Stockland's positive outlook

As the chief executive at one of Australia's biggest REITs, Stockland's Matthew Quinn could rightfully have claimed sweet victory in the budget after the Rudd Government surprised the beaten-up property trust sector with an increase in tax breaks.

The Government’s decision to make withholding tax changes more attractive than previously planned to foreign investors will surely benefit the flow of money into Australia's property industry, but Quinn will only say he’s glad to see a “level playing field”.

What's more, Quinn wants investors to look carefully at the obvious consequences of rising rental yields in a market where new home building is at record lows. Quinn says the answer has to be in high-quality, low-cost housing, and he will make sure Stockland is ready to exploit these developments.

If you want to hear how one of the best operators in the REIT sector appraises the post-credit crisis property trust sector, read on.

The interview

Michael Pascoe: Is the long Australian love affair with REITs over? Realistically, the returns that people can expect from REITs now are going to be much closer to the market norm, to economic growth?

Matthew Quinn: Well that is the $64 million question. My perspective on that, firstly, is returns should be judged over a longer period. We picked five years as a rolling measurement period. If I go back two or three years ago when financial engineering was the real thing, we under-performed. Our total shareholder return was lower than the industry benchmark purely because we didn’t get involved and that was the theme of the day. On a five-yearly cycle we can hold our head up very high as an industry.

The overriding theme though is that we’re the same as every other industry where the returns are going to be governed by supply and demand. If we look at what’s happened over the past few years, we’ve had the planets pretty well aligned in terms of strong demand and limited supply. I don’t see what’s going to change that. If anything, one of the first things that comes out of the credit crunch is there’s going to be less supply because people cannot get the finance to build the things that they were planning to do. And that would be limiting supply even further and give us potentially better returns from existing buildings.

Isn’t that a longer-term view? In the short to medium term, isn’t there a straight problem that the cost of money being what it is, the yield on buildings isn’t worth having, therefore the price of buildings should fall?

Not necessarily. There are two things that drive value: the yield and the rentable growth. If rents are stable or rents are dropping and yields blow out, then obviously values drop and that’s basically what we’ve seen in markets like the US and the UK where there’s been quite a substantial drop in real estate values.

If you look at what’s happening here, by our modelling we are seeing enough rental growth at least in office and retail space to cover a blowout in yields of 25 or 50 basis points. If that’s all it is, then I think we’ll have a status quo. For some of the secondary properties that don’t have the rental growth, values will fall, but across the board good quality property will still hold up and shine. It’s not just a yield issue, it’s a rental growth issue as well and rents are still growing very strongly.

Do you expect to be able to buy some properties cheaper in the next little while than they were for sale 12 months ago?

Logic would say so but from everything we’ve seen so far, despite all of the headlines and the doom and gloom, there’s actually been a total absence of transactions. Basically nothing’s happening. We’ve got a Mexican standoff between the buyers and the sellers and there’s no real urgency for the sellers to move. There’s probably no urgency for the buyers to move either, although a few people are underweight and are looking to get the weightings back up in this cycle. But certainly from a vendor perspective, we haven’t seen any real urgency, even those where there are headlines of imminent financial collapse. Nobody’s looking to really get it out there at any cost and take a big haircut.

But companies having to refinance at the moment would be under a lot of pressure wouldn’t they?

Well that could happen but the evidence is not there yet. Now that’s not to say that it won’t but the market relies on physical evidence of market activity and it’s not there yet.

That sort of pause, is that itself a worry that there’s normal business is not being conducted.

It depends. It is a worry if you want to buy things or you want to sell things and you can’t because of pricing, but that normally means that one way or the other you’ll end up meeting the market.

If you look at what happened in the UK last year, we had the similar kind of Mexican standoff that went for a while and then the sellers broke and that was because a lot of those sellers had to meet the market because they had to fund liquidity issues and redemptions. If you remember the early 1990s here, we had open-ended unlisted funds with that liquidity trap – we’ve seen exactly the same thing happen in the UK.

Same thing happened in Germany about four years ago. We don’t have that business model here so it’s not going to be a redemption trap that will force people to hit the market, it will be refinancing issues and so on and I just haven’t seen any sign so far of any financier pulling the pin and forcing a sale. It might be famous last words, but we haven’t seen that evidence yet.

And residential?

Residential’s interesting. It’s dear to our hearts because we’re a big residential developer and it’s dear to everybody’s heart because it has most of the family wealth. People tend to get quite emotional about residential property and base that emotion on last weekend’s auction clearance rate and what the doomsayers are saying in the marketplace.

