After a period of stunning gains, the Australian Real Estate Investment Trust (AREIT) sector has lost a little steam this year. Value is still hard to find, but price weakness or consolidation in key AREITs is creating better opportunities for long-term investors.
The AREIT sector needed a breather. The S&P ASX 200 AREIT index soared more than 30% from January 2014 to February 2015. As with other interest-rate-sensitive sectors, the rally was driven more by sentiment than fundamentals at the peak.
Near-zero interest rates and a lower Australian dollar overseas enticed international investors to buy Australian property and drive prices higher. Also, record-low domestic interest rates encouraged income-seeking investors to buy AREITs for yield.
Critics argued the sector in early 2015 was badly overvalued in absolute and relative terms. Many AREITs traded at a growing premium to their net tangible assets (NTA) and the sector looked more expensive than the banks, which offered better yield after franking.
I was not quite as bearish. Although the AREIT sector traded about 15% ahead of NTA in early 2015, direct property transactions suggested future NTA values had to rise at least a few percentage points, such was the strength of property markets.
Also, the sector should be able to trade a few percentage points ahead of NTA because AREITs have liquidity benefits over owning property directly. And some AREITs have funds management or other assets that add value for unitholders.
Adding it up, the AREIT sector was arguably about 10% overvalued at its February peak. Since then, the sector has fallen about 6% and at one stage was down more than 13% as the sharemarket correction intensified in August and September.
Care, of course, is needed with AREIT indices because of their high weighting in a handful of large AREITs. But there’s enough to suggest value has slightly improved in higher-quality AREITs, such as Westfield Corporation, Goodman Group and Dexus Property Group (to be covered in a later column in the Switzer Super Report).
Value is always relative. In a sharemarket where revenue gains hard to find, and earnings growth is becoming less reliable, the big AREITs offer a better risk-adjusted return than most sectors. Long-term leases on prime properties are less volatile than corporate earnings and there is much to like about the sector’s transformation since the 2008-09 GFC, with less debt on balance sheets and greater focus on managing property returns.
Westfield stands out
Westfield Corporation has several attractions: high exposure to the strengthening United States economy, no exposure to Australian retail, and potential for significant rental increases when a number of leases are reviewed from 2017. Asset valuation revisions and potentially a lower Australian currency in 2016 are other pluses.
Westfield’s US exposure is a key strength. I have become more bearish on Australia-focused retail REITs this year. Rising consumer confidence and improving retail sales growth are good news for shopping-centre owners. But gains could be short-lived as house prices in Sydney and Melbourne fall 5-10% next year and consumers feel less wealthy. Ongoing problems in department stores, and weakening performance from key anchor tenants, such as Woolworths, are other concerns for local shopping-centre owners.
Westfield Corporation has 71 % of assets under management in the US and 29 % in the United Kingdom. About three-quarters of its assets are in flagship retail properties and more funds are being invested in this segment over its lower-graded or non-core properties.
Continued improvement in the US economy in the next few years should further improve tenant occupancy rates and reletting outcomes at flagship Westfield properties. Compared with Australia, US retailing has stronger tailwinds in the next year or two.
Westfield should lift lease rates at its legacy US assets, thought to be 5-10 % below prevailing market rates, when they are renewed in the next few years. That should support medium-term earnings growth as its flagship centres attract higher rents and occupancies.
Asset valuations should be enhanced as several key projects in Westfield’s development pipeline open or near conclusion. The Village project at Topanga in Los Angeles opened in September 2015 and is 95% leased. The $1.4 billion Westfield World Trade Centre in New York is fully leased and is expected to open in the first half of 2016.
Major expansions of shopping centres in the UK and Italy in the next few years should add to Westfield’s NTA as these properties are further upgraded. The potential for apartment sales at UK properties not widely focused on in the market could also boost Westfield earnings. The result, a rising NTA that support a high price for Westfield next year.
