Top four pick up their act to create value

Financial engineering through asset sales and share buybacks were the dominant themes in the recent reporting season for the real estate investment trust (REIT) sector.

Financial engineering through asset sales and share buybacks were the dominant themes in the recent reporting season for the real estate investment trust (REIT) sector.

After six months of juggling a tough retail environment, exiting from overseas businesses and some management changes, the REIT industry reckons it's back on track.

But the priority remains for the managers to lift the return on equity (ROE) for the REITs and narrow the gap between net tangible asset value and the share/security price, and that can be done only by reducing the number of shares on issue.

Looking at the four largest REITs: Westfield, Mirvac, Stockland and the GPT Group, all except Mirvac are undertaking share buybacks and engaging in asset sales.

After absorbing the news, as given out by the REITs for the half year (Mirvac and Stockland) and full year (Westfield and GPT), property analysts say, in general, these four are the top picks.

John Kim of CLSA says Stockland had the highest amount of sales at $745 million, with GPT second at $617 million. But Westfield stole the show with its joint-venture deal with the Canada Pension Plan Investment Board and its surprise 10 per cent share buyback.

In a sector breakdown, limited development of new buildings kept office rents ticking along, while retail landlords did well despite the weaker state of the tenants.

E-commerce is proving a bonanza for the industrial property businesses as the more we buy on the internet, the more warehouses are needed for storage and distribution.

Although some investors are sceptical that the REITs could not find a better use for their cash than buying back their own shares, others argue it will boost the share prices that have been languishing since late 2008.

Simon Wheatley, the senior REIT analyst for Goldman Sachs, says the rent growth from various real estate sub-sectors has proven resilient with only minor moderation in growth rates, and results highlighting that the fixed (contracted) rent growth in non-expiring leases is carrying continued growth.

"Occupancy levels have remained strong - occupancy is the primary risk to comparative net operating income for both office and retail." he says. "There is no evidence of any loss of occupancy in shopping centres and office occupancy remains stable, although we suspect it has peaked and will soften into the end of financial year 2012.

"We did come away from reporting season with weaker conviction regarding the residential outlook."

The head of property research at Bank of America Merrill Lynch, Simon Garing, says capital management and lifting ROE are priorities.

"This encompasses continued buybacks with GPT, and Stockland all buying back stock post results, and also continued asset recycling and management of debt and hedging.

"Westfield joined the list with their announcement of a $9 billion war chest and a 10 per cent buyback program to commence in March." Garing says Mirvac showed it was on the right track, doubling its development work.

"Mirvac's investment division continues to surprise on the upside with best-of-class momentum in its commercial development pipeline. Mirvac remains the third of our top three picks of the major REITs."

On Westfield, brokers say with the profits from the Stratford mall in east London joining the profits from Sydney City, near-term earnings certainty was significantly increased.

Garing says Westfield's long-term growth, above the underlying and built-in rent escalations, will come from the core $11 billion development pipeline and other "blue-sky" growth through new mega mall projects in new markets, like the Milan and World Trade Centre, New York projects, as well as through further expansion in higher growth markets such as Brazil.

For Stockland, brokers say, more than than most, it is trading on consumer sentiment and mortgage rate moves by the local banks.

One says its "three R" strategy, while differentiating itself from peers, is moving against the appetite of the marginal (retail, retirement and residential) equity investor, who appears to be nervous about residential and retail, with retirement not yet proving to be the recurrent earnings that Stockland had hoped.

Looking at GPT's results, analysts say, after taking what they call "easy wins" from the focus on reducing overheads and debt costs, GPT must now focus on improving ROE by growing its funds management business greater realised development profits and buying higher-yield industrial to allow it to trade nearer net tangible assets.

"GPT's retail metrics are showing signs of stress with arrears increasing 30 basis points ... with vacancy picking up to 60 basis," Garing says.

"We believe these metrics will deteriorate further, thus reducing earning-per-share growth."

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