Liquid Real Estate, Euromoney magazine, October 2008

Australia has come out of the credit crunch reasonably well: its biggest banks show no danger of collapse, it has been insulated by its heavy concentration of big resource stocks, and its housing finance industry has been built on more stable foundations than that in the US. One area that really has taken a hit, though, is the listed real estate market.

Australia’s A-REIT market, as the listed property trust market was recently renamed, has been battered. “It’s been incredible really,” says Andrew Saunders, CEO of Real Estate Capital Partners, a Sydney-based real estate fund manager. “The A-REIT sector was worth about A$145 billion in June [2007]. Now it stands at $70 to $75 billion.” (On August 31, according to the Australian Securities Exchange, the 68 A-REITs had a combined market cap of A$84.5 billion, but that has fallen significantly since.)

In September, Fitch Ratings put out a statement looking at the results of A-REIT reporting season, noting that many had reported significant declines in profitability due to a reassessment of the carrying values of underlying assets. (Accounting standards require changes in asset values to go through to the P&L, which can lead to big changes in reported results.) “Most A-REITs have revalued a significant proportion, if not all, properties within their portfolios, undertaken by either independent valuations or by directors’ valuations, and usually a combination of both,” Fitch noted.

It may get worse. “The property cycle has definitely peaked and Fitch expects further downward adjustments in A-REIT property values, particularly secondary properties, as the present credit crunch reaches out more broadly into the property markets, forcing a reappraisal of values,” says David Carroll, a director of Fitch’s REITs team in Sydney.

In the worst cases, A-REITs have run into real trouble, particular trusts in the Centro, Rubicon and Allco groups. But some feel the sector is oversold and now presents opportunity. Stephen Hiscock, a fund manager at SG Hiscock & Co, says the forecast yield for the A-REIT market in 2009 is above 9%, and over 11% if Westfield – a huge and distorting stock in the A-REIT market – is counted out. “We are expecting further distribution cuts, but these will still leave the sector yield at extremely attractive levels, and importantly the yield will then be paid predominantly from underlying cashflow – a step which is necessary in order that confidence about the long term health of the sector is restored,” he says. Saunders’s active A-REIT portfolio is yielding around 14%.

“If you look at the pure A-REITs, the real rent collectors, they are trading at a 45% discount to NTA,” he says. “That’s just incredible: they have real, hard, physical assets.” An example is Westpac Office Trust, which owns the Westpac head office on Sydney’s Kent Street. “Westpac can clearly afford to pay their bills,” Saunders says. “Yet it’s paying a 9.5% yield and trading at a more than 50% discount to NTA.”

Fitch notes that tenant defaults are not yet occurring with any frequency, and that occupancy rates remain high. With the Reserve Bank of Australia beginning to cut interest rates, the pressure on debt coverage ratios begins to subside, although as Fitch points out: “This may be offset by rising debt margins as existing debt facilities mature and are rolled into new facilities that in most instances will see higher margins being charged.” Uncertain times.