June 27, 2019

June 27, 2019 | Investments Insightz


Recognising value in AREITs

As can happen with any asset class, from time to time sentiment can lead to irrational prices within the AREIT* universe. And this seems to be happening today, with securities in the office and industrial sub-sectors flying high while retail and residential securities have languished. But perhaps some of the headwinds that have been testing the residential names in particular are now starting to dissipate.


As can happen with any asset class, from time to time sentiment can lead to irrational prices within the AREIT* universe. And this seems to be happening today, with securities in the office and industrial sub-sectors flying high while retail and residential securities have languished. But perhaps some of the headwinds that have been testing the residential names in particular are now starting to dissipate.

Consider Stockland, which has historically had a strong correlation between its relative valuation and the move in residential house prices. For a prolonged period of time – 15 years - this relationship has tracked closely. For instance, strength in house prices have corresponded closely with an increase in Stockland’s relative valuation (versus the ASX200 Industrials ex-Financials Index). However, in recent times, and particularly over the last 12 months, there has been a substantial overshoot of Stockland’s relative de-rating when compared to the quarter-on-quarter fall in house prices, suggesting that significant negativity had been built into Stockland’s market valuation.

However, the surprise Federal election result in May brought with it policy continuity, meaning that the markets are no longer faced with the prospect of the removal of negative gearing and the reduction of capital gains tax discounts, both of which were potential negatives for residential markets. Around the same time, APRA proposed reducing the 7% serviceability buffer requirement for new mortgages and the subsequent rate cut by the Reserve Bank of Australia in June (with potentially more to follow) has been a further positive. All have been deemed positive for residential securities and there has been a strong move higher from Stockland in response from its previously undervalued position.

Retail securities continue to languish, in part due to investor concerns on the sustainability of retail mall valuations. However, perhaps these concerns have also been overdone. Recently, Scentre Group has sold a 50% stake in its Burwood Centre at a 4% premium to book value. 4% may not seem like a lot, though it provides market-tested support for Scentre Group’s net asset value and directly challenges expectations of weakness in retail valuations.  This is significant news and provides a valuation buffer. Rationale for the sale recognises limited development upside, but still sufficient quality for capital partners to consider. Scentre Group maintains the management rights and will use the proceeds to de-lever and improve their balance sheet. With these facts in mind, we believe that negative sentiment towards quality malls is overdone.

In terms of the AREIT market more broadly, the index itself is trading at a modest 7% premium (in terms of relative Price to Earnings [PE]) to its long run average and the sector’s yield spread versus the Australian 10-yr Government Bond remains healthy. However, at the stock level, there appears to be material mispricing. Since 2011, the PE multiple ‘spread’ amongst AREIT names has expanded substantially from 3.5x to 13x. While the bottom end of the range has not materially changed, the expansion in the spread primarily reflects the substantial re-ratings that have been afforded to the funds-management exposed names, such as Charter Hall and Goodman Group.

Bringing this re-rate into perspective, the AREIT Fund Managers have historically traded at a modest discount to Net Tangible Assets (NTA). However, in the last 12 months, the price which investors are willing to pay for Charter Hall and Goodman Group has expanded from a modest discount to NTA to a substantial premium of nearly 80%. Put another way, these stocks PE multiples are now at levels significantly above their pre-GFC highs, with Goodman Group leading the charge at 29x. Investors should also be mindful that a significant portion of those earnings are generated by fund performance fees and should not be considered a permanent fixture of earnings going forward.

So how should investors think about how to position portfolios in the AREIT space? It’s clear that there have been headwinds in the retail and residential sub-sectors and tailwinds for industrial and office segments. However, investors should remember that markets are short term and pro-cyclical in nature. At current valuations, the office and industrial segments are trading expensively and, conversely, retail and residential are offering relatively good value.

Renaissance Property Securities, manager of the Zurich Investments Australian Property Securities Fund, has been implementing a gradual shift to overweight retail and residential names and gradually moving to an underweight position in industrial, office and the very expensive names. The move to recognize value in the residential stocks, such as Stockland, has been rewarded by recent developments. The market is still proving slow to recognize value in the retail stocks and continues to price in negative headwinds, despite the recent positive mall asset transactions.

*Australian Real Estate Investment Trust

Source: Renaissance Asset Management; also some of the data used has been sourced from Goldman Sachs Equity Research (Australia Real Estate: REITs Valuation Focus Charts, dated 10th May 2019)

 

 

Important information: The content of this publication are the opinions of the writer and is  intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated June 2019, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such.  Past performance is not a reliable indicator of future performance and should be used as a general guide only. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich. Past performance is not a reliable indicator of future performance. GINN XYY9MQ.00000.SP.03. CSTT-014709-2019

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