Source : Business Times - 26 Aug 2008
With Australia poised to cut interest rates, beleaguered property trusts could see their rental yields become more attractive, but the bad news flow that has battered the sector may rumble on.
Australia’s highly leveraged real estate investment trusts (Reits) have suffered as the global credit crunch lifted borrowing rates and raised questions about a practice of using non-rental income to boost dividend payments.
With debt spreads widening to about 110 basis points from 50 basis points six months ago, GPT Group, Mirvac Group and Babcock & Brown Ltd have issued profit warnings and seen their share prices dive.
Centro Properties Group set off the bearish mood when concerns about debt refinancing emerged early this year.
The property index has lost 42 per cent since a peak last October, but has picked up over 20 per cent since mid-July.
Some analysts say the sector is still 20 per cent undervalued, and rate cuts would ease pressure on the securities, which pay most of their rent to investors as dividends.
After more than a decade of expansion backed by a commodity boom, Australia’s economy is now seeing signs of weakness, with consumer spending sapped by rising fuel and mortgage costs.
The Reserve Bank of Australia (RBA), the central bank, has said it would not wait for inflation to fall before lowering interest rates, giving the clearest indication it would ease monetary policy next month.
‘As the RBA begins the easing cycle, this will make Reits more attractive from a yield perspective,’ said Merrill Lynch analyst John P Kim.
The weighted average dividend yield for Australian Reits is 7.8 per cent, slightly above the central bank’s cash target rate of 7.25 per cent and compared with a 10-year government bond yield of 5.8 per cent .
‘The large-cap A-Reits will benefit the most, as equity and global property investors revisit the sector, now that one of the major headwinds against the industry appears to be headed for a reversal,’ Mr Kim added.
During the last two periods of falling interest rates, in 1996-98 and in 2001, Reit prices rose 6.7 per cent in the following 12 months, according to UBS.
UBS says groups active in residential development or which have large domestic floating debt exposure should benefit most, pointing to Stockland Group and Mirvac as examples.
Affordability has become an issue for Australia’s nearly A$3 trillion (S$3.7 trillion) residential market. Home prices have jumped five-fold in 20 years, while household income has only doubled, so lower borrowing costs should offer homebuyers some relief.
But even if the central bank cuts its policy rate, lenders could still be reluctant to adjust their views of risk for property trusts, said Clement Chong, vice-president and senior analyst for Moody’s Investors Service.
‘One has to wonder whether the cut in the funding cost will be passed on to corporate borrowers,’ Mr Chong said. ‘It’s a bit hard to build a rate-cuts case at this point.’
In May, Moody’s said it maintained a stable outlook on the ratings of Australian Reits over the next 12 months, but warned that a challenging credit environment and softening property fundamentals in some overseas markets were risks.
Dugald Higgins, associate director for property research firm Property Investment Research, said a deteriorating global economy could hurt Reit earnings, as commercial property values and rents suffer in Australia and the United States, where many Australian trusts own shopping malls, offices and warehouses.
‘It will only take a piece of bad news to hit the market and I imagine we will see a lot of people jump ship again,’ he said.
‘Valuations, fundamentals are still pretty much out the window and have been in the last six months and I don’t see that changing a lot throughout the rest of this year.’
Last week, Babcock & Brown, which has listed real estate vehicles, saw its share prices tumble after a profit warning due partly to revaluation of real estate assets. Babcock & Brown shares have crashed to below A$4 from almost A$35 in June 2007.
Office vacancy rates in Australia crept higher in July, prompting property executives to predict the global credit crunch will take its toll on rents and the value of buildings.
As the market braces for Reits’ earnings announcements, investors will watch property valuations to see whether the trusts apply mark-to-market accounting.
The practice, which has gained ground in Britain, relies on indices rather than appraisals of individual buildings, and allows companies to adjust their asset valuations faster.
‘Typically in Australia, we’ve still got six monthly valuations,’ said Tim Nation, director of international investment at DTZ.
‘It just inherently slows down the ability for asset values to reflect where the market thinks the pricing should be.’ - Reuters
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