14 — Money Management September 22, 2011 www.moneymanagement.com.au

Listed Property

The listedproperty shows

new blossom

Everything old is new. It seems that the listed property sector is returning to its previous modeland slowly becoming a defensive asset again. This has resulted in more positive adviser andinvestor attitude towards listed property, which is not to say that all bad apples have been weededout of the sector. Benjamin Levy reports.

LISTED property is going back tobasics. The 2007 investmentapproach of explosive growth,

unsustainably high dividends, andexcessive gearing levels that was shatteredby the financial crisis has given way towhat the sector was meant to be – aconservative, defensive growth asset offer-ing steady, inflation protected returns.

As the sector shifts focus, it is begin-ning to once again attract the attentionof financial planners looking for a steadyincome stream for retired clients and aviable alternative to the shaky perform-ance of domestic equities.

But choosing what to invest in needsto be a careful exercise. Listed propertygroups with ongoing debt problems stillexist and can yet prove dangerous to

investors, while others are too tied to themarket to provide alternative returns forportfolios. The issue of excessive concen-tration in the domestic market contin-ues to dog investors, while currencyvolatility in the Australian dollar threat-ens overseas income distributions.

In a sector where the research housesseem divided on where to placeinvestors’ funds and cannot offer a clearapproach, advisers need to carefullyconsider where the best opportunitiescan be found.

Back to basicsThe upheaval of the global financialcrisis (GFC), which forced listed proper-ty funds to slash their debt, cut highgearing levels and lower high dividends,

has sparked a return to conservatism inthe listed property sector.

Gearing levels in property trusts,which were once as high as 40 per cent,have been reduced to a sector-weightedaverage of 28 per cent. Exposure to over-seas assets has been reduced, andsources of funding have been diversifiedto cover bonds, US capital markets andthe banks.

Property trusts are moving back totheir core business of managing domes-tic property, according to co-director ofReliance Investment ManagementAndrew McGrath. Reliance is the fundmanager of Charter Hall Property Secu-rities Fund.

“The sector is back to its basics, backto being a defensive asset class, and that

“Listed property this yearis down actually aboutnine per cent, [and] a fairbit of that is equity marketvolatility even thoughlisted property trusts havereduced their volatilitycompared to the broaderequity market,” McGrathsays. ” – Andrew McGrath

MMSEP22_11.PG014.pdf Page 14 15/9/11, 6:51 PM

will gradually be recognised over time astrusts deliver on what they’ve said,”McGrath says.

Defensive trusts are announcing fourto six per cent earnings growth for nextyear. Despite still-visible GFC scars, thecurrent positive reporting season shoulddraw investors back to the listed prop-erty sector.

Research house Standard and Poor’s(S&P) most recent listed property reviewfound the domestic sector in muchbetter health thanks to the detoxingeffect of the financial crisis.

“After going on a drastic debt diet,undertaking sizable equity raising andreverting to ‘back to basics’ strategiesover the past few years, most of the [Asia-Pacific] region’s Real Estate InvestmentTrusts (REITs) emerged from the finan-cial and economic crises with strongerbalance sheets and improved r iskprofiles,” the report said.

The GFC also served to get r id ofunderperforming property trusts thatwere badly structured and debt-ridden,leaving up to five large, clean, well struc-tured property groups to choose from,

and the dealer groups are taking notice.ipac is using the listed property sector

to provide a real income stream for itsretired investors, according to ipac chiefinvestment officer Jeff Rogers.

The amount of leverage which inun-dated the listed property sector pre-GFCprevented dealer groups from using thesector to provide an income stream fortheir clients.

However, large scale recapitalisationand equity raisings in the past few yearshas reduced the amount of leverage andre-established the attributes of real under-lying property and rental schemes, allow-ing dealer groups like ipac a second look.

“It’s a reasonably high yield, sustain-able in terms of good rental streams, butan income stream that one would expectto rise at least with inflation, if not a littlebit faster over time,” Rogers says.

The retail sector of Australia’s economyis looking weak. The Reserve Bank has keptinterest rates on hold since late last yearas consumers refused to spend, and expec-tations that the Reserve Bank will drop itscash rate to stimulate the economy shouldfuel more investor demand for the defen-

sive exposure listed property now offers.Some of the banks have already reducedtheir term deposit rates.

