REITs become hot property again

The REITs takeover door is wide open … and more M&A deals are almost certain.

PORTFOLIO POINT: Takeover activity in the listed property trusts sector is heating up, with GPT’s offer for Australand’s assets likely to be just the start of the latest REITs rush.

Suddenly a new and potentially exciting factor has been added to the equation.

Australia’s listed property trusts, or Real Estate Investment Trusts (REITs) as they are officially known, have begun to emerge phoenix-like from the ashes of the financial crisis. They have a sharpened focus, sustainable debt, attractive yields and the potential for yield growth to be funded out of improved earnings.

As I highlighted a fortnight ago, they already had been a prime target for yield-hungry investors scouring the market for something to replace, or at least add to, the banks. Then, on Monday, one of the country’s biggest REITs unleashed a daring acquisition strategy that has thrown light on the entire sector.

After four years in the doghouse, rebuilding their operations and reputations, Australia’s REITs have become fertile ground for takeover activity. For those picking the right target, that spells handy capital gains.

GPT this week unveiled a novel and highly conditional $2.8 billion offer for all of Australand’s office and industrial portfolio which, if successful, will leave the target with just its residential arm.

GPT is a funds manager and property trust. But its property portfolio is heavily geared towards retail and shopping centres. If it snares Australand’s business, it will transform the group, doubling the size of its industrial portfolio and increasing its office portfolio by more than 40%.

As at last June’s balance date, GPT had 57% of its portfolio in retail, with 32% office and 11% industrial. It already had committed to shifting that mix. After this purchase, the mix will be 46% retail, 34% office and 19% industrial.

Investors should bear that transformation, and the strategy behind it, in mind when looking at REIT purchases. For there is a shortage of quality office and industrial assets available, and it is likely that future takeover activity will be concentrated among REITS specialising in those sectors.

With interest rates falling, the spread between the cost of debt and the yield on assets is widening. So rather than commit to greenfield developments, it is becoming cheaper to simply buy existing assets. The easiest way to do that is through a takeover.

Those believed to be vulnerable to takeover are pure office funds such as Investa Office Fund (IOF), with assets of $2.2 billion, and Commonwealth Property Office Fund, with a portfolio of about $3.7 billion. The other main player is Dexus, a diversified operation with $4.7 billion of Australian office space and a $3 billion industrial portfolio scattered around the country.

The other main diversified fund with office exposure is Mirvac, with a $3.5 billion portfolio. Despite its size, GPT’s office portfolio currently is valued at just $2.7 billion, and Stockland’s at $1.9 billion.

IOF is more heavily exposed to the softer Brisbane market than other operators, but that is offset by a strong portfolio in Sydney and Melbourne that has reasonable expiry deadlines.

IOF currently delivers a 5.8% yield, rising to an estimated 6.3% in 2015 and, at $2.94 a unit, a discount to its net tangible assets of $3.14.

Commonwealth Property is yielding 5.7% but has less prospects for yield growth than IOF, according to recent research by Bank of America Merrill Lynch. It does, however, trade at a hefty discount to net tangible assets of around 12%.

The list of pure industrial funds is a list of one. Goodman Group is the sole main player. Considered to be close to fully priced, the group, with close to $20 billion worth of industrial property globally, scored headlines this week when China’s state owned CIC hit the jackpot with its sale of a 6.9% stake in the group.

In the three years since it bought into Goodman, it has doubled its money and should net about $520 million from the sale. But it still owns just under 10% of the company and this week’s sale could potentially put Goodman into play, although it is believed the Chinese group needs to hold its remaining stake for another 12 months for tax reasons.

Goodman also is involved in a large expansion into Chinese industrial property and it is possible CIC may want to hang on to its remaining interest.

As an illustration of just how far REITs have come, Goodman hit a low of 16c in 2009 as it desperately sought to extricate itself from debt problems.

Goodman is followed by Dexus and Australand in the industrial stakes. One is already under offer. Clearly, the games are about to begin.


Listed Property Trusts Portfolio Values

GPT
(GPT)

Dexus
(DXS)

Commonwealth
Property Office
(CPA)

Investa
(IOF)

Mirvac
(MGR)

Stockland
(SGP)

Share Price*

$3.60

$1.005

$1.055

$2.94

$1.505

$3.38

Australian office $bn

2.7

4.7

3.7

2.2

3.5

1.9

Australian industrial $bn

0.9

3.0

0

0

na

0.8

Premium (discount) to NTA

(1.3%)

1.9%

(9.4%)

(6.3%)

(9.3%)

(8.1%)

Source:  Annual reports, JP Morgan. * Share prices at close on December 13, 2012.