Residential back in favour with investors
The 2013 reporting season has turned up an emerging and almost unexpected trend - real estate investment trusts with a residential focus are likely to be favoured by investors in the coming year.
Lower interest rates, first-home buyer grants and "up-graders" are leading the charge, which will underpin the large billion-dollar housing developments being undertake by the main REITs.
This is a turnaround from two years ago when any REIT exposed to housing was put on an immediate rating watch for a potential downgrade.
The only issue is that margins on home sales remain low and few developers are forecasting an improvement in the next two years.
Mirvac and Lend Lease were the last of the major diversified trusts to report for the 2013 season and both said the residential division was gaining momentum.
This follows commentary from Stockland and Australand, the first of the major REITs to kick off the earnings season.
Brokers said a review of all the data from recent profit updates indicated NSW was picked as the best performing residential market, followed by Victoria, albeit with the latter improving from a low base.
Mirvac, which reported its full-year result last week, was one of the more active across the detached, semi-detached and apartment housing projects.
For the year to June 30, the diversified developer and landlord reported a statutory profit of $139.9 million, which was affected by the residential impairments of $273.2 million announced in February.
Excluding one-off items, the operating earnings were $377.6 million, up 3 per cent from $366.3 million in the 2012 year.
Mirvac chief executive Susan Lloyd-Hurwitz said the group had seen a rise in demand in its residential division with the lower interest rates.
At Citi, analysts said residential development margins for Mirvac were slowly recovering to more normalised levels.
"Mirvac's earnings before interest and tax margins have moved from a low point of about 6 per cent in 2010 to about 11.5 per cent in 2013," the Citi analysts said.
"This recovery looks set to continue with the roll-off of impaired inventory continuing in line with management's forecasts, restoring margins along the way."
The bulk of the development earnings for Mirvac in 2014 will come from two projects, Chatswood ERA and the office at 8 Chifley Square.
The Harold Park Precinct 1 in the inner west will boost earnings for the second half of 2014 and into 2015 earnings.
"Their [Mirvac directors'] outlook commentary suggests a degree of caution in extrapolating some of the pre-sold development stock into future levels of activity. However, sales rates have exceeded their internal targets and expected lot sales for 2014 are about 22 per cent up on 2013," the analysts said.
UBS analysts said after the Mirvac result that with 37.8 per cent of the group's residential business in NSW, it would be the strongest performing state in 2014 with residential approvals recovering after a sustained period of weakness. (NSW has the most acute undersupply of any state).
First-home buyer incentives in NSW continue to provide the most relative support for new housing (given incentives for existing housing have been completely removed since mid-2012).
"The outlook for Victoria is still the weakest of all the states, the market previously being stimulated by large incentives and since mid-2008 experiencing the strongest uptrend in commencements and approvals, which suggests potential overbuilding."
Richard Jones at JP Morgan said for Mirvac the residential returns were trending the right way, but 2013 would be a year of stabilisation before stronger expected growth in 2014 and 2015 as Yarra Point, Victoria, Harold Park and Chatswood ERA settlements come through.