Fund managers have already startedbenefiting from increased dealer groupinterest in listed property as a result.AMP Capital was recently placed onCount Financial’s approved product list.

Dealer groups connected to NationalAustralia Bank and Westpac have alsostarted adding property options to theirproduct lists.

“In the last 18 months to two years,there was a lot of aversion to risk, a lotof people moving into just cash, whichwas pretty safe, but as you know youdon’t get any growth in cash, just inter-est,” AMP Capital head of retail distribu-tion Ben Harrop noted recently.

However, the confluence of factorsleading to a more conservative invest-ment strategy and playing to expecta-tions of a ‘back to basics’ approach arealso leading to projections of low growthin the next few years.

There are less high risk offshore invest-ments, less development profit beingearned, and fewer non-traditional retail

office returns with volatile income.While it’s a perfect mix for producing

income, retail investors hoping for thesame “shoot the lights out” result thatthey experienced before the financialcrisis will be disappointed.

Retail investors have some way to catchup on funds under management anyway.Institutional investors placed $5 billion innew inflows into the sector last year.

Market volatility Market volatility is driving some finan-cial planners to invest more in listedproperty than they usually would.

“We’re increasing our appetite for realassets – we reckon they represent goodvalue over equities, especially for ourmore conservative investors,” saysDuncan Essery, financial planner at RIAdvice in Surry Hills, NSW.

RI’s asset sector includes global anddomestic real estate investment trusts,as well as infrastructure. Strategically,their exposure shifts between 5 and 20per cent and their exposure is currentlyat 10-14 per cent.

Importantly, Australian REITs arecurrently less volatile than growth assetssuch as equities, but with inflation-protect-ed yields of 6 to 7 per cent. That allowsEssery to treat them as a growth asset.

“If you get a greater return above infla-tion with half the volatility of the market,that’s a good thing,” Essery says.

However, some fund managers areconcerned that listed property is toocorrelated with the share markets.

Listed property has been going up anddown with the share market for the lastsix to nine months, and dealer groupsand asset allocators are beginning toplace their AREIT exposure into equityexposure instead of property as a result,according to Centuria Property fundschief executive Jason Huljich.

Many of those dealer groups, whichinclude the banks and large institutions,are moving into direct property for theirproperty exposure as a consequence.

However, while the whole sectordisplays unusual volatility in its dailycapital price, it may be a reflection ofunreasonable fears that listed propertymay once again become as volatile as itdid during the financial crisis.

That fear, which some have brandedas backward-looking, also fails to takeinto account the internal structure ofmany property trusts and the steps theyhave taken to recapitalise and fix theirbalance sheets.

“Because they’ve recapitalised andbecause they are focused on rentalschemes, even though their price can bevolatile in the short-term, I’d actuallysay that’s not a concern if you’re focus-ing on the income stream, provided thatthe income stream is sustainable,”Rogers says.

Reliance Investment is expecting retailinvestors to place more funds than usualin the REIT sector.

McGrath admits that there is somedownside in the correlation betweenlisted property and the share market, butstill expects a lot of interest in listedREITs as deposit rates reduce.

“Listed property this year is down

www.moneymanagement.com.au September 22, 2011 Money Management — 15

Listed Property

Continued on page 16

“We recently had a newgroup come in and investwith us in our latest fund,and they spent six monthsresearching us as amanager as well asresearching the actualproduct.” - Jason Huljich

MMSEP22_11.PG015.pdf Page 15 15/9/11, 6:52 PM

16 — Money Management September 22, 2011 www.moneymanagement.com.au

actually about nine per cent, [and] a fairbit of that is equity market volatility eventhough l isted property trusts havereduced their volatility compared to thebroader equity market,” McGrath says.

“In a low growth environment – andwe’re expecting the next couple of yearsto be fairly low growth – REITs shouldperform relatively well, so in this situa-tion you’d probably have more than younormally would in a REIT portfolio,”McGrath says.

However, direct property will proba-bly end up outperforming this yearcompared to the high volatility listedsector, because the valuations of directproperty don’t move around as much.

Portfolio allocationDealer groups need to be selective beforeinvesting in listed property. Just becausethe financial crisis knocked out severalproperty trusts and taught a few harshlessons doesn’t mean that the remainingones are as good as new.

