Expert Investment Strategy Updates

The Property Analyst

Monthly strategic commentary on the Property market

by Adrian Harrington

May 2011

Australia’s Population Growth – A Few Surprises

A shift is occurring in Australia’s population growth. Two recent releases from the ABS provide a fascinating insight into Australia’s demographic trends which will have far-reaching consequences for our housing markets, the provision of key infrastructure and services and our overall economic growth.

Australia’s population grew by 1.6% or 345,000 persons in the year to September 2010 (Chart 1). The growth rate was well down on the record 2.2% growth recorded in calendar year 2008 and the lowest rate recorded in four years.

The slowing growth rate was driven by a massive 35.5% fall in net overseas migration. Natural increase (births less deaths) increased by 2.1% or 159,752 persons. Birth rates have picked up markedly in recent years. In 2010, the number of children born was above 300,000 for the first time in history.

 

Despite net overseas migration levels falling to 185,772, the lowest level recorded since December 2006 and well off the record high of 315,686 set in December 2008, net overseas migration still accounts for around 54% of Australia’s population growth.

 

Chart 1 – Components of National Population Growth

Rolling Annual Growth: 1982 - 2010

WA’s population growth (2.1%) continued to race ahead of the other states in the year to September 2010. Queensland (1.8%), Victoria (1.7%) and the ACT (1.7%) were also above the national average. Tasmania recorded the slowest growth in population of just 0.8% (Table 1).

 

Table 1 – Estimated Resident Population by State: September 2010

 

	Total Population(million)	Natural Increase	Net Overseas Migration	Net Interstate Migration	Total Annual Increase	% Annual Change
NSW	7.25	49,400	56,079	-10,322	95,157	1.3
VIC	5.57	35,435	52,334	2,695	90,464	1.7
QLD	4.53	39,961	33,827	8,399	82,187	1.8
SA	1.65	7,499	13,243	-3,307	17,435	1.1
WA	2.31	18,810	25,475	2,983	47,268	2.1
TAS	0.51	2,161	1,571	362	4,094	0.8
NT	0.23	2,911	1,144	-1,163	2,892	1.3
ACT	0.36	3,562	2,101	353	6,016	1.7
AUST	22.41	159,752	185,772	n/a	345,524	1.6

All States and Territories are now recording rapid deceleration in their rate of population growth (Chart 2). What is of most concern is that the resource states – WA and QLD – which have a significant need for workers, recorded the largest slow-down in population growth. WA’s annual population growth rate has fallen from 3.4% in December 2008 to 2.1% in September 2010 and Queensland’s fell from 2.9% to 1.9%.

 

Chart 2 – Population Growth Rates: Year to December 2008 and September 2010

 

Queensland is no longer the powerhouse of population growth. Queensland’s population increased by 82,187 in the year to September 2010 – the lowest annual increase since June 2002.

A key reason behind the sunshine state’s slowing growth is the significant decline in net interstate migration. Only 8,399 persons moved to Queensland from other parts of the country in the year to September 2010, the lowest number in more than 30 years and one-third of the number who moved there in 2003.

Net interstate migration now represents just 10% of Queensland’s population growth; a far cry from the early 1990’s when Queensland was the beneficiary of the mass exodus of people from Victoria and NSW during the recession. Back then, net interstate migration contributed to around 60% of Queensland’s population growth. This is a worrying sign for Queensland. This decline in net interstate migration has yet to pick-up the impact that the State’s cyclone and floods in early 2011 will have on people’s decision to move to Queensland.

Huge swings in interstate migration are no longer prevalent. Australian’s are generally staying put. There’s no doubt that consumer confidence is impacting on people’s decision to relocate. Also, housing affordability now plays a key role. Go back 10 or 20 years, and people could relocate from NSW and Victoria to significantly cheaper housing in Queensland and Western Australia – that’s not the case now. The gap in house prices has narrowed. According to RP Data, Melbourne’s median house price is just $35,000 higher than Brisbane’s and the same as Perth’s.

Victoria continues to arrest its net interstate migration losses. In the year to September 2010, 2,675 people moved to Victoria compared to an average annual loss of 2,100 people between 2003 and 2007 and the significant average annual losses of around 24,450 persons between 1993 and 1995. However, Victoria has been hard hit by a fall in international migration levels, particularly the sharp loss in international students.

Even NSW, which has recorded net interstate migration losses to other States for more than 30 years, recorded it lowest outflow – 10,322 in more than 25 years.

Western Australia, the boom resource state, was only able to attract 2,983 people from other parts of Australia – 52% less the 6,265 people who moved there in 2008. Even migrants from overseas are not flocking to WA like they use to. Net overseas migrants totalled just 25,475 down from a peak of 48,236 persons in December 2008.

Some interesting population trends are also visible at the regional level (all figures are to year ending June 2010):

• Melbourne recorded the largest population growth of all capital cities (up by 79,000) – the ninth consecutive year it has held the number one spot. Sydney (up by 75,600) and Brisbane (39,000) were in second and third place respectively.

• Since 2001, Melbourne has grown by 605,000 people or 17%, well ahead of Sydney (447,000), Brisbane (380,000) and Perth (303,000).

• The outer suburbs of Melbourne are driving the record growth in Melbourne – 4 of the 5 fastest growing LGA’s in Australia were located in Melbourne’s outer areas – Wyndham (which includes Werribee) – 8.8%, Melton – 7.1%, Cardinia (which includes Cranbourne) – 6.7% and Whittlesea (which includes South Morang) – 6.1%.

