Property sector round up 2012

A year ago, when we reviewed the listed property sector, we found four companies worth buying: Westfield Group, Westfield Retail Trust, Australand and Abacus Property Group (see Clouds clearing for A-REITs from 7 Oct 11). ALE Property Group was added to that list during 2012. A year on and they've generated total returns of nearly 30%, whilst taking on less risk than the overall market.

The ASX300 A-REIT index meanwhile has returned 33%. Listed property has been a fantastic place to invest in 2012, as falling interest rates and a chase for yield have stoked demand.

So, considering the market's appreciation, is there still value to be found and where should you focus your money? In short, value is thin on the ground, with no current buys in the sector, but there are plenty of businesses worth holding onto. Let's start with the retail groups.

Retail A-REITs

In January we highlighted that Australia retail rents were excessive compared to global peers (see Reassessing Westfield—Part 1 from 25 Jan 12). Concerns remain, making continued steep rental growth unlikely. Excess returns will be driven by company's ability to create value through property development. And in this we continue to favour Westfield Group, which gives investors global exposure and access to one of the best property management teams. HOLD.

Westfield Retail Trust, which primarily owns assets in Australia, remains our pick of the local options. It's also a HOLD. As is Carindale Property Trust which, in conjunction with Westfield, owns 50% of the Carindale shopping centre in Brisbane. A recent renovation means earnings are likely to increase in 2013, HOLD.

Elsewhere, we recommend steering clear of the poorer quality, regional and suburban focused portfolios of Federation Centres (formally Centro Retail) and Charter Hall Retail REIT. Charter Hall is also busy exiting an ill-conceived expansion into the US and Europe. Both also trade at premiums to their net tangible assets (NTA), meaning we're also not interested on valuation grounds. Both are AVOIDs.

CFS Retail Property Trust holds more appeal, owning the Chadstone and Myer centres in Melbourne, and Chatswood Chase in Sydney. It too is nearing full value, for now HOLD.

BWP Trust which owns warehouse centres primarily filled with Bunnings hardware stores has been on our radar for a while, given its attractively structured long leases and low gearing. Management, though, raised our ire during the global financial crisis, raising capital unnecessarily. Still, at a 19% premium to NTA, there's no margin of safety at the current price. AVOID.

Similar to BWP, Woolworths recently spun off a portion of its property assets into the newly listed SCA Property Group. But as we explained in Not WOWed by SCA Property Group on 16 Oct 12 (Avoid – $1.50), the structure of the leases and the full valuation make it less attractive than BWP, despite being superficially cheaper. AVOID.

Office A-REITs

In the office sector there are three options. Commonwealth Property Office Fund and Investa Office Fund both own prime assets in Australia's capital cities and have manageable debt levels. While we note that both portfolios are practically full, and a steep economic slowdown could hurt demand for office space, both appear reasonably priced. HOLD.

Not so, Cromwell Group, which has a lower-quality portfolio and key tenant risk, with Qantas being responsible for nearly 10% of the group's income. The current security price premium to NTA appears unwarranted and the debt is too high. AVOID.

Diversified A-REITs

Here there are plenty of options. Starting at the small, lower-quality end of the spectrum, FKP has done a spectacular job of destroying investors' capital. Despite a recent capital raising, it remains highly indebted and there are question marks over the value of its retirement assets. I pitched the stock to our internal vetting process, but we collectively decided to pass. AVOID. (For more on FKP see Buying FKP.)

Similarly Aspen Group, which owns a motley collection of properties, from caravan parks and office towers to wool stores, has freed investors of plenty of capital over the past decade. However, a recent capital raising has reduced debt to a manageable level and management has been replaced with a more shareholder friendly group. Aspen was also put to our internal review process, but the share price ran away before we had a chance to upgrade. It's not without risk, but we're happy to HOLD.

Challenger Diversified and Growthpoint Properties both carry too much debt for our liking. And, in regards to the former, we have little faith in management's ability to make sensible acquisitions. AVOID.

Merger activity also seems likely over the next year or so. Australand has been targeted by GPT Group, and there has also been speculation that Mirvac might make a tilt. Both are keen to acquire Australand's industrial assets – which may become more important as internet shopping drives demand for warehouses. For now, after selling out in Australand: Sold from 09 Oct 12 (Sell – $2.98), we're not too disappointed with missing out on the additional, and unexpected, gains. It remains a SELL.

GPT owns the best property portfolio in the country and Mirvac is not far behind, and neither appear expensive, trading at 3.3% and 8.8% discounts to their respective NTAs. HOLD.

Abacus Property Group is a company we've previously recommended. We are impressed with management's approach of buying poorer performing properties and improving them. It is hovering around the price where we'd upgrade but, for now, it's a HOLD.

Returning to the larger players, Stockland's focus on retirement, residential and retail assets may be in doubt following the departure of long-standing chief executive Matthew Quinn. The security price has also risen about 10% this year despite a clear admission that the company's residential development division is performing below expectation. We're close to exiting; until then HOLD.

Goodman Group are smart operators. In a similar vein to Westfield, Goodman can potentially create plenty of shareholder value via developments and joint ventures. It also grants investors exposure to more attractive overseas markets though a $20bn funds management business that covers Europe, China, Japan, New Zealand and, more recently, Brazil. This helps justify the stock's large premium to NTA, but only to a degree. We'd upgrade to HOLD below $4, for now AVOID.

Dexus Property Group is another we'd own at the right price. It has extracted itself from its misguided expansion overseas, following the recent sale of its US industrial portfolio at a 13% premium to book value but, at around asset backing, it is starting to look fully valued. HOLD.

Lend Lease is now less of a property trust and more of a developer/contractor following its sale of property assets and the purchase of Valemus in 2011. This makes it prone to large swings in earnings. Still, many respect Lend Lease as one of the best in the business, which we don't doubt. But it's a vastly complex business, operating in a very difficult industry. Don't let Lend Lease's size and brand name fool you, this is a high-risk business. AVOID.

Other options?

The ASX also offers a couple of more obscure property investments. Astro Japan (a former Babcock & Brown vehicle), for example, owns retail and office property, mainly in Tokyo. This stock too faced our internal 'dragon's den' late last year, but didn't survive the flames. A year on, the thesis has played out mostly as expected and, despite the high debt levels (which are somewhat misleading due to the structure of the debt), it's worth holding onto. HOLD.

ALE Property Group, an owner of 87 pubs leased to a joint venture owned by Woolworths and pub baron Bruce Mathieson, is a particularly attractive property investment, owing to the long fixed lease structure and potential to increase income following any rent reviews. This helped earn ALE a positive recommendation for the majority of the year. Below $2.25 we recommend you Buy, but with the share price up 4% since A still-tempting ALE from 30 Oct 12 (Buy for yield – $2.25), we're downing a notch to HOLD.

There's also a number of companies too small for Share Advisor to officially cover, including RNY Property Trust, Mirvac Industrial Trust and Real Estate Capital Partners USA Property Trust. The Intelligent Investor Value Fund owns these stocks and has discussed them in more detail on the Bristlemouth blog. They may hold some interest for more adventurous members.

Focus on quality

All up that's 28 property stocks, and half are worth holding, although none are cheap enough to buy right now. Returns from here are likely to be more subdued and tilted towards distributions rather than capital growth. Opportunities arose throughout the past year, however, and there are bound to be plenty more in 2013.

Note: The model Growth portfolio owns shares in Abacus Property Group and Westfield Group, whilst the Income portfolio owns shares in Abacus Property Group, Westfield Group and ALE Property Group.