The listed property sector is current-ly split into three types of trusts. Themost dangerous for investors are “thewalking dead”, as Rogers colourfullylabels them, with residual leverage anddebt problems.

Barely surviving through the GFC, theyare likely to stagger on until debt holdersor the banks decide to call in their loansand shut them down, and both advisersand property trust managers shouldavoid them.

The second class are more tradition-al property structures that are closer towhat the sector looked like ten years ago.They focus on yield and income streamsand should be used for incomeinvestors. The third class are much moreclosely correlated to the share market,have similar characteristics to equities,and will go up and down with the sharemarket.

Dealer groups are performing signifi-cantly more due diligence on the sectorthese days to work out which is which.

“We recently had a new group comein and invest with us in our latest fund,and they spent six months researchingus as a manager as well as researchingthe actual product,” Huljich says.

It’s a sign of advisers’ concerns thatthey are being as careful as that evenwhen a reduced field of competitors hasmade it easier to pick out the winners.

“You have some pretty high qualitygroups left in this space, so now it’s a loteasier for these planning groups to iden-tify the quality managers and who theyshould be investing with,” says Huljich.

Portfolio allocation becomes trickierwhen deciding over global REITs versusAREITs.

The research houses and fundmanagers seem to be of two minds onthe outlook for listed property, makingit difficult to know which path to take.

ING Investment Management hasanticipated a positive year for globallisted property despite the debt crisis andEurope. Infrastructure spending on thefew REIT properties in Japan damagedby the natural disasters there will boosteconomic strength in the Asia-Pacificregion more generally, while quarterlyreturns of more than 8 per cent in theUnited States offers opportunities inanother region, the fund manager saidrecently.

Standard and Poor’s weren’t nearly sopositive, warning that the performanceof most overseas funds is sti l lconstrained by global economic eventsdespite small improvements. Only twoglobal funds were upgraded out of 21rated by the research house.

Morningstar would seem to be quitebullish towards domestic REITs at themoment, recently upgrading six of their18 rated investment strategies. Most fundmanagers believe AREITs now possessattractive valuations, the researcher said.Morningstar cited improved fundamen-tals and conservative investment posi-tions across the sector for their positiveperformance.

That support comes with a caveat,however: Morningstar suggested only a

minor allocation role of five per cent fordedicated AREIT exposure in a portfolio.

Only one month earlier Morningstarseemed to go the other way, noting thatglobal listed strategies were likely to payout income distributions at the end ofthe 2010-2011 financial year.

Global real estate investment trustsdid not suffer as much as their domes-tic counterparts during the GFC andrecent capital raisings, reconstructedbalance sheets and improving funda-mentals meant that payment constraintswere unwinding, the researcher noted inanother report.

Co-director of Reliance Investment DavidCurtis says both global and domestic REITsare needed in a property portfolio.

“I think sometimes people forget thatultimately global REITs does not deliverwhat people would expect from adomestic REITs portfolio,” Curtis says.

The two sub-sectors offer their verydifferent risk and return profiles, Curtis says.

Global REITs have been very popularamong financial planners and investors inthe last couple of years, but with the amountof money that has been poured into them,valuations in that sector have been pushedto unattractive levels, such that domesticREITs are becoming more popular.

Essery’s exposure to domestic REITshas been minimal in the past 12 monthsand they are just now shifting focus awayfrom global REITs.

“Twelve months ago we were quitebullish on the global REITs sector, andthat was a good time to move into that,so what you saw there 12 months ago isprobably what you’re seeing now inAustralia,” Essery says.

Domestic REITs with quality propertyand clean business models are trading atmassive discounts to net tangible assets,and running at yields of 6 to 7 per cent,making them attractive for Essery’s clients.

“We think it’s really good exposure forour clients to be getting into,” Essery says.

Exposure to global REITs has droppedfrom 40 per cent to 25 per cent recently.

Tossing up between currency anddiversificationREITs were created so investors whocouldn’t afford to buy an entire proper-ty could still get exposure through buyingproperty shares. But if investors don’tbuy Australian REITs, they won’t beprotected against Australian inflationand will be open to overseas problems.

Morningstar noted in their recentreport that volatility in the Australiandollar earlier this year resulted in largelosses on currency hedging, and incomedistributions suffered.

