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Ann: Change of Director's Interest Notice - David Bryant, page-15

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Investor Bob

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23/03/23

11:06

Post #: 66917617
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Originally posted by Arpeebee ↑

I don't have the answer @pete11 but you raise an interesting point.
Distributions are funded from the underlying and recurring cash earnings of the Group’s operations (AFFO). Capex spending is included in the calculation of AFFO. 1H23 spend was $31M. This accelerates to $106M in FY24.

@Investor Bob has rightly pointed out that based on FFO ratio is 115%. He is not alone in worrying about the debt. The market clearly has concerns about asset valuations. Interestingly Gearing is forecast to increase to 38% (40% with Kaiuroo settlement) which breaches their target range of 30% - 35%.

Given RFF's Increase in earnings was primarily due to positive revaluations, what are the implications if valuations stop rising?
The following article, whilst primarily about commercial property, provides some interesting commentary on revaluations and gearing:
Property is ‘sleepwalking’ towards its biggest test since the GFC
Interestrates have soared, but commercial property values have barely moved. Investorswant little to do with a sector heading for a big dose of reality.

Mar20, 2023 – 5.00am

Asone of the country’s top fund managers reminded Chanticleer recently,monitoring the actions of a company’s executives and directors is a tried andtested investment strategy.

Whenan insider buys, you buy. When they sell, you sell. And when they walk away,you always ask why.

Ourfund manager and his team have spent months hunting for value in Australia’sASX-listed real estate investment trusts, attracted by a group of stocks thatare trading at discounts of up to 40 per cent to the value of the assets ontheir book, which in the property sector is called a REIT’s net tangibleassets.

Butin the end, he says he just needed to follow the insiders.

Thechief executives of four of the country’s seven largest REITs have eitherrecently departed, or announced plans to. Scentre Group chief executive PeterAllen retired on September 30 last year; Vicinity Centres boss Grant Kelleyleft last November; Mirvac’s Susan Lloyd-Hurwitz signed offlast month and GPT’s Bob Johnson announced last month hewill retire by the end of this year.

Whilethe retirement of four long-standing executives is not necessarily a surprise,the fund manager says it’s become clear the quartet got out at the top of thecycle.

Suddenly,the five key drivers of the commercial property market – occupancy, rents,valuations, incentives, and cost of debt – are all moving against the sector atthe same time.

Hebelieves the commercial property sector is sleepwalking towards a painfulperiod that is likely to involve plunging asset values,distressed property sales and potentially even capital raisings.

Aveteran banker to the sector is similarly bearish. “These guys have had atailwind from falling interest rates and rising valuations for 20 years. Thiswill be their biggest test since the GFC.”
Itseems like every day brings a weird and wonderful story from the world ofcommercial real estate. In Europe, private capital giant Blackstone defaults ona bond backed by Finnish offices and retail outlets. In America, investors fromthe Pacific Investment Management Co. to the Columbia Property Trust default onbonds, while property developer RXR had handed back the keysto some of its Manhattan office buildings.
Butin Australian commercial property, it’s what is not happening that is mostremarkable.

WhereNorth American commercial property values fell by the second most on record inthe December quarter, and European valuations are recording similar falls, theFebruary reporting season delivered a baffling lack of movement.

MorganStanley analyst Simon Chan says capitalisation rates (basically the propertyversion of yields, which move in the opposite direction to valuations) movedjust 0.11 per cent in the December half, to around 5 per cent, despiteAustralia’s 10-year bond rate surging from 1.4 per cent to 3.6 per cent overthe course of last year.

Justas remarkably, Chan says NTAs fell just 0.6 per cent in the December half.

Thiswould appear to be fantasy land stuff, given the movements in listed propertyvaluations and in overseas markets. But the methodology by which independentvaluations of properties are conducted allows REITS to look investors in theeye and stand by their NTAs.

Propertyvaluers rely heavily on comparable transactions to judge what a building isworth. But because of the gap between what buyers think their property is worthand what sellers are prepared to pay, properties are being pulled from salebefore the owner has to swallow a much reduced price; The AustralianFinancial Review’s property editor Nick Lenaghan revealed on Saturday how super fundgiant REST had yanked a Melbourne office building from sale afterreceiving bids about 15 per cent below book value.

