Australia | Mar 13 2017
Brokers sift through Australian Real Estate Investment Trusts (A-REITs) and re-allocate preferences, as office returns continue to improve and retail returns deteriorate.
-Growth rate for A-REITS at lows not witnessed since FY12
-Preference is to be overweight active stocks versus passive
-Developers managing apartment settlements with minimal defaults
By Eva Brocklehurst
Having passed the latest reporting period, Australian Real Estate Investment Trusts (A-REITs) are under the microscope as brokers sift through the sector and re-allocate preferences. Active groups are envisaged doing better than passive groups.
Macquarie forecasts long-term bond yields will rise and highlights the strong negative correlation between the A-REIT sector's share price performance and changes in the long bond. The broker observes A-REITs have not had a growth rate this low since FY12.
Macquarie's strategy is to be overweight in the growth vehicles such as Goodman Group ((GMG)), Mirvac Group ((MGR)), Lend Lease ((LLC)) and Charter Hall ((CHC)) at the expense of those more passive A-REITs that are not growing earnings attractively, such as Westfield ((WFD)), Scentre Group ((SCG)) and Vicinity Centres ((VCX)).
The broker notes the fund managers – Goodman Group and Charter Hall – are still enjoying elevated transaction fees while the developers are managing apartment settlements with minimal defaults – Mirvac and Lend Lease. Brokers observe the retail segment is slowing, residential strength is lasting longer, office is better than expected and the industrial segment is running as anticipated.
In terms of individual stocks, Macquarie believes dilution via asset sales is negatively affecting Westfield, Vicinity Centres and Charter Hall Retail ((CQR)) in FY17. Cromwell Property Group ((CMW)) is underperforming because of elevated performance fees in FY16 and problematic lease expiries.
Morgan Stanley continues to prefer those stocks that can add value and deliver superior growth through development, funds management or asset management, such as Goodman and Lend Lease. The broker prefers office over retail and believes the divergence between the two asset classes will widen, as office returns continue to improve and retail returns deteriorate.
The broker's preferred play in office is through Dexus Property ((DXS)), Mirvac or GPT Group ((GPT)). In retail, Scentre Group is considered a quality stock, while for more diversified exposure Morgan Stanley prefers Mirvac or GPT.
Morgan Stanley Upgrades And Downgrades
Despite the strong run in the year to date, Morgan Stanley believes Charter Hall will deliver superior growth in the medium term and upgrades to Overweight. The broker also takes up an Overweight stance on Mirvac and GPT. Mirvac has shown it is less reliant on a growing residential cycle and the broker believes its property trust is one of the best in the sector. GPT is expected to accelerate its growth profile as development and fund management earnings rise.
Morgan Stanley downgrades three A-REITs to Underweight, including Westfield, Investa Office Fund ((IOF)) and Stockland ((SGP)). Westfield is unlikely to re-rate, in the broker's opinion, from its elevated multiple until there is real evidence of a strategy driving superior free funds from operations (FFO) and asset growth.
Investa is supported by a takeover play from Cromwell and is viewed increasingly as fully valued. In the case of Stockland, its residential business remains relatively defensive but the broker is increasingly concerned about a slowing in the property trust. Morgan Stanley's top picks in the sector include Goodman and Lend Lease.
Ord Minnett considers the A-REITs around 8% undervalued and expects the sector, excluding Westfield, will deliver 4.7% growth in earnings per security on an weighted average basis in FY17 and 4.5% in FY18. The broker also notes the slowing of the retail trend continues while residential remain strong.
Ord Minnett expects an elongated residential cycle but believes volumes have probably peaked. The broker agrees settlement defaults are not, thus far, an issue. Better leasing markets are being experienced in office, and in Sydney this flowed through to higher net income and occupancy in the latest reporting period.
UBS agrees the challenges facing the sector have risen over the reporting season. Asset growth has likely peaked and retail sales continue to grind lower. Sydney office rents did little to affect A-REIT FFO while the housing market, which beat the expectations, is at peak levels. In this environment, UBS moves its global allocation to market weight from overweight but remains cautious about becoming too negative.
Australian real estate markets continue to be a preferred option for global capital and assets in the direct market are well bid, the broker observes. UBS finds value in select exposures such as Mirvac, Lend Lease, Westfield and Scentre Group. The broker observes serious headwinds in the retail sector, and suspects these may accelerate. UBS considers Mirvac is the best way to play the office segment and prefers Dexus over Investa.
The broker finds the variation in market valuations for the development businesses of Goodman, Mirvac and Lend Lease look unusually large and does not believe the market has the balance right. In this sense the broker favours Mirvac and Lend Lease over Goodman.
UBS believes the acquisition-led growth profile for Growthpoint Properties ((GOZ)) is coming to an end and downgrades to Sell from Neutral. Further de-leveraging is expected in addition to the underwritten distribution reinvestment plan, as management focuses on reducing gearing towards the middle of its 35-40% target range. Given the de-leveraging that will occur, growth in earnings per share is expected to be affected going into 2018.
In the case of BWP Trust ((BWP)), UBS believes leasing risk remains a headwind and also downgrades this stock to Sell from Neutral. The broker notes 23% of the portfolio expires over the next three years.
Five assets have already been vacated, with a further seven expected to be vacated in the next three years as Bunnings re-locates to more favourable locations left by the exit of Masters. A further nine vacancies are occurring in the next three years. Taking vacancy factors into account and assuming 12 months downtime, UBS expects there will be a hit to earnings in the vicinity of -1% and -2.2% in FY18 and FY19.
Another A-REIT that UBS sets its downgrade sights on is Vicinity Centres, downgraded to Neutral from Buy. The broker believes the decline in retail sales growth is a worrying trend, as is a large number of assets that are posting declines in sales. Hence, a buy rating predicated on a discount to valuation can no longer be justified. This company is well positioned for returns from various at assets, but UBS would like to witness an improved performance across the entire portfolio.
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