No answers to value questions plaguing GPT and peers in property malaise

Scarce credit, higher costs and an aversion to property extended the financial-sector crisis.

Scarce credit, higher costs and an aversion to property extended the financial-sector crisis. AFTER GPT chief executive Nic Lyons briefed property sector analysts about the property trust's decision to cut expected 2008 income by 27% and its expected distributions for the calendar year by almost 31%, he was asked whether the group's business strategy still worked. It was a fair question, because GPT has lost momentum in the businesses that were meant to be its new sources of growth. Its older, core Australian retail, office and industrial property portfolios are still solid, and their expected income contribution in 2008 was actually upgraded, by 2.8%. The weakness is mainly in the new, offshore businesses that transformed GPT into a more aggressively geared, global, player after it rejected Lend Lease's takeover offer in 2005: a $7 billion European property joint venture with Babcock & Brown, a European property fund management business that was meant to sit symbiotically alongside it, and a retirement home division in the New England region of the United States. Lyons answered by saying that GPT was trimming its sails, but not changing tack: its future continued to be in not only owning real estate but in developing properties for resale, and in managing property and property funds. GPT's downgrade nevertheless highlights very big headwinds for the property sector, and it's yet another reminder that what began a year ago as a banking and financial sector crisis has metamorphosed into a more general malaise. Scarce credit, higher funding costs for what credit can be located and a reluctance on the part of buyers to move out of the safety of cash and commit to property has extended the financial market freeze to the property industry worldwide, and projections from previous years about demand are no longer operative. It is too soon to declare that this is either a temporary change or a permanent one, and that is part of the problem. Compared with stated net assets, shares in property groups can now be bought at massive discounts. After yesterday's losses, the property trust component of the S&P/ASX 200 Index is down 34.77% so far in 2008, 42.3% in the past year, and is at its 52-week low. GPT is down 48.8% so far this year, and is 59.5% below its 52-week high of $5.11 at the start of October last year, and 45% below the group's stated net assets of $3.86 a share. GPT is not alone. ING Industrial Fund's share price is 70% of book value, for example, Macquarie Office's is 48%, Valad's 48% and Bunnings Warehouse is 74%. Westfield is the big exception in the sector, with a share price that is 114% of stated net assets. But just as beaten-down industrial company share prices here and overseas reflect uncertainty about future earning power as the economy both interacts with the market meltdown and back-feeds it, the discounts to net assets in the property sector reflect uncertainty about the solidity of valuations, and GPT's downgrade sums up the key question: to what extent has demand slowed, how long will it be depressed, and what do the answers to those questions mean for the develop-sell-manage industry model? GPT's expected profits from development activities this year have been wound back from $88million to $29 million to reflect a sharp fall in big property sales, its anticipated earnings from the European joint venture with Babcock have been trimmed from $141 million to $125 million to reflect weaker European prices and "abnormally low" activity, and GPT's European funds management operation is expected to book a loss of $15 million instead of a $26 million profit. These are all aspects of the same problem: the sharp slowdown in property investment and sales activity in the wake of the crisis. The European fund management business has not grown as expected - late in May for example, plans for a $1.5 billion industrial property fund were shelved in the face of investor apathy - and costs are overwhelming income. The plan is cut the cost base by 30% to get it to break even by mid-2009. But the stunted growth of the fund is also closing off some options for the GPT-Babcock joint venture, which was slated to sell properties into it. Lyons says GPT and Babcock still plan to accelerate the sale of joint venture properties. He says the venture is not a forced seller, because income is covering debt service charges. The pace and value of asset sales now depends on external demand, however, and it is palpably weak. That puts a cloud over the timetable for the return of the $2billion of capital that GPT has tied up in the venture and, for that matter, the plan to sell everything and effectively wind up the fund by 2010. The US retirement home division's expected contribution has meanwhile been cut from $24 million to $15 million to reflect lower occupancy levels that are a result of the US housing market downturn: customers need to sell their homes to raise retirement home entry money, and house sales are simply taking longer. Lyons said yesterday he thought Australian property prices were holding up (although tourist properties and hotels are also being hit by the high Australian dollar and higher travel costs), and said mark-to-market write-downs for the June half in the US retirement accommodation business, the joint venture with Babcock & Brown and the European funds management business would probably not be material for a group of GPT's size. The caveat however is that there are so few asset sales occurring that the benchmarks lack solidity. The real valuation impact of the downturn on GPT and the rest of the property owning-developing-managing industry won't be apparent until at least the end of the year, and possibly later - which is why property shares are weak generally, and why GPT's shares went down almost 15% yesterday.

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