Property Trust Champion

Just as the usual suspects have been (wrongly) predicting the demise of Australian equities in favour of international shares, a chorus has for some years been forecasting that Australia’s love affair with listed property trusts (LPTs) was about to come to an unhappy end.

Both chants seem to be based more on uneasiness about past success than analysis of the fundamental future. LPTs have underperformed the sharemarket over the past 12 months, but according to Simon Jones, co-head of Macquarie’s real estate empire, they’re still ahead over the decade and last year’s 18% wasn’t too shabby. It’s not that LPTs did badly, shares just did outrageously better.

Jones’ official title is co-head of Macquarie real estate capital and chief executive of Macquarie Office Trust. One way or the other, he oversees five listed property trusts and a few unlisted trusts as well with billions of dollars worth of property in Australia and the US plus growing interests in Asia and Europe.

Jones believes fundamental drivers for the LPT industry’s performance remain in place, although the composition of that growth '” the split between capital values and yields '” may change with the new interest rate environment.

And as you can see in our video interview, it’s the office sector that he’s tipping as the best performer in the year ahead.

The interview

Michael Pascoe: There have been expectations around the market for a number of years that LPTs were due for a fall and they haven’t. Will they eventually?

Simon Jones: Well, I’m not sure where those expectations came from but the trust sector has delivered an 18% return for the last 12 months. There have been some standout performances from Centro and Macquarie Goodman, but certainly its performance over the last three [years] of around 18% versus equities around 23% has been strong and over the 10-year period I think it’s around a 14.5% return versus equities of 12.5%, so you’re still getting a good bang for your buck in LPTs.

What would you say the long-term sustainable yield of LPTs would be?

Well I think the long-term sustainable yield is only one equation in the total return. I mean people are making returns from the distribution growth and also from the asset growth '¦ and we have had favourable conditions in terms of contraction in capitalisation rates, which has meant greater value in assets.

Just put that into English.

OK. Capitalisation rates '” that is the yields on properties are falling.

And how has that been good for the sector?

Well when the yield falls, basically the value of the asset increases. We’ve benefited from that over the past two years with falling interest rates. As interest rates start to move back up to more normalised levels, there may be an impact but I don’t think it’s going to be the major impact over the next 12 to 18 months.

What is going to be the major impact on the sector in the next 12 to 18 months?

Well I think it’s going to be how the fundamentals of rent are growing and I think we’ve seen, especially in the office sector, a lot of office absorption now starting to translate into office rental growth. We’re seeing very strong rental growth in markets such as Brisbane and Perth, and Sydney and Melbourne are catching up, and I think the retail sector is chugging along quite well, especially in the food-based areas.

Yet it's that fear of an interest rate rise hitting capital value of LPTs that seems to hang over that sector?

Yeah, well I think the interest rate rises are pretty much '¦ a lot of them have been factored in. I keep turning over my paper and seeing a new one every month in the US but I think the US is probably getting towards the end of its cycle. Interest rates at 5% or 5.5%, you’ve still got cap rates [rate of capital growth] of 6% or 6.5%, there’s still spread there. We don’t think it’s at a level which is actually going to impact values at this stage. There’s still a lot of capital looking for a home in property. The baby boomers looking for a yield, good solid yield, good solid capital and anti-inflationary type returns, are still keeping strength in capital searching for property returns and we can’t see that changing over the next 12 to 18 months.

So another 18% total return '” is what you’re expecting?

I’m no forecaster. I know some of the broking houses are saying 8–10% and they normally say that because they say 6–7% out of yield, 2–3% on growth. They always get it wrong. We always under-estimate it. Let’s hope we under estimate it again.

That’s the industry. What about Macquarie Bank’s property trust empire? What’s different about it? What’s better or worse about it?

OK. Well I think Macquarie’s a real specialist in trying to be innovative in trying to find returns from not just property in Australia but returns from out of Australia. We’ve certainly gone into the US in a big way over the past two or three years. We’re now moving more into Asia and Europe as potential avenues to take our model '” our property trust model '” and expand it into those markets and we’re starting to do that quite successfully, whether it’s listed property or unlisted.

Of the different sectors, what do you like best at the moment? What looks best in the year ahead?

If you look at the returns for the past 12 months, the returns of office trusts outperformed retail and I think that’s the swing in the movement away from the consumer led growth in the economies to more business growth. I think we’re still seeing that business growth starting to come through so we’ll see good employment numbers, good growth in office rents and I think that’s probably a good factor. The real growth has probably been in the trusts that are doing a lot of funds management-type activities. This is the Centros and the Macquarie Goodmans, which are more of akin to a Macquarie Bank in their nature in that they are funds managers as well as owners of property, and they’re having a good run at the moment as well. Query whether they’re starting to get to fully priced values.

There is that spread between the outperformers and the laggards to come up with that 18% average in the industry. To what extent are those outperformers sustainable or are they due for a fall back?

I think the outperformers probably show they’ve got business models and in their particular market segments '” whether retail or industrial '” they’ve been very strong. I would say that there’s opportunities this year for the office trust just to continue to shine in this next 12 months but I don’t think that the business models of a Macquarie Goodman or a Centro is in any way impaired and they should continue to derive good returns for investors.

What’s best to invest in '” the trust or the manager of the trust when you have that choice when they haven’t been stapled together?

I think that’s a good question. I think they’re two different risk models. I mean the manager depends on whether he is a good manager '” whether he is sustainable or whether he has a sustainable business and whether he can grow a business. I think the trust is whether you think that you’re going to get your better returns over the coming period out of property. And if you weren’t in property over the past two or three years you wouldn’t have been getting the return on equities that you would have been getting potentially out of just owning a funds manager. Now that will depend on where we are in the cycle and I think, going forward, I think, you know, it’s good to have a diversity in both. If you own Macquarie’s property trusts I also suggest you also might to own some of Macquarie Bank and you can combine your investment and get the best of both worlds.

Final question. Alan Moss, the Macquarie Bank chief executive, has foreshadowed a review of the structure of the organisation, perhaps separating out the bank from its other activities under a holding company. Does that make any difference to the property trusts?

No I don’t think so. I think this is a bigger issue for the bank in actually working out whether the bank is best structured under a banking licence regime under APRA and/or having activities which are outside of APRA’s control. I think this is something which the bank has toyed for a number of years and as we’ve grown internationally and expanded the base of the business, I think it’s a normal activity for the chief executive to look at logistics and that. I don’t think that will have too much implication.