• Queensland does not have one LGA in the top 10 fastest growing areas and only two – Somerset (11th) and Ipswich (20th) - in the top 20. It wasn’t that long ago, that a league table of fastest growing regions was dominated by the Sunshine Coast and Gold Coast areas. Although it should be noted the Gold Coast LGA recorded the second largest increase in population – 12,943 people, and 4 of the top 10 LGA’s with largest growth were in Queensland.

• NSW has only one LGA – Canada Bay – in the top 20 fastest growing LGA’s. Canada Bay surprisingly is not on the urban fringe but an in-fill area just 15kms from the CBD. Parramatta, another in-fill location, was the second fastest growing LGA in Sydney and came in at 24th overall with an increase of 3%.

• Sydney’s west continues to grow – the Blacktown LGA recorded the sixth largest increase in population up 8,324 for the year (however, this was only a 2.1% increase placing it 33rd in the fastest growing LGAs).

• The rush to coastal towns in NSW has slowed - 9 of the 10 fastest growing LGA’s in NSW were in the Sydney metropolitan area.

• Strong population growth continued in the Perth CBD and in the urban fringes (Armadale, Serpentine-Jarrahdale, Wanneroo, and Rockingham). Perth CBD recorded the fastest growth – up 5.1% but Wanneroo took the honours for the largest increase – up 5,999 people.

• Despite north-west WA leading the resources boom, the south-west remained the fastest growing region in WA. Capel, Murray and Busselton LGA’s were ranked 5th, 10th and 13th respectively.

• With the exception of the Perth CBD, the other nine fastest growing LGA’s in Australia had a median house price range of between $275,000 (Melton) and $467,500 (Serpentine-Jarrahdale) and a median unit price range of $235,000 (Melton) to $340,000 (Whittlesea).

 

Table 2 – Top 40 Fast Growing LGA’s in Australia: Year to June 2010
Estimate Residential Population 2009 to 2010

 

CLICK HERE to open table 2.

1. Australian Demographic Statistics, September 2010 released on 29 March 2011 and Regional Population Growth 2009-10 released on March 31, 2011

2. RP Data-Rismark Home Value Index – March 2011

3. Regional Population Growth 2009-10 released on March 31, 2011

4. New Residents Flock to Melbourne’s Urban Fringe – RP Data Blog – April 1, 2011

 

Adrian Harrington
Head of Funds Management
Equity Real Estate Funds Management, part of Folkestone Limited

 

April 2011

Australia – Still An Attractive Destination Despite the Strong $A

A surge in the Australian dollar has not stopped foreign investors flocking to buy Australian non-residential real estate.
Foreign investors are seeing Australia as an ideal place to capitalise on the resurgent commercial real estate industry and the numbers speak for themselves. According to Jones Lang LaSalle, “off-shore investors accounted for 19.9% of commercial (office, industrial and retail) transactions (>$5m) in 2010, the highest proportion of buyers since 1994.” However, it was our office assets that were most in demand – Asian private equity groups, pension funds and sovereign wealth funds accounted for 40 per cent, or $2.4 billion, of acquisitions last year.

Why is Australia on the radar despite a strong $A?

Australia remains one of the most popular targets in the Asia-Pacific region. There are a number of reasons for this, including:

• the relatively strong performance of the Australian real estate market;
• Australia’s high transparency,
• the growth in pension fund capital;
• the growth in Asia-Pacific real estate capital flow; and
• changes to the tax treatment of certain offshore investments in Australia.

The Australian non-residential real estate market has performed well since the GFC. In the year to December 2010, Australian non-residential real estate generated a total return of 9.5% according to the PCA/IPD Australia Property Index.

Australia was ranked no 1 globally in the 2010 Jones Land LaSalle Transparency Index . Australia’s stable political environment, strong regulatory system and high quality information on the underlying real estate markets are attractive to foreign investors.

Pension fund capital continues to grow. According to a report by the Asia Pacific Real Estate Association , Asia accounts for 8 of the top 20 largest pension funds globally and dramatic growth is expected over the next 10 years, with assets expected to double to over $4.3 trillion by 2020. Global pension funds typically invest 7-10% of their portfolio in real estate, yet for most of the Asian funds it is considerably less although this is changing.

 

We are also seeing a strong increase in the number of Asia-Pacific real estate funds which include Australia as part of their mandate. According to DTZ’s report on Global property flows – The Great Wall of Money , US$329bn of capital is available for investment in direct real estate markets. Of which US$104bn is targeted at the Asia-Pacific region, a 45% increase on the US$71bn available in mid 2010. DTZ found “China and Australia remain the most popular targets in the Asia Pacific region. Both countries have a majority of markets rated as WARM or HOT.”

Also, Australia’s Managed Investment Trusts (MIT) regime has recently been amended to make Australia a more competitive and attractive destination for foreign investors. This supports Australia’s aim to be stronger financial hub in the Asia-Pacific region. The key benefit to foreign investors who use an MIT compliant structure to invest in Australia is a significant reduction in the withholding tax to 7.5%.