Westfield has a good strategy. Focus on the higher-growth US economy, convert more properties to flagship assets, and lift medium-term rents and asset valuations.
Westfield’s total shareholder return (including distributions) is 12 % over one year to December 2, 2015. The S&P/ASX 200 AREIT accumulation index has returned 17 % over that period. After strong gains in 2012 and 2014, Westfield has had a period of consolidation this year. It should outperform the AREIT sector in 2016 given its exposure to the US economy, the quality of its assets and its operational performance.
Macquarie Equities Research has a $12.13 price target in 12 months for Westfield. Morningstar has a fair value of $11. At the current $9.68, Westfield is undervalued on those forecasts. The market, generally, has mixed views on Westfield, with sell and hold recommendations slightly outnumbering buys, according to consensus analyst estimates.
On this occasion, I’ll side with the bulls on Westfield. A 3.7 % forecast yield and the prospect of reasonable capital gains suggest Westfield should outperform its sector and the broader sharemarket in 2016. A lower Australian dollar, part of my thinking for 2016, would be another earnings tailwind
Westfield Corporation (WFD)
Source: Yahoo!7 Finance, 2 December 2015
Goodman Group’s attractions
Like Westfield Corporation, Goodman Group has a high proportion of overseas earnings. More than half of its revenue comes from its European, United Kingdom, and Asian assets. It is also building a stronger presence in the United States through development projects and is particularly strong in industrial property in Continental Europe.
About half of Goodman’s assets are in warehouse/distribution facilities. The rest are spread across industrial estates, business parks, landbank developments and office parks. The group had $32.3 billion in assets under management in the first quarter of FY2016.
Goodman had a solid first-quarter trading update. It reaffirmed earnings guidance of 39.4 cents a share for FY16 – slightly ahead of market expectation. The guidance is possibly a touch conservative given the backdrop of rising property asset values.
Goodman continues to recycle capital successfully from lower-return properties into higher-yielding new assets. Its development work in progress increased 12.7 % to $3.4 billion in the first quarter of 2016, spread across 78 projects.
Importantly, Goodman expects the new projects to have a forecast yield of 8.7 %. Simply, assets that were yielding 5-6 % are increasingly being sold and capital rotated into higher-quality projects that earn better returns.
Goodman’s strategy of owning offshore industrial properties has merit. Global pension funds, thought to be underweight industrial property, should find greater attraction in this lower-yielding, lower-risk asset class in a low interest-rate environment. In time, that should drive more funds into Goodman’s fund-management platform.
Growth in online retailing and moves to better integrate global transport supply chains should also support greater investment in industrial property. The global agribusiness sector, for example, requires trillions of dollars in supply-chain upgrades as more food must be moved, stored and processed to feed a growing global population and expected middle-class consumption boom.
Like Westfield, Goodman is in the right place at the right time as several tailwinds drive property demand, earnings growth and asset valuations over the next 3-5 years.
However, the market has mixed views on Goodman. Four of 10 broking firms that cover it have a buy recommendation, five have a hold and one a sell, consensus analyst estimates show. A median target price of $6.38 suggests it is near fair value at the current $6.25.
Goodman can beat market expectation as it raises equity from wholesale investors at lower rates and recycles more capital into higher-earning projects in the medium term. In the long term (five years plus), its exposure to higher-quality industrial projects worldwide has latent strategic value as global supply chains are upgraded and expanded.
Like Westfield, it has underperformed the broader AREIT sector over 12 months with a 13 % return after strong gains over three and five years. Goodman, too, looks well positioned for its next leg of unit-price growth after a period of consolidation.
A 4 % yield is another attraction, although Goodman suits long-term investors wanting a mix of income and capital growth from global AREITs, and who can tolerate higher risks from AREITs that have a stronger project-development focus.
Goodman Group (GMG)
Source: Yahoo!7 Finance, 2 December 2015
– Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at December 2, 2015
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
