The coming day of reckoning is mostly for unlisted REIT.
TOT current 35%+ NTA discount might be overcooked. There's a chance the SP might recover to mid-80s by August when FY results are announced if published NTA is cut by 20% only.
Might get a chance to top-up if it gets under 70s with all the current bad publicity for REIT and EOFY tax-loss selling.
The sale of a half stake in Sydney’s tallest office building, the $2 billion Salesforce Tower overlooking Circular Quay, is on pause with bids about 10 per cent lower than hoped for, the latest evidence the surge in interest rates could wipe billions from Australia’s office sector.
Late on Friday ASX-listed Dexus, one of the country’s largest owner of office towers, added a crucial piece of evidence to the emerging picture that a major reset in values is under way.
Dexus announced it had finalised the sale of a 26-storey A-grade office at 44 Market Street in the centre of Sydney – home to the ABS – to a Hong Kong private equity player PAG for $393.1 million, a 17 per cent discount its December book value.
“This should worry a lot of office owners,” veteran investment manager Winston Sammut at Sequoia Financial Group told The Australian Financial Review.
The jump in long-dated bond yields has put pressure on commercial property, especially office towers, for more than a year. While ASX-listed landlords have felt the pain – the uncertainty has sent property stocks tumbling – the holders of unlisted assets, including some of Australia’s biggest super funds, are next in the firing line.
The office sector is under pressure on all fronts. Occupancy rates are weakening, while the price of debt and construction costs have risen. The work-from-home trend has prompted employers to reconsider their requirements for office space, adding further uncertainty to the sector.
Despite that, the valuations ascribed to office towers by the major landlords have remained relatively resilient – and unrealistically so, according to the bears – until now.
Material softening
The sale price of 44 Market Street is also 22 per cent below its Dexus book value of a year ago – $507 million – an indication that the December valuation recognised, albeit modestly, that there are headwinds blowing across the office sector.
Buried in the metrics of the Market Street transaction – although not announced – is key evidence for valuations which analysts quickly seized on. That is the deal’s capitalisation rate, or cap rate – the industry jargon for an investment yield – which move in the opposite direction to values.
The cap rate for Market Street is an estimated 6.5 per cent, one percentage point higher than the building’s cap rate of 5.5 per cent recorded in December.
It represents a very material softening in cap rates which could signal hefty write-downs in valuations across the office market sector.
”The transaction serves as a key market evidence data point for the Sydney office market and we therefore anticipate a shift up in cap rates throughout 2023 in the office market impacting the listed and unlisted peer group book values,” City analyst Howard Penny wrote on Monday.
The steeply discounted deal shows times are changing even faster than many landlords have registered in their books. And Dexus is by no means alone in that.
It is a wake-up call for Australia’s office tower owners: from the publicly listed real estate investment trusts (REITs) and fund managers, to the owners of unlisted assets, ranging from major super funds, to small syndicates and wealthy families.
The Market Street discount speaks volumes as the major ASX-listed REITs – such as Dexus, Carter Hall, Mirvac, Stockland and GPT – are completing the June 30 valuations for their office portfolios. Many may already be complete.
While those valuations should recognise the evidence of the Market Street deal provides for a broader recalibration in office tower values, it may have come too late for some portfolios, according to Sequoia’s Mr Sammut.
“If they don’t the reflect those numbers [implied in the Market Street deal] then the worst is not over,” he said.
“What’s going to happen now is that the unlisted stuff should be where the brunt of the pain is going to be. They haven’t revalued downwards as much, whereas the market has done it for the REITs.”
The Dexus deal, while significant in itself, is not alone. The prices agreed in a clutch of major deals under diligence also point to major discounting in book values.
Non-deals
Among them, ASX-listed Mirvac is hoping to finalise the sale of 367 Collins Street in midtown Melbourne – better known as the Optus centre – for around $365 million, a 12 per cent cut on its December book value.