Money is flowing to core “trophy real estate” – high quality assets, with relatively long lease terms - the sector most investors perceive to be the least risky alternative. This wave of capital coupled with competition from local A-REITs and superannuation funds has seen prime office and retail real estate prices well bid in the past twelve months. However, we question whether this is the optimal investment strategy at this stage of the cycle to generate the best risk-adjusted returns. We view the best investment alternatives are in those areas where capital is constrained – which in the case of Australia is currently not the trophy assets.
Some high profile foreign investors in Australian non-residential real estate include sovereign wealth funds - Government of Singapore Investment Corporation, Abu Dubai Investment Authority and the China Investment Corporation, pension funds such as the South Korea National Pension, the Canadian Pension Plan Investment Board (CPPIB) and the Dutch juggernaut - All Pensions Group (APG), and global real estate fund managers including LaSalle Investment Management, Pramerica and Cohen & Steers.

LaSalle Investment Management, one of the world’s largest unlisted real estate fund managers with $45bn in assets under management, is expected to allocate to Australia a significant part of the remaining funds in its LaSalle Asia Pacific Opportunity Fund III. Following on the heels of their recent investments in Australia including a 25% interest in ANZ’s new Sydney headquarters, and the Wentworth Sofitel Hotel in Sydney, Ian Mackie, LaSalle's head of private equity for Asia Pacific, was recently quoted in Business Spectator saying the Fund has "several hundred million dollars.. and… we are very happy to allocate the significant part of the remaining capital to Australia."

South Korea’s National Pension Fund, a $260bn powerhouse, has just purchased a 90% stake in 595 Collins St, Melbourne for around $130m after acquiring the $650 million Aurora Tower in Sydney in early 2010. The cashed up pension fund’s first foray into Melbourne was advised by Pramerica, a US based global real estate fund manager with a significant Asian presence. Commenting on the deal, Pramerica’s Asia-Pacific Chief Operating Officer said “with its prominent location in Melbourne’s central business district this property represents the type of value opportunity we seek for our investors.”

We also expect to see more money flowing from China. As the number of wealthy Chinese continues to grow, more and more will look for avenues to invest their wealth and Australian real estate fits the bill perfectly.

Buying individual assets is not the only attraction for foreign investors in Australia. The recent privatisation of the $2.6bn listed ING Industrial Fund, by a consortium comprising the Goodman Group, Canada Pension Plan Investment Board, All Pensions Group (APG) and China Investment Corporation confirmed Australia’s listed A-REITs are also on the radar of foreign investors.
Less than 10 years ago, offshore investors in the listed A-REIT sector owned less than 10% of the sector, now it’s closer to 40%. Foreign flows into the A-REIT sector have significantly increased in recent years, and these investors are now major players in the price movements of individual A-REITs.

A-REITs with significant offshore investors on their register include:

• GPT, Australia’s oldest REIT, and owner of some of Australia’s premium quality office towers and retail centres has the Government of Singapore Investment Corporation (11%) and the New York based fund manager Cohen & Steers ( 5%) as two of its largest investors;
• Cromwell recently did a placement to Redefine International, a listed property company that trades on AIM in London, taking their holding to 22%; and
• Abacus Property Group has a South African link with the Kirsh Group owning 33.9% of the stock.

With the Australian dollar forecast by many market commentators to remain high for some time, it’s not expected to put the brakes on foreign capital flowing to Australia. However, the continued foreign interest will have significant implications for the pricing of Australian non-residential real estate and the listed A-REITs.

Adrian Harrington
Head of Funds Management
Folkstone

 

References:

Values, Vacancies and Transaction Volumes – Jones Lang LaSalle – March 2011
PCA/IPD Australia Property Index – IPD - December 2010
Global Real Estate Transparency Index – Jones Lang LaSalle - June 2010
The Significance of Real Estate in Asian Pension Funds – Asia Pacific Rea Estate Association – September 2010

The Great Wall of Money – DTTZ – 10 March 2011
LaSalle Eyes More Deals in Australia – Business Spectator - 4 March 2011
Korean Fund Swoops on Collins Street – AFR – 7 April 2011

You can contact Adrian by visiting the website www.equityrep.com.au. Make sure you mention that you have been reading his analysis on our website so he knows where you are from. Adrian is now Head of Funds Management at Folkestone, an ASX listed property investment development and funds management company (ASX Code: FLK) following Folkestone’s recent acquisition of Equity Real Estate Partners. Adrian has 18 years of experience in the funds management and real estate industries.

 

 

February 2010

2011 – Real Estate Outlook

2011 has kicked-off with a mixed-bag of economic news that will set the scene for the performance of residential and non-residential real estate markets throughout the rest of the year.

A number of key indicators remain subdued – consumer sentiment, retail sales, and house prices. At the same time, unemployment is reaching historical lows and mining investment continues to create capacity issues for the economy. Short-term, the floods and cyclones that hit Australia over the summer break will impact economic growth at least for the next two quarters. Consensus GDP forecasts for the year ahead are between 2.5% - 3.75% – a reasonably large range and reflects the wide divergence in views on the outlook for 2011.

The recovery in the commercial real estate sector will continue but is unlikely to shoot the lights out. In the year to December 2010, unlisted wholesale property funds, as measured by the Mercer/IPD Australian Pooled Property Fund Index, recorded a total return of 9.5% and we’d expect a similar return this year.

While cap rates for prime non-residential real estate are likely to firm by a further 25-50bps, we still see non-residential returns being driven by the income side of the equation, with active management the key to increasing income and hence growth in total returns.