The problem was only likely to persistgiven the continuing instability in thevalue of the Australian dollar, Morn-ingstar said.

“Currency exposure can create all sortsof issues on the actual return you end upgetting,” Curtis says.

Investors are caught in a catch-22when it comes to currency. Any returnson overseas REITs can be wiped out bymoves in the Australian dollar if theydon’t hedge their returns, but if investorsdo hedge their returns they have to forkout the money they’ve earned to coverhedging costs if the currency moves thewrong way.

The danger of ruining your returns bycurrency hedging increases when yieldson listed property around the world areforecast to be low for the foreseeablefuture.

But abandoning global REITs for thosereasons and investing only in domestic

“I think sometimes peopleforget that ultimately globalREITs does not deliver whatpeople would expect from adomestic REITs portfolio.”

- David Curtis

Continued from page 15

Listed Property

MMSEP22_11.PG016.pdf Page 16 15/9/11, 6:52 PM

REITs comes with its own problems, aswell. The two stocks owned by Westfieldmake up approximately 40 per cent ofthe AREIT index.

A fund manager following the indexmay only be able to deviate by 3 percent, but it would still leave them with a37 per cent exposure to only two domes-tic property stocks.

That stranglehold makes it nearlyimpossible to achieve meaningful diver-sification for investors without resort-ing to overseas stocks.

But there are other ways to achievediversification without going overseas.

Reliance Investment follows a bench-mark unaware approach.

Fund managers wanting to concen-trate on domestic REITs and still getdiversification shouldn’t follow theindex, McGrath says.

Managers who are benchmarkunaware can overweight inflows intostocks that won’t make up a dispropor-tionately large amount of the index, andwith 40 investible stocks out of a total of60 in the sector, there is plenty room fordiversification, according to Curtis.

Investors and advisers may complaina lot about concentration and diversifi-cation in the domestic REIT sector, butthey are going to have to wait for thefund managers themselves to do some-thing to solve those issues. Most domes-tic REIT fund managers are still follow-ing the index. MM

www.moneymanagement.com.au September 22, 2011 Money Management — 17

DURING the financial crisis,listed property funds had toscrabble under the couchcushions to raise debt capitalas the banks tightened thepurse strings.

Drastic debt cutting meas-ures and multiple equity rais-ings helped most REITs pullthrough the worst of theGFC, but now that marketshave improved, many REITsare looking for debt fundingonce again. Where are theygetting it, and have theconditions changed?

There are indications thatthe listed property fundshave learnt their lessonsfrom the debt crisis and arediversifying their fundingsources.

According to S&P’s reportcard on debt credit trends onthe listed property marketwhich was released earlierthis year, REITs that arelooking to fund maturingdebt in 2012 are now access-ing the bond market toprovide an alternative source

to the banks.S&P called the move posi-

tive for credit quality.REITs are also issuing their

own corporate paper, as wellas approaching super fundsfor debt funding.

The search for alternativesources like bonds and superfunds for long-term debt ispart of a move to shift the jobof the banks from guarantee-ing long-term debt to provid-ing funding for the REITdevelopment pipeline,according to S&P REIT creditanalyst Craig Parker.

That shift would make thebank funding period lessthan two years in most cases,a scenario that would prob-ably make both the banksand the property fundshappy.

“The sources and thesupply of credit hasimproved dramatically forREITs, and that’s criticalbecause the pain was exac-erbated by the fact that theyhad no alternatives during

the GFC, and that’s definite-ly changed and put the REITsin a much stronger position,”says McGrath.

Although market volatilityhas temporarily driven thelisted property sector all overthe place and caused someto fear about the high corre-lation between the sharemarket and REITs, trustshave had no trouble at allsourcing funding of all kinds.

Property group Stocklandraised funding for 10 years inthe US bond markets lastmonth.

But REITs that aren’t as bigas Stocklands should becareful.

“The banks are morediscerning in who they wantto lend to, but our portfolioof rated REITs is strong andthey will have the support ofthe banks. If you are a weakerREIT, one that we don’t rate,I’ve heard anecdotally thatthe banks are trying toreduce their exposure,”Parker says. MM

Where are REITs getting their capital?

Listed Property

MMSEP22_11.PG017.pdf Page 17 15/9/11, 7:12 PM