What we have at the moment is certainly a situation where the last interest rate rise did bite and buyers are a lot more cautious. You can see that in the consumer sentiment figures and the attitude towards spending money in general. In the short term that’s going to have some kind of dampener on residential demand.

But if you look through the short term, the supply and demand fundamentals here are quite frightening. Kevin Rudd has acknowledged that we have a housing issue, a housing deficit that’s already large and is growing to the tune of 35,000 dwellings a year. That’s something that the previous Government would just not confront.

When you have that kind of supply constraint and you know that the demand is going to continue to grow because of the skills shortage and the requirement for increased immigration, which I think everybody supports, it means that there is going to be upward pricing pressure.

What’s happened in the past few months is that that upward pricing pressure has come away from new homes because buyers have hit that affordability limit and it’s now moved into the rental space – rents are ballooning out of control. We’re going from housing affordability being the major issue from an ownership perspective to it being a rental perspective. We’re going to have lots of stories on the six o’clock news about people caught in that rental trap and it’s a terrible situation.

What it does mean for business is like ours that there is upward pricing pressure that’s just being held back at the moment because of buyers taking a breather, but in the long term that’s going to come back. We’re trying to work with the Government to alleviate that pressure and get some really good supply initiatives into the marketplace, and we’re very pleased that the Government has made the first move towards that in this budget. I think it’s long overdue.

Should canny developers be looking to build more affordable housing – instead of units with three marble bathrooms and so on, to be looking to build more modest homes that more of the market can afford?

Definitely, and we are. And I keep on saying to the Government the best way to deal with the housing affordability issues to make the housing affordable and that means more efficient housing, lower price point. “Lower price point” has traditionally meant an inferior product and that is not necessarily the case. There is very good product that you can bring to market that has much more efficient use of land and the built form.

I think people’s expectations are that unless you live in a house that’s ginormous, and as big as your parents’, you’ve failed, I think that kind of mentality has to change because it’s not required and we are over-investing in houses where a lot of people are bouncing around. I think the right proposition is that new home owners can come in, have something that’s more modest, more akin to their actual requirement at that time that they can use then to grow from, as their family grows. We’re out there with a range of products to meet that demand, that market segment, and they are selling very, very well.

What impact do think the reduction in the withholding tax will have on the Australian REIT industry?

Well it’s great news and it’s great to see that a promise the Rudd Opposition made has come to fruition at the first opportunity. It’s more staggered than we anticipated but the end result of 7.5% is actually lower than their original commitment to 15%. That’s fantastic and I think if you look at what the Prime Minister is saying and the Assistant Treasurer Chris Bowen, who’s driving it, it’s very much about making Australia a real financial services and funds management hub, which we obviously support.

What this means for us and our investors is that we have removed a blockage – perceived or real – for them to invest in product in this country through REITs and other unlisted property products.

While it’s nice to talk about Australia’s potential as a financial hub, isn’t the reality that, Macquarie Bank notwithstanding, the only funds management area that we shine in and have significant weight internationally is property?

Yes, and long may that continue. We’ve had a few hiccups recently which we have to put behind us, but property in Australia has punched well above its weight and, interestingly, the REIT model that we have, with the stapled securities and so on, is now basically the business model around the world. We’ve adapted. We’ve changed. We’ve moved from an external management model at the right time and the world has followed and we’re keen to have leadership.

The reality though is that this thing has globalised significantly. Five years ago 10% of our shareholders were based overseas. That’s now over 30%. The reason for that is that we are now a global asset class, very similar to what happened with shares and international equities. If you go back 30 years, fund managers’ holdings in international equities were quite low but are now part of their focus.

Similarly in property, local investors are investing overseas, overseas investors are investing in us. At 30%, our withholding tax was uncompetitive. So we were punching with one arm behind our back.

The Australian REIT industry has been knocked extremely hard by the credit crunch. Does this really have the potential to turn it around?

I think it’s a step in the right direction. I don’t think anybody would see it as a salvation and neither should they. I’m very much a fan of everybody standing on their own two feet with a level playing field. I wouldn’t want us to be in a position where we have a tax break that gave us an unfair advantage either, because all that does is incentivise people to come up with products that are more tax-driven than real estate-driven.

But that’s exactly what everyone does do.

With the withholding tax reduction, I think that just gives us back a level playing field. I don’t think it provides any incentives at all. When it comes to financial engineering, I think that was an era that we went through that is now past. It was an era where there were some overly exotic things that happened and people have now woken up to that. That’s a good for our business because net property has always come first and I think that’s going to be the real thing for the next few years.