According to the Property Council of Australia’s latest office market audit, the Australian CBD office market is improving with the national vacancy rate falling to 9.5% in January 2011 , the first decline since the GFC took hold three years ago. All CBD markets, except Hobart and Adelaide, recorded a net take-up in office space. The two key CBD office markets – Sydney and Melbourne recorded vacancy rates of 8.2% and 6.3% respectively. Off the back of this rising demand, rents are set to improve in 2011. Sydney and Melbourne will continue to be the markets most investors will focus on but Perth with its significant exposure to the resource sector may surprise on the upside in 2011.

On the retail front, it is likely to be a tough year especially for larger retail centres which are highly dependent on discretionary spending. As the RBA pointed out in their Statement of Monetary Policy in February, “The household sector has continued to exhibit considerable caution in its spending….nominal retail sales remain weak and retailers report that consumers continue to very value-conscious.” This was backed-up by Myer’s latest trading update with the CEO saying “We, like other discretionary retailers, have observed a consumer that is more cautious to spend and has a tendency to save.” Also, with the high Australian dollar and internet shopping becoming more popular, retail expenditure is increasingly leaking off-shore. We continue to favour neigbourhood and smaller sub-regional retail centres that focus on non-discretionary spending.

 

The A-REIT sector continues to trade at a discount to NTA and whilst significant progress was made on repairing balance sheets and getting back to basics - a greater focus on improving income streams and concentrating on domestic exposures – the A-REIT sector finished 2010 with a total return of just 1.2%. The market will look to increases in earnings growth from A-REITs to close the gap in NTA, although M&A activity and share-buy backs could be a catalyst in the short-term.

 

Source: AFR(4)

 

Liquidity is returning to the direct markets, with a number of large transactions completed in the December quarter.

 

Asset	Vendor	Purchaser	Price	Yield
Melbourne Office Portfolio	Grollo	Commonwealth Property Office Fund	$581m	7.6%
Doncaster Shopping Centre (25% interest)	LaSalle	ISPT	$350m	5.7%
Brisbane Square	Westscheme	Telstra Super/Charter Hall Fund	$300m	7.7%
Industrial Portfolio	Colonial Direct Property Fund	Dexus Wholesale Property Fund	$232m	9.0%

Prime non-residential real estate will continue to be attractive to large wholesale funds, superannuation funds and off-shore investors. Many super funds now have built up significant cash and are looking for long-term investments. As the Chief Executive of the $18bn REST super fund recently said in relation to their purchase of a $240m office tower in the Dockland “we look for good-quality investments such as commercial office property, because it provides strong levels of cashflow and a degree of inflation protection” . The A-REITs have by and large remained out of the market but as the gap between their share prices and NTA close, they will become active buyers of real estate again.

Debt availability and margins have improved from the dark days of the GFC, but unfortunately for many developers banks continue to rationalise debt and this will continue to put a drag on new development. Furthermore, the disparity between markets rents and the rent required to underpin new construction will continue to be a hurdle to kick-start the next wave of construction.
We believe in the non-residential space, the best up-side will come from buying smaller assets in good locations, that are either too large for private owners who have difficulty getting access to finance, or are too small for institutions who are focused on chasing larger prime assets. Many of these assets have significant upside potential from repositioning through active management.
On the residential front, we expect price growth to be subdued in 2011. The market clearly peaked in May 2010 after a stellar run. Sentiment and affordability will be the main drag on the sectors performance in 2011.

According to RP Data-Rismark, Australian capital city residential prices increased by 0.2% in December. However, there was divergence across the major cities. Prices in Melbourne (0.4%mom, +8.4%yoy) and Sydney (1.0% mom, 6.6%yoy) increased while prices in prices in Perth (-0.9%mom, -2.3%yoy) and Brisbane (-0.1%mom, -1.0%) were lower.

Sentiment toward the housing sector took a hit in the second half of the year as the RBA’s fourth interest hike in November, which was topped up by a fifth via the banks, increased the cost of finance and put further pressure on housing affordability.
The rental market remains buoyant with low vacancy rates as first home buyers decide to rent rather than buy. The national vacancy rate at December 2010 was just 2.2% - with Canberra recording the lowest rate of just 0.9% and Melbourne the highest at 3.6%. One worrying sign is that the number of first home-buyers in the market has weakened. In November 2010, first home-buyers accounted for just 15.6% of purchasers compared to a record 28.5% in May 2009 .

Taking a longer-term view, we still like the residential sector. Supply remains constrained and we are not building enough accommodation to meet overall demand. Low unemployment, solid wages growth and reasonable high net overseas migration should underpin longer-term demand.

 

Adrian Harrington
Executive Director
Equity Real Estate Partners

 

1.Property Council of Australia – Office Market Report – February 2011
2.Reserve Bank of Australia – Statement on Monetary Policy – February 2011
3.Myer Holdings – Update on Trading and FY2011 Outlook – 7 February 2011
4.Australian Financial Review – REITs: Bridging the Gap a Focus for Investors – 5 February 2011

5.Investors Chasing Big-City Office Towers – Australian Financial Review – 3 February 2011
6.RP Data – Rismark Home Value Index Media Release – 31 January 2011
7.SQM Research – National Vacancy Rate – December 2010 – 23 January 2011
8.ABS – Housing Finance , Australia November 2010 – published 12 January 2011

 

You can contact Adrian by visiting the website www.equityrep.com.au. Make sure you mention that you have been reading his analysis on our website so he knows where you are from. Adrian is currently a founding partner of Equity Real Estate Partners and has 18 years of experience in the funds management and real estate industries.

