is now 29%, having been lowered by a combination of asset sales and new equity capital raising. This has also been assisted by the upwards revaluation of underlying real estate assets over the past two years. Of the larger A-REITs, none has a gearing level above 40%. A global survey of investors by UBS concluded that gearing of 30% - 50% was appropriate.  
At the height of the GFC in March 2009, some A-REITs had gearing ratios substantially above 40%. Of the ten A-REITs with gearing ratios above 40% at that time, only one is still trading on the ASX. Names such as Macquarie DDR Trust with gearing of 60%, Macquarie Countrywide (59%), Babcock &amp; Brown Japan Trust (58%), and Tishman Speyer Office Trust (56%) have all been acquired, merged or operate under new management. Pressure from lenders was significant. During the GFC the increase in corporate interest rates was part of a credit squeeze. These factors combined to reduce the net earnings of A-REITs.  
Gearing in other countries with listed REIT markets have higher gearing compared to Australia as interest rates are structurally lower. This is noted in Table 1.
Table 1: Average Gearing from Global Markets
<table cellpadding="0" cellspacing="0" border="0" frame="box" style="width: 470px;"><tbody>
<tr>
<td valign="top" width="284">
REIT market 
</td>
<td valign="top" width="284">
Average Gearing (%)
</td>
</tr>
<tr>
<td valign="top" width="284">
Australia
</td>
<td valign="top" width="284">
29
</td>
</tr>
<tr>
<td valign="top" width="284">
Japan
</td>
<td valign="top" width="284">
45
</td>
</tr>
<tr>
<td valign="top" width="284">
France
</td>
<td valign="top" width="284">
41
</td>
</tr>
<tr>
<td valign="top" width="284">
Singapore
</td>
<td valign="top" width="284">
40
</td>
</tr>
<tr>
<td valign="top" width="284">
USA
</td>
<td valign="top" width="284">
48
</td>
</tr>
<tr>
<td valign="top" width="284">
UK
</td>
<td valign="top" width="284">
48
</td>
</tr>
</tbody></table>
Source: UBS, BDO  
Negative gearing occurs when the cost of interest on debt exceeds the income return earned by an investment. Gearing increases variability of potential return outcomes because of the fixed obligation to pay interest against variable income and capital returns as illustrated in Chart 2. Gearing amplifies prospective positive and negative returns. The marginal impact of gearing between 30% and 50% is not substantial. Gearing has a substantial impact beyond 60% when prospective negative outcomes are large.  
Chart 2 - Effect of Increasing Gearing on Property
<img src="/images/stories/2013/06/markwistjune26one.jpg" width="470" height="288" alt="markwistjune26one"> 
At elevated gearing levels of 60% and higher, the risks of negative property valuation movements are exacerbated as there is a smaller protective equity buffer and higher exposure to increased interest payments on a larger debt.  
Several A-REITs have raised new debt or refinanced existing debt over the past year to take advantage of lower interest rates. A-REITs have also demonstrated an appetite to diversify the source of debt finance away from domestic banks to include offshore banks, and domestic and offshore bond markets.  Within the last three months, Commonwealth Property Office Fund raised $60 million and GPT raised $250 million through bond issues; Dexus raised $300 million in a private placement in the USA; and CFS Retail Property Trust raised $50 million in medium term notes and refinanced a $150 million bank facility. A total of $5.2 billion of debt has been raised or refinanced by the major A-REITs over the year to 31 May.  
A-REIT balance sheets are now in sound financial shape with low gearing ratios by bank credit standards, low interest rates, and stability of values in the property markets. Interest rates on debt are below yields on property assets. Property acquisitions will enhance return on equity.
Mark Wist is senior asset consultant at <a rel="nofollow" target="_blank" title="Atchison Consultants" href="https://www.atchison.com.au/">Atchison Consultants</a>.
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markwist-Vaq6S8Xoby