Chansays transaction values across the industrial, office and retail sectors cameto about $300 billion in 2022, which was a third lower than in 2021 and between20 per cent and 25 per cent lower than in pre-COVID times. Fewer transactionsmight protect valuations for now, but they also mean the risk of a disconnectfrom market realities is growing.

Sowhat are the REITS playing at?

“Theminimal moves in asset values and cap rates can only mean two things in ourview,” Chan says. “The revaluations in the [REIT’s] August 2023 results will bemore material and the listed asset owners have simply delayed the inevitable,and/or the REITs are gripping onto their current book values and metrics,hoping that they can grind out the next 12 months to 18 months, with pressurealleviated when interest rates start to decline in 2024.”

Material revaluations may only be months away

Chansays diplomatically that the lack of movement in valuations “could indicate thetraditional REIT valuation metric of price-to-NTA is less dependable”.

Giventhe steep discounts to NTA that REITS are trading at, the market seems to sharethe less polite view of our fund manager: NTAs are fiction right now.

To befair, bond markets are suggesting that rates will eventually come down,possibly as early as the later stages of calendar 2023. But those cuts arelikely to come well after the sector’s next balance date of June 30. Materialrevaluations may only be months away.

Ifvaluations were to fall between the 15 per cent implied by the REST example,and the 20 per cent drop that will occur if cap rates rose from 5 per cent to 6per cent – as observers such as Shane Quinn, chief executive of boutique fundmanager Quintessential Equity, believe is likely in the office market – thenpressure could build on REITs which are testing the top end of their targetgearing ranges.

Macquarieanalysis shows that since the GFC, gearing levels across the REIT sector haveremained stable at between 25 per cent and 35 per cent. But the amount of grossdebt has risen from about $200 billion to around $375 billion over that period,and if valuations start falling, the divergence between debt and gearing couldstart to close again.

REITshave a few options to reduce debt. They can hit pause on developments,something several, including Mirvac, announced they would do last month. Theycan sell assets into a market that may show distress. Or they can raisecapital.

Ourbanker says selling a property at a 15 per cent discount will be more palatablethan the incredibly dilutive capital raisings that the sector was forced toundertake during the GFC. Those raisings still haunt the sector – even sectorleader Goodman Group, which has ridden a logistics property boom to deliver adecade of strong share price growth, still trades below its 2007 share pricehighs.

Industryleaders are pinning their hopes on strong rental growth offsetting any rise incap rates. At an event hosted by Citi earlier this month, Charter Hall chiefexecutive David Harrison, pointed to strong occupancy levels and the 3.6 percent rental growth the group gets on its office properties “every friggingyear” as evidence of the attractiveness of the Australian commercial propertysector.
“Thereis no doubt Australia has always had, and is continuing to get, the mostattractive rental annual bumps in the world.”

Heand Dexus chief executive Darren Steinberg agreed there was pain coming forparts of the market, but expect bifurcation between newer, greener and moremodern stock and older properties. This is particularly the case in the officemarket; Harrison says those with second tier stock could be “looking atUS-style 20 per cent vacancies”.

Unsurprisingly,every REIT chief executive seems to believe they are on the right side of thisbifurcation. And none countenance a fall in second tier rents and valuesdepressing the top tier too.

Thereis also a question as to whether rental growth will be as strong if thepredicted economic slowdown arrives. Rental collection was strong in theDecember half across the sector, but what that looks like a year from now is afascinating question.

It’simportant to note that different parts of the commercial property sector arelikely to experience different rates of change in the next 12 months.

Theoffice market, still adjusting to remote work and oversupply in key marketssuch as Melbourne, is generally seen as most vulnerable.

Retailhas held up well but faces a test as consumer spending slows.

Industrial(particularly logistics) has enjoyed a strong few years and should benefit fromthe realignment of supply chains, but valuations are high and there are signsoverseas logistics markets are slowing as ecommerce normalises after thepandemic.

Rightnow, investors don’t seem to be discriminating too much between commercialproperty’s sub sectors. They’re just waiting for the industry to get its bigdose of reality.

Expand

I never did like the office sector but this is definitely a warning to all REIT's
Raising capital is only going to become more expensive and hit share registers hard.

RFF Price at posting: $2.02 Sentiment: Hold Disclosure: Held
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