 

December 2010

Property and SMSF’s – Growing industry but beware the spruikers

This month Adrian provides us with a discussion piece on the topic above. We have put it on our Blog, and you can also join in and leave comments there as you wish.

 

CLICK HERE to go to it.

 

You can contact Adrian by visiting the website www.equityrep.com.au. Make sure you mention that you have been reading his analysis on our website so he knows where you are from. Adrian is currently a founding partner of Equity Real Estate Partners and has 18 years of experience in the funds management and real estate industries.

 

November 2010

A-REIT Sector – Going Through Change Again!

Pulses are racing as corporate activity heats up in the A-REIT sector. Just when everyone thought the number of trusts was only going one-way – down, Westfield announced they were splitting into two – Westfield Group and creating a new listed vehicle to be called Westfield Retail Trust.

The Lowy’s are masters of reading the market and adapting to change. In the past 50 years, Westfield has re-invented itself on numerous occasions. In 1979, Westfield spun-off Westfield Trust into a separately listed vehicle and generated enormous upside to its shareholders. In 2004, they remerged into one entity, which Frank Lowy said at the time was “to provide a management and capital structure with improved scale, competitive advantage and access to capital to pursue opportunities globally”. The success of Westfield in pursing global growth is the envy of not just the A-REIT sector but corporate Australia en masse.

In 2010 Westfield are going almost 180 degrees and spinning out part of the business. The current proposal involves spinning-off half of its Australian and New Zealand assets (bar two) from the Westfield Group into a A-REIT managed by Westfield with approximately $12bn of assets and gearing between 9 and 24% depending on the success of the capital raising to assist in funding the new entity.

I still remember the day - 22 April 2004 - when Westfield announced the merger of their three vehicles (Westfield Holdings, Westfield Trust and Westfield America Trust) to create the Westfield juggernaut. The A-REIT sector went into a frenzy as investors dumped A-REIT stocks across the board to free-up cash to take-up the new Westfield Group securities.

For active managers of A-REIT securities funds, the new look Westfield was a nightmare. Investors began questioning why they should pay active management fees to a manager to select A-REIT securities that could outperform the Index when 50% of the Index was made up of one stock – Westfield Group - and more than 75% of the Index was concentrated in just 5 stocks.

Active REIT securities managers and direct investors should be more than happy with this latest change. Westfield Group will now comprise around 27% of the Index and the Westfield Retail Trust will be a new addition at around 13% of the Index. The timing couldn’t have been better as the sector has recently lost the Mirvac Real Estate Investment Trust and the Westpac Office Trust both to the Mirvac Group. Depending on the final proposal put to unitholders, the Goodman Group with the help of a few very powerful and cashed-up pension/sovereign wealth funds – China Investment Corporation, Canadian Pension Plan Investment Board and APG (a Dutch pension fund) - are set to take the ING Industrial Fund private. The other four ING managed A-REITs are now all up for grabs as well.

The A-REIT sector has seen three distinct phases of consolidation in the past 10 years so it’s not new:

• 2000 – 2003: A-REITs merged to get scale – Paladin Commercial with Deutsche Commercial and Paladin Industrial with Deutsche Industrial or internally managed vehicles acquiring externally managed vehicles – Stockland’s raid on both the AMP Diversified Fund and Flinders Industrial Trust, and Investa Property Group’s take-over of the Principal Office Trust.

• 2004 – The rise of stapled securities – where externally managed vehicles merged with their management companies to create A-REIT stapled securities – Goodman, Dexus (the Deutsche vehicles) and Westfield.

• 2007 – Public goes private – three major listed vehicles went private – Brookfield took Multiplex private, Morgan Stanley acquired Investa and Prologis acquired Macquarie Prologis.

An active capital market also creates opportunities for new vehicles and a greater choice for investors. Between 1993 and 2000 a number of unlisted trusts went from the private to the public markets and between 2003 and 2007 we witnessed a number of IPO’s, particularly vehicles that owned offshore assets such as Mirvac Industrial Trust (US), Galileo Japan Trust (Asia) and APN European Retail Fund (Europe) and new stapled securities like Valad, Cromwell and Multiplex. So going forward, new vehicles will emerge but don’t expect the sector to offer the same degree of choice as in 1999 when there were more than 60 A-REIT vehicles.

At least the Westfield deal will offer investors a choice between the more passive, income focused Westfield Retail Trust and the more active, development orientated Westfield Group. One of the criticisms in recent years of the A-REIT sector has been the increased risk-profile of many of the A-REITs, particularly those with a stapled security structure where a company and trust are stapled together. Invariably the exposure to active earnings from development and funds management activities in the company dilutes the ‘lower risk’ earnings from the income producing assets.

As Frank Lowy said when announcing the latest Westfield deal “it responds directly to significant market demand for a domestic trust focused on investing in high-quality retail real estate, with conservative gearing and income sourced primarily in Australian dollars”.

 

The market will no doubt put the spot-light on other A-REITs with stapled security structures to see whether they too should follow the Westfield lead and let investors choose how they allocate capital between active and passive earnings depending on their own specific risk appetite.