Increased A-REIT gearing can be a good thing for investors: Mark Wist

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With rumours that Mirvac may be interested in a possible bid for Australand following the exit of GPT, A-REITS analyst Mark Wist provides answers to the key questions behind Australand's decision to sell and what this may mean for the listed property trust sector.
Why is Australand so motivated to sell the business? 
Australand is an A-REIT listed on the Australian Securities Exchange. It has a market capitalisation of just over $2.0 billion. Australand’s major security holder is the Singapore based property group, CapitaLand Limited, which owns approximately 59% of the issued capital. CapitaLand’s stated intention following a business review is to divest its holding in Australand which is a non-core asset.
What aspects of its business would appeal to investors?
Australand has a commercial office and industrial property portfolio of $2.3 billion. It is also possible that some capitalisation rate decreases will see values increase in this portfolio. Australand has a substantial residential development business with development land held on balance sheet mainly in Sydney and Melbourne with completed value estimated at $8 billion.  It also has an office and industrial property development business.
In December 2012, GPT announced an interest in acquiring the investment property portfolio and commercial and industrial business of Australand.
GPT had a particular interest in Australand’s industrial portfolio. An acquisition of a controlling stake in Australand would have given GPT the opportunity to bolster its own industrial portfolio with quality assets, some of which had value-adding potential.
In May, GPT announced that it was no longer pursuing the proposal.
Mirvac had also expressed interest in Australand, however withdrew from the bidding process earlier than GPT.
What would be the concerns for investors?
There are two major components of the business being an investment portfolio and a residential property development business.  The combination does not attract interest from a wide range of potential providers.  Asian investors do consider both activities.
Ultimately it seems that there were two stumbling blocks to a successful conclusion to a sale of CapitaLand’s stake to GPT. First was the price of the acquisition. GPT made it clear that there was a pricing expectation mismatch between it and the vendor. Second was that GPT had little interest in Australand’s residential development business or assets. GPT could not identify a partner to acquire that part of the business and Australand for its part was only considering selling its stake in one transaction without separating the businesses or assets in the portfolio.
What does the potential sale of Australand mean for the AREIT sector?
If Australand was acquired by, it would result in further consolidation among A-REITs. In April 2012 there were 53 A-REITs listed on the ASX. In April 2013 this number had fallen to 46 despite the market capitalisation of these A-REITs increasing from $81 billion to $100 billion.
If acquisition is by cash it would release capital for re-investment prospectively back into the sector. 
Are there likely to be other consolidations in the AREITs space?
A number of A-REITs currently have the balance sheet capacity and support to acquire other A-REITs. However, it is more likely that as the sector is now trading at a premium to net tangible assets, we will see private unlisted funds seeking listing on the ASX to take advantage of the liquidity benefits associated with listing.
Mark Wist is senior asset consultant at <a href="https://www.atchison.com.au/" title="Atchison Consultants" target="_blank" rel="nofollow">Atchison Consultants</a>.
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Australand's residential and commercial mix does not appeal to investors: Mark Wist