Dexus is also looking to sell another Sydney tower, 1 Margaret Street, where top accounting firm BDO has its headquarters, for $296 million, a 15 per cent reduction to its latest book value.
Just as important are the non-deals, with some major owners reluctant to meet market offers. The latest example is Chinese insurance giant Ping An’s effort to divest a 50 per cent stake in the recently completed Salesforce Tower, designed by top global architects Foster + Partners as a landmark overlooking Circular Quay, the city’s tallest office tower.
The best offers for that stake came in bids with around a 5 per cent cap rate. Yet in June last year Lendlease, which developed the 55-storey building at 180 George Street, brought its investment arm in for a 20 per cent stake on a 4.25 per cent cap rate. That investment last year valued the tower at around $2.2 billion. The latest bids imply the tower is worth around $2 billion, or a 10 per cent fall in value, according to market sources.
Jefferies analyst Sholto Maconochie said it might take several rounds of office market valuations to reflect the full extent of the office market reset under way.
“They will mark them down over time. It will be death by a thousand cuts. With real estate, valuations go up in the elevator and down by the stairs,” he said.
“It’s the calm before the storm. Unfortunately, they don’t mark to market as much as they should because there is not enough transactional evidence. It is going to happen, it’s just a matter of time.”
The seeds of a major recalibration in office values were sown close to 18 months ago. Interest rates began rising around the world as central banks fought to contain inflation that resulted from pandemic-disrupted supply chains and the Russia’s war in Ukraine. As rates rose, so did the long-term bond yields, the risk-free rate against which returns from property are typically compared.
With tenants delivering revenue over long-term leases, real estate, especially commercial property, is regarded as a bond proxy. It commands an investment yield – the cap rate – at a little above the risk-free rate. Cap rates are the sector’s shorthand for value. As cap rates rise, values fall, all else being equal.
But cap rates for office towers – and corresponding book valuations – have scarcely budged in the past year even though the yields on long-dated bonds have jumped.
Dramatic sell-off
That disconnect has had analysts and investors wondering when the write-downs would come finally. While landlords stood their ground, stockmarket investors made up their minds long ago, in a dramatic sell-off that began early last year as bond rates began to rise. The REIT sector fell by 25 per cent last year – and many are still trading at substantial discounts to their portfolio values – as the broader sharemarket dropped 5.5 per cent
As bond rates shot up and REIT stocks plunged, owners of commercial property, both listed and unlisted, may have been hoping they could simply ride out the storm, holding values relatively steady until interest rates began easing again. Major landlords are also hanging their hopes on a flight to quality narrative, with the newer buildings they have invested into winning more tenants, better rents and holding value compared to older towers.
But reality may have finally catching up with office tower owners, courtesy of the Market Street transaction.
Values in the direct commercial property market typically lag price movements in the more liquid listed market, where investors can respond quickly to business and economic signals. The price discovery process can be painfully slow. Deal flow grinds lower as sellers and buyers wait to see which will blink first. Commercial property deals sank 73 per cent to $5.3 billion in the first quarter to their lowest level in more than a decade, according to MSCI.
As well, commercial property valuers are hesitant to mark down book values in the absence of comparable transactions.
Dwight Hillier, managing director of Colliers valuations arm, says investors are expecting higher returns globally as interest rates rise. At the same time, there are fewer market participants, which leads to less competition and “tension on pricing”.
“People are pricing in uncertainty, which is not good for any real estate, whether it be residential, commercial, retail or even industrial,” he said. “People are baking in as much as they can to compensate them for the unknowns down the track.
”That’s why Dexus’ Market Street deal is important, and one that “will become a broader benchmark for the market”, Mr Hillier told the Financial Review.“
They will interpret it how they will. It is only one sale. We’re anticipating a deeper body of evidence over the coming months.
“It will certainly give the valuation fraternity and the broader market an additional reference point. It’s probably the first proper reference point that we’ve got in this current environment. So, it is certainly very important.”
TOT Price at posting:
72.0¢ Sentiment: Hold Disclosure: Held
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