Adrian Harrington
Executive Director
Equity Real Estate Partners

 

You can contact Adrian by visiting the website www.equityrep.com.au. Make sure you mention that you have been reading his analysis on our website so he knows where you are from. Adrian is currently a founding partner of Equity Real Estate Partners and has 18 years of experience in the funds management and real estate industries.

 

October 2010

Australian Housing Bubble – Fact or Fiction

Not a day seems to go by without another newspaper headline on whether the Australian housing market is heading for a crash or not. Property commentators remain as divided as ever as to where the housing market is headed.

Here’s a selection of views:

“In my view, Australian house prices are expensive on every value metric, they are expensive relative to history and expensive relative to houses in comparable countries.” Gerard Minack, Morgan Stanley, August 2010

“Concerns of a housing bubble are often based on a superficial/incomplete analysis of the Australian market.” Commonwealth Bank, 9 September 2010

“Australia’s housing market’s soft-landing has been broad-based.” Christopher Joye, Rismark International, 30 September 2010

“Australia already faces a chronic housing shortage which is set to worsen over the next two years as demographic demand outstrips supply.” Goldman Sachs, September 2010

In the past few months, two excellent reports have been produced that provide some interesting facts that commentators on both sides of the debate should consider. The first report “Are We Banking on a Bubble” was released by the UBS banking team on 31 August 2010. Those commentators pushing the bubble theory often point to the fact Australia’s real estate appears expensive by global standards. On face value that is probably correct but what such analysis doesn’t do, is take into account the spatial distribution of the population and allow for the “coastal versus inland price differentials”.

Approximately 83% of Australia’s population lives within 50kms of the coast. UBS compared the house prices in Australia’s capital cities to other global capital cities and found “that Australia is not materially out of line with many other countries”.

 

House Prices of Global Coastal Cities -
House Price to Income Ratio

 

Source: Demographia, UBS estimates

The second report is by the RBA, who have over the past six months become regular commentators on the housing sector . In the RBA’s six monthly Financial Stability Review, they undertook a detailed analysis of the balance sheet of households.
The following four graphs from the RBA’s Review caught my attention and support their view that “household financial circumstances are in aggregate, relatively strong” and “signs of financial stress in the household sector remains fairly limited, with the improvement in the labour market further underpinning household’s debt serving capacity despite higher interest rates.”

 

The first of the RBA’s graphs looks at owner-occupier debt servicing ratios. Using data from the Household, Income and Labour Dynamics in Australia (HILDA) survey, the RBA found that more than “two thirds of households with owner-occupier debt faced repayments smaller than 30 per cent of their disposable income in 2008 (when interest rates were higher than they are now)”. The HILDA survey also found that in recent years more than half of owner-occupiers have been ahead of schedule on the repayments on their property loans.

 

The second of the RBA’s graphs highlights household savings indicators. Australians have taken a more conservative approach to their finances as a result of the GFC. The net savings of Australians increased during 2008 and 2009 to levels well above that recorded for most of the past decade. The savings rate has fallen in recent months as consumer confidence improved driven by the rebound in Australian economic prospects and falling unemployment. Also it’s not surprising with the attractive bank interest rates on savings that deposits remain a preferred place for savings while concerns about rising interest rates are encouraging the paying down of debt.

 

The third RBA graph looks at the bank housing loan characteristics. The key take-outs of this graph are:

• Low documentation and other loans (loans approved outside normal policies and other non-standard loans) have fallen in the past two years from 8% to around 7% and 0.8% to 0.3% of all loans respectively. One of the saving graces of the Australian housing market was the fact that unlike the US and other countries, Australia’s underwriting of mortgages was significantly better. In the US, sub-prime/low doc mortgages accounted for more than 25% of all loans in the lead-up to the GFC.

• Loan to value ratios of >90% have fallen for both owner-occupiers and investors to around 11% and 7% of all new loans in the June quarter. The spike in LVR’s above 90% to around 26% of all owner-occupier loans in early 2009 was driven by the surge in first home buyers. The RBA point out “the entry of such a large group of new home-buyers was an usual development, but although housing interest rates have increased by around 150 basis points…liaison and available data suggests little evidence to date of worse loan performance …than earlier co-horts of first-home buyers displayed”.

 

 

The fourth RBA graph highlights the arrears rates on loans. Perhaps the best, and most direct, indicator of households’ capacity to support the increase in debt is the arrears rates on loans. The current arrears rate is very low at around 0.7 per cent. This is one of the lowest rates among developed economies and well below that of the US where non-performing housing loans represent more than 8% of all loans.

 

There are signs that the Australia's housing market is cooling. Three key indicators of the health of the housing sector were all down in August. The latest RP Data-Rismark house price index showed national house prices dipped by 0.2% in August, the HIA – Jeld Wen Home Sales Report found the number of new homes sold in August fell by 2.6% and were 11% lower than a year ago and according to ABS, total building approvals fell 4.7% in August to be down 12% over the three months to August 2010.

No doubt the debate on whether a bubble is occurring or not will continue over the coming months. Hopefully, the above graphs will contribute to a more informed debate.

 

Adrian Harrington
Executive Director
Equity Real Estate Partners

 

Investors should obtain relevant and specific professional advice before making any investment decision. The information contained herein does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision investors should consider, with or without the assistance of a licensed advisor, whether the information contained herein is appropriate in light of their particular investment needs, objectives and financial circumstances.

 

The articles herein contain the current opinions of the author only. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of the author.