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Performance of the listed A-REIT market is shown in Table 1.
It shows that significant positive returns have been achieved over the past three years especially in the last year.
The five-year performance is negative reflecting the substantial falls encountered during the crux of the GFC.
Volatility is also significantly lower over three years than five years reflecting more stable markets.
<img src="/images/stories/2013/04/wistapril30one.jpg" width="470" height="89" alt="wistapril30one">
The A-REIT sector has underperformed broader shares over the past five years. However, most of that underperformance occurred in year to 31 March 2009.
Over the past two years, A-REIT out-performance has been significant.  
The average annual total return for broader shares over the past five years has been 3.1% compared with -3.7% p.a. for A-REITs.  
Going in to the GFC in 2008, companies in the A-REIT sector had significantly higher levels of debt than had been employed in previous years.
Many significant companies owned property in overseas markets where asset values declined sharply.
Others were engaged in property development activities. Each of these components contributed to negative earnings. A-REIT prices declined partly as a consequence.  
Listed property companies have recapitalised balance sheets by raising new equity, selling property and reducing debt with the proceeds. As a consequence, the earnings outlook is more secure.  
Table 2 shows the average debt holdings and exposure in overseas property between 2008 and 2013 for A-REITs.
<img src="/images/stories/2013/04/wistapril30two.jpg" width="470" height="89" alt="wistapril30two">
Table 3 shows the income return from A-REITs, along with the average Australian 10-Year Government Bond yield.
<img src="/images/stories/2013/04/wistapril30three.jpg" width="470" height="87" alt="wistapril30three">
The current listed property distribution yield is 5.9% which sits significantly above the 10 year bond rate as at 31 March of 3.3% giving a premium of 2.6%.  
A-REITs have lower debt levels and reduced exposure in overseas property.
This more stable investment structure combined with high relative income yields has attracted investor interest.
As a result returns have been very strong.  At present price levels the income yields and growth prospects are attractive.
Mark Wist is senior asset consultant at <a href="https://www.atchison.com.au/" title="Atchison Consultants" target="_blank" rel="nofollow">Atchison Consultants</a>.
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Strong performance over past year for A-REITs: Mark Wist

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In February, Westfield founders the Lowy family announced the sale of its entire 7.1% stake in the Westfield Retail Trust for $664 million.
The motivation was to diversify its investments internationally. The Lowy family retains its 8% interest in Westfield Retail Trust’s stable mate Westfield Group worth approximately $1.8 billion. 
The action highlights the potential performance differential of passive asset-owning A-REITs compared to those with a higher earnings growth prognosis. 
Westfield Retail Trust is a passive property-owning A-REIT.
Earnings growth is largely generated by rental increases from assets held in the portfolio.
While rent reviews on retail property held in A-REIT portfolios continue to generate rental increases of up to 3%, renewals and new leases have seen rental reductions of up to 7% with some increases in lease incentives acting as a further drag on earnings.
The difference in the change in rental between renewal of existing leases and new leases is the re-leasing spread. Westfield Retail Trust reported the weakest releasing spread in the retail A-REIT sub-sector at -2.6%. 
Westfield Retail Trust’s forecast earnings growth is 3.0% and its estimated dividend yield for the 2013 financial year is 6.3%.
This compares to the forecast earnings growth for Westfield Group at 4.9% with an estimated dividend yield of 4.5%. The yield differential reflects the difference in anticipated earnings growth. 
Westfield Group also owns property. However, its earnings growth is boosted by profit from property development; revenue generated by higher fees from increased funds under management and increased asset management fees.
Westfield Group reported an 18% increase in net profit over the 2012 year driven largely by profit earned from development of its own shopping centres.
Development profit and fee revenue are more volatile than rental income.
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What motivated the Lowys to sell out of the Westfield Retail Trust?

