Source : Business Times - 14 Mar 2009REAL estate investment trusts are supposed to be stable assets and a core retiree holding, whose regular yield distributions help to cushion a portfolio. All these attributes went out the window in the wake of the severe and on-going credit crunch.
Kim Redding, executive director and global portfolio manager of AMP Capital Redding Investors, believes that Reit prices globally have overshot on the downside, like most publicly traded assets. Almost uniformly across various markets, Reits’ net asset values have dropped 25 to 30 per cent, and their share prices have fallen even more deeply by 65 per cent.
‘Real estate is very capital intensive. In Australia and Asia, most of the liabilities or loans have been relatively short term. Most of the issues relate to the need to refinance debt, and very little debt is available. It’s less of a real estate problem than a capital markets problem.’
Reits’ share prices have been battered amid the flood of deleveraging as investors dumped more liquid equity and bond holdings. Mr Redding, however, says Reits’ underlying cash flows remain sound. The caveat is that the more prolonged the credit squeeze, the greater the pressure on valuations and rentals. ‘Cash flows have been reasonably good. We think the world is focused on the wrong metric. To ascertain the value of a building an appraiser tries to find the cash flow or net operating income and arrives at a capitalisation rate. They look at other buildings . . . but we’ve had very few transactions. The way to really judge value in real estate is the cash flow. Right now, rents are under pressure, but lease terms can be long, so cash flows continue.’
Mr Redding has more than 20 years’ experience in real estate and has founded and co-founded three investment advisory firms specialising in real estate securities.
The AMP Global Property Securities Fund has US$1 billion in assets. In the year to end-December, the fund generated a return of minus 44.8 per cent in Aussie dollar terms, against minus 45.6 per cent by the UBS Global Real Estate Investor Index. Since inception in November 2004, the fund has delivered an annualised minus 3.8 per cent loss, compared to the index’s minus 5.9 per cent. The fund is not available to offshore investors.
Mr Redding notes that valuation metrics are at the lowest levels historically, with substantial yield spreads against Treasuries. In Singapore, listed Reits’ yield spreads against 10-year Singapore government bonds are well into double digits. In a March report, OCBC Securities’ Meenal Kumar estimates that S-Reits are currently valued at a 61 per cent discount to reported NAVs. ‘Lenders’ appetite for loan-to-value (LTV) have fallen because of an expectation of falling capital values and a decreased appetite and capacity for risk,’ she wrote.
Mr Redding is sanguine even as he notes that many Reits are in technical breach of their LTV covenants. ‘But if you look at the interest cover, or cash flow to service debt, that’s still very strong. In Australia, which is struggling, (Reits) have 2.7 times interest cover. We think lenders have so many problems, it’s hard to imagine that they would force companies that can adequately pay their interest costs into bankruptcy. Rational minds will prevail.’
He is often asked by investors if they should remain invested, and when is the right time to re-enter the market. The firm, which manages some US$2.9 billion in securities, saw net inflows last year. This year, some US investors have also allocated capital. ‘If we do have financial stability and one day we flip to inflation, Reits will do quite well.’
He sees some positive signs in California where home sales have picked up. US households’ savings rate have also shot up to 5 per cent from minus 2.5 per cent last year. ‘The sooner people repair their balance sheets and work off a solid base, the better off we’ll be.’ Large firms such as Westfields are beginning to scout for acquisitions - a sign that the market is on the mend.
The portfolio is defensively positioned with securities that the firm puts into the top quintile in terms of quality. Mr Redding, however, says that he is beginning to scrutinise lower quintile firms for opportunities. ‘I have to be an optimist. I think US$3.4 trillion in US fiscal stimulus will ultimately stabilise the system. So then the companies that would do best are those that trade like they are almost going into bankruptcy. They could see a very rapid rise in share prices. But we have to be cautious because we don’t know how long capital markets will stay frozen.’
Meanwhile, Moody’s in a January report maintained its negative outlook on the Singapore Reits sector due to a number of risks relating to refinancing, asset devaluation and a weaker operating environment. Moody’s has since downgraded three S-Reits, including Ascendas, and put a number of others on credit watch.
The firm says 11 rated S-Reits have some $3.7 billion in debt maturing this year and nearly half are CMBS (commercial mortgage backed securities). As the latter market is now moribund, the Reits will have to rely on bank lending. It points out that S-Reits also have a high level of encumbered assets, which limit their financial flexibility. For rated S-Reits, only 17 per cent of assets are unencumbered against 70 per cent among rated Australian Reits. ‘As S-Reits try to get new loans over the next 12 to 18 months, the relative share of secured debt is likely to increase through new charges over assets.’
The prospect of asset devaluation is yet another concern. S-Reits have enjoyed sharp rises in property values in the last couple of years. ‘This rise in property values masks an underlying high level of leverage, even though debt-to-asset metrics have remained well below 45 per cent. The ratio of debt to Ebitda, however, presents a different picture. Several rated S-Reits are close to or have already breached their trigger levels for downgrades.’
Moody’s reckons that a 15 per cent decline in S-Reits’ asset values would have the most impact on those trusts with high leverage and covenants tied to such measures.