 

September 2010

With not a lot having changed from the immediate previous months in the property space, this month Adrian has written us a more educational and informative peice on the current landscape in the unlisted property trust market, the back to basics approach that is being demanded by investors, the debate on manager remuneration, and what to look for in a good manager. We have included it on our Blog given the nature of the content.

 

CLICK HERE to open up this article.

 

 

August 2010

A-REITs – Reporting Season is Upon Us

The Australian listed real estate trust (A-REITs) sector reporting season kicks off in earnest this week with the one of the largest REITs in the sector, Stockland, scheduled to report on August 11. Stockland is a bellwether for the sector given both its size ($9.0bn market cap) and extensive reach across the office, retail and residential sectors.

 

The past 12 months has seen a significant turnaround in the performance of the A-REIT sector. At the end of June 2010, A-REITs returned 20.3% for the year, a stark contrast to their abysmal 2009 performance when A-REITs lost investors 42.0%. A-REITs comprehensively outperformed equities – 20.3% versus 13.1% in the past year.

 

Post the GFC, the A-REIT sector has gone back to basics - the larger REITs have recapiatlised their balance sheets, lowered their gearing, disposed of non-core assets and reduced their distribution pay-out levels to more sustainable levels. The A-REIT sector is not without risks. Many of the smaller cap A-REITs have yet to fully re-capitalise their balance sheet and reduce gearing. Some A-REITs like the Galileo Japan Trust and the EDT Retail Trust (formerly known as the Macquarie DDR Trust), and more recently, the Mirvac Industrial Trust (MIX) has issues with debt funding. MIX announced on August 7 that they had defaulted on a US$123.5m commercial mortgage-backed security (CMBS) loan facility.

 

UBS recently released a report setting out seven key factors that will drive A-REIT returns during the forthcoming reporting season and over the next six months. Here’s a snapshot of what UBS have suggested investors look out for:

1. Earnings – “we see few surprises to FY10 earnings”;
2. Earnings risk in active segments – “the greatest risk lies in the active earnings, and in particular the residential names (Stockland, Mirvac and Australand)”;
3. Office Recovery – “the recovery seems to have been pushed out to the second half of CY11 at the earliest …we have downgraded our earnings assumptions for office stocks”;
4. Debt – “UBS estimate $27bn of debt expires over 2010-12…importantly ….sector leverage has fallen from 39% at its peak to 24% ex WDC”;
5. Asset values – “we therefore expect only very marginal changes in asset values … the uncertainty of Europe has neutralised any potential for meaningful upside”;
6. Distribution policies – “the sector has now settled with FY10e DPS/EPS payout ratio of 78%, rising marginally to 79% in FY11e” (Note: this is well down from 100% plus payout ratios between 2004 and 2008); and,
7. Real estate retail funds – ‘the net inflows in the past year indicate a recovering retail investor appetite for property exposure”.

 

Investors shouldn’t expect any significant earnings per share (EPS) or distribution per share (DPS) growth for the FY10 year.

The significant dilution from their huge capital raisings in 2009, the lower active earnings stream and the more conservative pay-out ratios have put paid to that. Take for example Stockland - it distributed 45.5c per share in FY08 compared to just 21.8c per share in FY10.

 

With on-going uncertainty surrounding the global economic outlook and patchy demand in some sectors – like retail – expect management to be extremely cautious on publicly setting specific earnings targets for FY11. The acid test for the sector is whether with the significantly larger capital bases, the A-REITs can generate significant earnings and distribution growth going forward. With an average yield across the sector of 6.1% against a 10 year bond rate of 5.2%, A-REITs are not compelling value unless you take the view earnings growth is going to be strong in FY11 and FY12.

 

Most A-REITs are still trading at discount to net tangible assets. According to JP Morgan, the A-REIT sector is currently at an 8% (ex Westfield) discount to NTA, although there is wide variation across the individual trusts. This suggests that there is still have some way to go before investors are fully confident that the worst is over and earnings growth gains momentum.

 

One of the key issues we believe investors need to focus on is A-REIT debt. Whilst A-REIT debt levels may have fallen, as noted above, there is still a significant amount of debt to be re-financed in the next few years and the cost of debt will remain high. How A-REITs manage their debt – duration (length of debt), sources of debt (banks vs corporate bond markets, domestic vs offshore) and the cost of debt (margins, line fees etc) will be a key factor in picking the winners from the losers.

 

Turning back to the UBS report, they conclude that the re-structuring of A-REITs has reinstated their defensive characteristics and should provide investors with a lower volatility investment relative to general equities.

 

Adrian Harrington
Executive Director – Funds
Equity Real Estate Partners

 

You can contact Adrian by visiting the website www.equityrep.com.au. Make sure you mention that you have been reading his analysis on our website so he knows where you are from. Adrian is currently a founding partner of Equity Real Estate Partners and has 18 years of experience in the funds management and real estate industries.

 

July 2010

The Australian real estate markets are in much better shape than a year ago. Here’s a snapshot of the state of the markets and an insight into what to watch-out for in the coming 12 months.

 

Real Estate Debt Markets

Credit for non-residential real estate remains tight. Whilst banks are slowly starting to lend again, they are using more conservative underwriting criteria and requiring larger equity stakes from borrowers. Debt margins are coming down, albeit gradually, but still remain above levels recorded at the peak of the market.