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The A-REIT sector showed a total return of 33% for 2012, outperforming shares, which returned 20% over the same period.
Drivers of this outperformance included reducing debt servicing costs and an improved capital position, strong capital inflows to the sector and a surge in merger and acquisition activity in the second half of the year.
An average sector earnings yield of 7.2% and an average payout ratio of approximately 81% underline the strong income proposition offered by A-REITs.
Debt servicing costs for the larger A-REITs have reduced by 1% over the past year to approximately 5.5%. This will benefit those A-REITs with interest rate hedges expiring this year and those who can fund earnings accretive property acquisitions with debt.
With A-REIT sector distribution yields around 6% and Australian 10 year government bond yields currently around 3.5%, a significant yield premium of 2.5% exists.
Share buy backs had been a common capital management strategy in the first half of 2012 as A-REIT prices traded at a significant discount to their asset backing. However, in the final quarter of 2012, over $600 million of equity was raised including $400 million by Goodman Group and $100 million by Charter Hall Retail.
In addition, both the 360 Capital Industrial Fund and the Shopping Centres Australasia Property Group (the Woolworths property offshoot), which raised $472 million, were listed as A-REITs. Excluding Westfield Group, the A-REIT sector discount to asset backing has closed from 10% this time last year to a 5% premium.
At the end of 2012, GPT made an unsolicited bid to acquire the non-residential property and corporate assets of Australand. While the bid was rejected, the principal shareholders of Australand have indicated their willingness to exit their investment.
Mirvac has also expressed interest in acquiring Australand. It is anticipated that Australand will be acquired this year. The benefits of increased scale will a driver of corporate activity. Smaller A-REITs without the capacity to grow their balance sheets without external capital are likely to be among the targets.
While rent growth is likely to be subdued in 2013, development and redevelopment pipelines are likely to boost earnings growth. Continued low interest rates, the prospect of corporate activity, and the relatively high yield from A-REITs compared to equities and fixed interest investments are expected to be factors contributing to another positive total return in 2013.
Mark Wist is senior asset consultant at <a href="https://www.atchison.com.au/" title="Atchison Consultants" target="_blank" rel="nofollow">Atchison Consultants</a>.
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Another positive return for A-REITs in 2013 after strong 2012: Mark Wist

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Slow retail sales growth over the past year has produced a difficult retail trading environment. Retailer margins are being pressured as low turnover growth and fixed rental increases raise occupancy costs, however retail A-REITs are forecasting nominal distribution yield growth of up to 4% in 2013.
Retail sales growth remains positive overall at 2.6% per annum, although this is significantly below its long-term average of 6.2% per annum.
Department stores and household goods retailers are being particularly affected. Online sales now represent approximately 5.5% of total retail sales and are growing at around 20% per annum.
To date, this has not represented a substantial threat to high-quality shopping centres, and many retail A-REIT managers have adopted strategies to incorporate the effects of online retailing such as purchase collection centres and enhanced personal mobile device technology. The recent failure of the Click Frenzy online sale will have done little to enhance the reputation of the technology to the unconvinced.
Measures of annual turnover growth in the retail A-REITs have generally improved over the year to September 2012, however remain below long term averages at around 1% to 2%.
Fixed rental increases embedded in existing leases are reflected in average rental growth of around 2% to 3% across the retail A-REIT sector.
This contrasts with releasing and new leasing activity which shows reductions in rent of between 1.5% and 3%. Lease incentives, often in the form of contribution to fit out, range up to 20% for five-year terms for some shopping centres, particularly those with a high discretionary retail element or those which do not dominate their catchment areas.
While regional shopping centre vacancies have increased from 0.6% to 1.2% over the past two years, the average vacancy in the retail A-REITs is 0.5% demonstrating the value of active professional management.
The retail A-REITs have been active in capital management, portfolio development, acquisition and disposal in order to maintain and enhance the quality of their portfolios:
<ul>
<li>Westfield Retail Trust and Westfield Group have recently undertaken a complex asset swap and restructure of seven Australian shopping centre assets held in joint venture with AMP Capital; </li>
<li>CFS Retail Property Trust is developing Emporium, a shopping centre in the Melbourne CBD. Emporium is stage two of a project alongside the refurbished Myer building which is expected to cost in the order of $740 million;</li>
<li>Charter Hall Retail REIT has recently raised $100 million to fully equity-fund the acquisition of three sub-regional shopping centres at a 2% premium to net tangible assets (NTA); and</li>
<li>The listing of Woolworths’ proposed new Shopping Centres Australasia Property Group on the Australian Securities Exchange will increase the liquidity and diversity of retail A-REITs. The total value of the retail property portfolio will be in the order of $1.4 billion.</li>
</ul>
Retail A-REITs provide investors with an exposure to quality retail real estate portfolios and management expertise. The Shopping Centres Australasia Property Group is likely to yield an income return higher than the retail sub-sector, depending on its final share price. The additional development return potential from the Westfield transaction should increase its distribution return. Westfield Retail Trust’s share buy-back will improve its NTA. The subsector should benefit from this acquisition and development activity and result in some share price growth despite the below trend retail trading environment. Fixed rental increases at rent reviews will largely offset rent reductions at lease renewal while cost efficiencies and low interest rates will cushion slow retail sales growth for retail A-REITs.
Mark Wist is senior asset consultant at <a href="https://www.atchison.com.au/" title="Atchison Consultants" target="_blank" rel="nofollow">Atchison Consultants</a>.
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Retail A-REITs grow despite economic environment

