Australian REITs Refocus

Ernst & Young’s 2012 Global REIT Report: Over the past few years, Australian REITs, or A-REITs, have restructured their balance sheets by paying down debt and selling assets worldwide.

From Ernst & Young’s 2012 Global REIT Report 

Over the past few years, Australian REITs, or A-REITs, have restructured their balance sheets by paying down debt and selling assets worldwide. From the end of 2009 until early March 2012, A-REITs covered by SNL, a provider of business intelligence services, sold 1,039 properties worth $16.2 billion.

A large component of this sell-down has been a retreat from offshore investments, such as the sale last April by Tishman Speyer Australia Limited of Tishman Speyer Office Fund (TSO), which owned 16 high-quality commercial office properties in the U.S.   Some A-REITs are also buying back shares with proceeds from their asset sales. In February 2012, global mall owner and developer Westfield Group announced a buyback of 10 percent of its stock using capital from the sale of assets in the U.S. and U.K. 

While domestic investors are cautious about investing in A-REIT equities, and some domestic and foreign banks have pulled back from lending to A-REITs, Australian pension funds are showing some initial interest in providing debt financing to A-REITs to fill the gap left by retreating banks. And some offshore investors have demonstrated an interest in capitalizing on the current Net Asset Value (NAV) discount implicit in A-REIT share prices.

Market outlook

Today most A-REITs are in a stronger financial position; however, memories of their steep losses during the global recession and financial crisis still linger. A-REITs have yet to win back the full trust of the investor community, and many of their shares continue to trade at discounts to NAV although recent months have seen that price gap continue to close. Some investors are putting money into unlisted property funds and direct investment that otherwise might have been invested in A-REITs.  Some offshore commentators believe that Australia’s property values are high relative to other global property markets and therefore contribute to the NAV gap. But perhaps the primary reason is that investor confidence in A-REITs has been slow to return, and A-REIT share prices slow to recover, after some A-REITs moved beyond the traditional passive income model to take on higher-risk investments, mainly in overseas properties.

As long as A-REITs’ shares continue to trade at discounts to NAV, any property acquisitions they make will likely dilute their earnings.  In an ongoing effort to restore investor confidence, A-REITs continue to de-risk their business models, by reducing their offshore exposure or narrowing their strategic focus to those property classes where they have a core competency, for example. They are also looking to improve operating efficiencies through investment in upgrading IT systems and transforming back-office processes. The reduction in the discount to NAV at which many A-REITS are trading suggests that these initiatives, together with the impact of share buybacks, are starting to pay dividends.

Larger players report that financing today is more available from a wider range of sources, at lower margins and for longer durations. However, diversity of debt sources is still a concern to the approximately one-half of Australia’s REITs that are not rated and therefore do not have access to bond markets as a funding alternative. In earlier times, as an alternative or supplement to borrowing, A-REITs could raise equity capital in secondary stock offerings to help finance property investments. But the fact that A-REIT shares have been trading at discounts to NAV has precluded this option.  Some smaller A-REITs have higher debt loads and among these, some are struggling to service their debt. For the major REITs, the issue is more about loan maturities. In the course of refinancing existing debt or, if they so decide, taking on new debt, REITs are trying to stretch out the maturities over a longer period of time to mitigate the maturity risk. In the past, REITs sometimes have had several loans reaching maturity within a relatively short time period. When debt markets began to dry up, this increased the pressure on them to pay off or refinance the loans, leading to some of the highly dilutive capital raisings that occurred at the height of the financial crisis. 

Today, a few well-capitalized A-REITs experienced in investing overseas continue to invest in global markets, but most A-REITs are focused on the Australian market. They have gone back to basics by concentrating on clearly defined sectors of the market that complement their core competencies and generate reliable income streams, mainly from rentals. Australia’s commercial property markets are reasonably healthy and are generating stable cash flows for A-REITs and other owners. The industrial property sector is improving and attracting more investment interest. Some retailers are struggling, but this has not yet had a significant impact on the market for investment in institutional retail properties.