Distressed real estate sales have been low compared to previous cycles. In this cycle, the banks have avoided, where possible, foreclosing on borrowers. So long as the debt is being serviced, loans are being extended/rolled over shorter terms (generally 1-2 years) in exchange for higher margins, an equity injection, or a payback of the debt or a combination of all three. Development projects continue to struggle to obtain finance unless they are of a high quality, have significant pre-commitments and are sponsored by developers with strong track records in delivery. Some developers, keen to get their projects kick-started especially in the medium density residential sector, will look to take on partners who can supply equity, preferred  equity/mezzanine finance, or even senior debt, thereby reducing the LTV ratio and the amount of debt actually required from the banks.

 

A-REITs

The A-REIT sector (listed property trusts) showed a marked turnaround in performance in the last financial year. In the 12 months to June 2010, A-REITs recorded a total return of 22.8% compared to 14.3% for the broader equities market. Go back 12 months, and it was a very different story. A-REITs returned negative 42.1% compared to negative 20.3% for equities.
The turnaround is due in part to an improving economic outlook but also because A-REITs responded to their fall from grace during the GFC by recapitalising their balance sheets, reducing gearing, moving to more sustainable payout ratios and divesting non-core businesses.

Looking ahead, A-REITs are now better placed to deliver more ‘defensive’ returns to investors -  a trait that historically has made A-REITs popular with investors. The key issues to watch-out for in the A-REIT sector in the next 12 months include – the re-emergence of rental growth to drive earnings and support the next leg of recovery, the sectors ability to refinance debt given the continued volatility in global debt markets and at some point the next round of M&A activity will invariably kick-off again.

 

Direct Real Estate Markets

Returns from unlisted non-residential property are now on the mend. In the year to March 2010, (the most recent period of data), the IPD/PCA Index recorded a total return of just 0.9%. Retail real estate was the best performer during the year with a 3.0% total return while industrial returned 1.1% and offices negative 1.1%.

Looking ahead, the best returns will come from buying well at the asset/project level and generating upside through good old-fashioned active real estate asset management. At the sector level, the best opportunities in the next 12 to 24 months are likely to be in the residential, retail and selectivity in the office and industrial sectors.

 

Non-residential Real Estate

Sentiment towards non-residential real estate is significantly more positive than a year ago. The stronger economic outlook, improving demand and the fact Australia’s real estate markets didn’t fall as heavily as offshore markets, has re-ignited both domestic and off-shore interest in non-residential real estate.

Transaction activity has gathered pace in 2010 but still remains below historical averages. The availability and cost of credit continues to have an impact on the sector. The competition for quality assets will be stronger as institutional investors, especially the A-REITs, come back into the market to capitalise on the market turnaround. The larger A-REITs are well capitalised with low gearing. Also, the rally in equities since the March 2009 lows has eased the ‘denominator effect’, so superannuation funds are now under less pressure to reduce their real estate allocation, and for some, actually need to increase their real estate exposure. Superannuation funds have allocated capital to a number of the major wholesale real estate funds in the first half of 2010.

It is important that investors focus on the underlying fundamentals of real estate and careful underwriting of deals. A key risk for the sector is that the money starts flowing back in too quickly (the UK is experiencing this now as bargain hunters are rushing to get set) and the lessons from the last few years are forgotten. It appears that values, at least for prime non-residential real estate, have now bottomed. It is unlikely, during the remainder of 2010 that yields will firm significantly (and therefore generate significant capital value increases) – finance is remains tight, vacancies are still high and tenant demand has yet to fully recover. However, prime asset values will recover first, further increasing the pricing spread between prime and secondary assets.

The next upswing in the real estate sector will be driven by under-supply. Rents and real estate prices will need to increase further before the next round of construction kicks off in earnest. Asset management remains key – managing tenant rollovers, leasing vacant space, and ongoing cost reduction programs are important. Real estate managers who can effectively manage and add value to their portfolio will have an advantage in this next phase of the cycle.

 

Residential

The residential sector slowed in the first half of 2010 after a stellar run in 2009. With the unwinding of the first home buyers’ stimulus, the recent interest rate hikes, and expectations of further rate rises, demand for housing has slowed and we expect only modest price growth in 2010. Overall housing finance fell 0.8% in April after falling 3.3% in March. However, while owner-occupied housing finance fell by 2.4% in April, the total value of finance for investment housing rose 2.2% - the fifth straight monthly increase.

Investors are returning to the market buoyed by low vacancies and rising rents. In Sydney, the vacancy rate fell to 1.3% in April while Melbourne’s vacancy rate was just 1.6%. A shortage of housing compounded by forecast strong population growth is a major issue for the sector. For many years, there have been simply too few dwellings built to support the growing population. This has been further compounded recently by the lack of availability of debt to developers, especially in the medium density sector.

Housing affordability remains an issue. Higher interest rates, rising prices, together with supply barriers such as high infrastructure costs on new land releases and overly restrictive and time consuming approvals process, affordability is likely to deteriorate. The medium to long-term outlook for housing remains positive, as high population growth, rising incomes and relative lack of new supply will result in higher demand for housing than supply.

 

 

 

Investors should obtain relevant and specific professional advice before making any investment decision. The information contained herein does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision investors should consider, with or without the assistance of a licensed advisor, whether the information contained herein is appropriate in light of their particular investment needs, objectives and financial circumstances.

 

The articles herein contain the current opinions of the author only. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of the author.