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Woolworths has announced its intention to sell down 69 shopping centres currently held on its own balance sheet into a new fund that it intends to list on the Australian Securities Exchange (ASX) as a new A-REIT. The fund will be called the Shopping Centres Australasia Property Group (SCA Property Group).
The new fund will be the seventh substantial retail A-REIT listed on the exchange and will increase the value of total assets under management in the sector by 2.2%.
To fund the acquisition, SCA will conduct a capital raising of between $425 million and $506 million. The proposed raising would offer a discount to the net tangible asset backing of the new group of between 5% and 20%. The distribution yield of the proposed trust would be between 6.9% and 8.3% depending on the final price paid. This is considerably higher than the weighted average ASX retail sector distribution yield of 5.5%.
The portfolio of 55 Australian and 14 New Zealand neighbourhood, sub-regional and freestanding shopping centres is valued at A$1.4 billion. Of these, 13 properties are still under construction. The centres are currently 95% leased, including Woolworths rental guarantees, somewhat below the A-REIT sector average of 99%. Woolworths will contribute 61% of the gross rental income. The weighted average lease term of the proposed fund is 15.8 years, compared with an ASX retail sector average of approximately 7.3 years. Gearing of the proposed fund is 27%, which is in line with the ASX retail sector gearing of 29%. 
Woolworths will have no ownership of the new company, which would have a separate board and management team. 
Woolworths shareholders will have the opportunity to vote on the proposal at the its annual general meeting on November 22. Should it be given approval to proceed and should the listing application be successful, the trust would start trading on November 26.
Mark Wist is senior asset consultant at <a href="https://www.atchison.com.au/" title="Atchison Consultants" target="_blank">Atchison Consultants</a>.
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Woolworths to create new A-REIT

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The Australian Real Estate Investment Trust (A-REIT) sector outperformed the broader equities market over the year to September 30. A-REITs returned 28.9% compared with 14.5% for equities.
Click to enlarge
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And they are forecast to continue to provide both distribution and capital growth. This is expected to be as a result of lower debt service costs, the opportunity to redevelop portfolio assets and the potential for a reduction in the currently high distribution yield premium to the risk-free rate.
A-REITs have been taking advantage of low interest rates by refinancing. While there is a cost associated with refinancing, the benefit to earnings of a lower ongoing interest rate is lower debt service costs. Among those A-REITs to have refinanced with lower debt costs are Centro Retail Australia and Goodman Group.
Tight vacancy rates across the office and retail sectors will encourage the redevelopment of assets held in portfolios. On completion of property redevelopment, the rental yield on costs is high relative to outright asset acquisition. The asset value will increase as a result of the redevelopment. This redevelopment income into A-REITs will compensate for slowing office leasing activity, lower specialty and department store sales, which have put pressure on rent growth and slower residential development lot sales. Mirvac and Westfield Group are among the A-REITs with substantial asset redevelopment pipelines.
The 10-year government bond rate is the risk-free rate. The difference between the A-REIT yield and the bond rate represents the premium offered by A-REITs.
This premium compensates for the business risks associated with A-REITs. The current A-REIT sector distribution yield is 6.2%, which sits significantly above the benchmark 10-year bond rate of 3%, giving a current premium of 3.2%. The five-year average A-REIT yield premium is 1.8% above the 10-year government bond rate. The difference of 1.4% between the current premium and the five-year average represents potential for capital gain from yield tightening as the premium reverts to mean.
This combination of lower debt funding costs, the potential redevelopment activity of properties already held in portfolios and the relatively high yield premium will provide the scope for A-REIT distribution and capital growth over the coming year.
Mark Wist is senior asset consultant at <a href="https://www.atchison.com.au/" title="Atchison Consultants" target="_blank">Atchison Consultants</a>.
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A-REITS set for capital growth as sector outperforms equities

