Eureka Correspondence

Mortgage Choice takeover, investing in REITs, residential property versus stockmarket.

Mortgage choice takeover

I enjoyed reading Tom Elliott's thoughts on a likely bid for Mortgage Choice (see Bank on it! Our next takeover target). I note that the return on equity (ROE) for MOC is still an impressive 18%, though it has dropped significantly from five years ago. Management seems to be paying out an increasing ratio in order to maintain the dividend. I have a few questions though:

How can a company that exists as a broker be owned by one bank? What would be the purpose of Mortgage Choice if it is owned by Commonwealth Bank? Why would CBA have sold some MOC shares recently? Lastly, would the regulator be concerned by the prospect of one bank acquiring MOC?


Tom’s response: Thanks for your letter. CBA also owns another broker, Aussie Home Loans. Supposedly the staff there remain neutral between CBA and non-CBA products. Regarding selling shares, the various investment arms of CBA may trade in and out of MOC separate from the bank's corporate arm but all such holdings must be amalgamated for substantial shareholding reporting. Lastly, the regulator may well be concerned if CBA bought all of MOC - but there are lots of mortgage brokers out there.

Investing in REITs

Thanks for hosting the webcast on property, Property Investment: Getting to know A-REITs and syndicates, I found it very informative.

I was hoping to get some insight from one of the team on the apparent conflicting objectives when investing in REITS:

First, if economic activity improves, I expect that companies such as Goodman should benefit from selling / leasing industrial properties at higher prices.  Second, I'm reminded that long-term property investors such as GPT might be expected to behave like fixed income proxies and would be hurt by any rise in interest rates.  How can these two behaviours be balanced?


Dugald Higgins’s response: The question, while not without merit, is probably not the one you should ask yourself. Economic activity and interest rates are obviously interlinked and real estate is capital intensive and so generally funded partially with debt. Property performance is driven by a complex matrix of factors including economic activity, business and consumer confidence, interest rates and physical supply and demand or real estate. These effects are global, as well as local to a greater or lesser extent.

At its simplest, commercial real estate values are underpinned by the income generating ability of the asset (we’ll exclude land value which is only part of the equation). The attractiveness of the income stream generated and the willingness of a buyer to set a price on securing that income stream is what drives values. Yes, companies like Goodman may benefit from increased economic activity. But this can also drive increased supply of industrial space, which constrains asset values. And yes, rising interest rates may have an impact to a greater or lesser extent on a REIT, depending on the level of gearing maintained and how much exposure there is to floating-rate debt. The larger REITs are however relatively lowly geared these days, so the impact is unlikely to be devastating. However, each REIT will have its own particular drivers. The individual investor needs to understand these and then make a judgement call on how changing conditions will impact each REIT.

Residential property versus stockmarket

The older I get the more I am convinced property is the worst investment one can have apart from cash in the bank. I was in a debate yesterday on Fairfax radio about renting versus buying and made the point that if one retiree had $5 million in the All Ordinaries Accumulation Index, and another had the same sum in residential property, the former would be much better off. For starters, they would not receive one bill for repairs, rates, insurance, land tax, maintenance etc, and they would not have the problems with the lack of liquidity that property has. In contrast the share portfolio would return about the same yield, 4.5%, but the income would have massive tax advantages. To me it's a no-brainer.


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