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No equity capital has been raised by A-REITs since March 2011. This is in stark contrast with 2009-10, when almost $17 billion of equity was raised to restore balance sheets. As new equity was issued at a significant discount to net tangible assets (NTA) and not offered as rights issues, this equity was dilutive for existing unit holders. 
For the past year, share buy backs have been a common capital management strategy among A-REITs. Conducting a share buy back when shares are priced at a discount is an effective way to increase NTA. 
In order to fund these buy backs, most A-REITs have undertaken asset sales. This has amounted to $1.1 billion of domestic asset sales and $12 billion of offshore asset sales since the beginning of 2011. Among those conducting the asset sales programs have been: 
<ul>
<li>Westfield Group, which has sold $1.2 billion of non-core assets in the United States. It proposes to buy back up to $1.9 billion of shares of issue, although has conducted only 0.3% of this target to date;</li>
<li>Dexus, which will use part of the proceeds of the sale of a $750 million portfolio of US industrial assets to fund its $200 million buy back;</li>
<li>Stockland has sold $972 million of office and industrial assets this financial year in pursuit of its residential, retail and retirement asset strategy. A portion of the proceeds are being directed to an on-going buy back programme of approximately $675 million;</li>
<li>GPT which is selling its Homemaker assets for a reported $195 to extend its buy back from 5% to 10% for approximately $550 million. </li>
</ul>
Other assets up for sale include GPT’s share in Sydney’s MLC Centre with a value of approximately $750 million; a 50% share in three of Centro Retail Australia’s prime assets worth approximately $665 million and Investa’s interest in its $200 million office asset at 231 Elizabeth Street, Sydney. 
Australian assets worth approximately $3.7 billion are reported to currently be on the market for sale by A-REITs.
Mark Wist is senior asset consultant at <a target="_blank" title="Atchison Consultants" href="https://www.atchison.com.au/">Atchison Consultants</a>.
 
 
 
 
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A-REITs have sold $12 billion worth of assets since the beginning of 2011

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The long-term prognosis for Australian residential real estate is sound. <place>Australia</place>’s population is forecast by the Australian Bureau of Statistics to grow from around 22.4 million in 2011 to 30.9 million in 2031, an increase of 34.6%. This underwrites residential property demand. The deficiency in numbers of dwellings increased from an estimated 22,700 in 2006 to an estimated 124,400 in 2011 according to BIS Shrapnel. This supports price stability. 
A-REITs such as Mirvac, Stockland and Australand have exposure to the residential property sector through residential property development. These A-REITs also have exposure to other asset classes such as office and retail. Recent sentiment towards those A-REITs with significant residential property exposure has been negative. Stockland recently revised down its 2012 financial year earnings estimate as a result of deterioration in the number of lot sales and settlements and adverse weather in NSW disrupting development. This revision was released only six weeks after the group reaffirmed earnings estimates in its first-half results announcement. The result was a 7.3% fall in the share price in the month of March. Compounding this have been tougher lending requirements for both home buyers and property developers. 
A-REIT balance sheets are sound and gearing levels are moderate. The larger diversified groups are able to pre-fund infrastructure works which are important in establishing buyer confidence and aesthetic appeal in a green-fields residential development. Sales volumes are currently more robust in lower value residential property. As a consequence, groups like Stockland are adjusting their planning to accommodate a higher proportion of lower price and smaller lot size residential product. 
Despite the current funding and sentiment challenges, those A-REITs with the capacity to deliver suitable residential product to meet the market will flourish over the medium to longer term.
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