SYDNEY: With Australia expected to cut interest rates, beleaguered property trusts could see their rental yields become more attractive, but the bad news that has battered the sector may rumble on.
Australia's highly leveraged real estate investment trusts, or REITs, have suffered as the global credit crunch lifted borrowing rates and raised questions about a practice of using nonrental income to increase dividend payments.
GPT Group, Mirvac Group and Babcock & Brown - which have listed REITs - have issued profit warnings and seen their share prices dive.
Centro Properties Group set off the bearish mood when concerns about debt refinancing emerged early this year.
The S&P/ASX 200 REIT index has lost 42 percent since a peak last October, but has picked up more than 20 percent since mid-July.
Some investors say U.S. bailout of housing giants is inevitableU.S. businesses face economic dilemmaDoubts on global economy undermine shares.
Some analysts say the sector is still 20 percent undervalued, and rate cuts would ease pressure on the securities, which pay most of their rent to investors as dividends.
After more than a decade of expansion backed by a commodities boom as the nation sold iron ore and copper to China, the Australian economy is now seeing signs of weakness, with consumer spending sapped by rising fuel and mortgage costs.
The Reserve Bank of Australia said that it would not wait for inflation to fall before lowering interest rates, giving the clearest indication that it would ease monetary policy next month.
"As the RBA begins the easing cycle, this will make REITs more attractive from a yield perspective," said a Merrill Lynch analyst, John Kim.
The weighted average dividend yield for Australian REITs is 7.8 percent, slightly above the central bank's cash target rate of 7.25 percent and compared with a 10-year government bond yield of 5.8 percent.
"The large cap A-REITs will benefit the most, as equity and global property investors revisit the sector, now that one of the major headwinds against the industry appears to be headed for a reversal," Kim added.
During the last two periods of falling interest rates, in 1996 to 1998 and in 2001, REIT prices rose 6.7 percent in the following 12 months, according to UBS.
UBS said that groups active in residential development, or which have large domestic floating debt exposure, should benefit most, pointing to Stockland Group and Mirvac as examples.
Affordability has become an issue for Australia's residential market of nearly 3 trillion Australian dollars. Home prices have jumped fivefold in 20 years, while household income has only doubled, so lower borrowing costs should offer homebuyers some relief.
But even if the central bank cuts its policy rate, lenders could still be reluctant to adjust their views of risk for property trusts, said Clement Chong, vice president and senior analyst for Moody's Investors Service.
In May, Moody's said it maintained a stable outlook on the ratings of Australian REITs over the next 12 months, but warned that a challenging credit environment and softening property fundamentals in some overseas markets were risks.
Dugald Higgins, associate director for Property Investment Research, said that a deteriorating global economy could hurt REIT earnings, as commercial property values and rents suffered in Australia and the United States, where many Australian trusts own shopping malls, offices and warehouses.
"It will only take a piece of bad news to hit the market, and I imagine we will see a lot of people jump ship again," Higgins said. "Valuations, fundamentals are still pretty much out the window and have been in the last six months and I don't see that changing a lot throughout the rest of this year."
Babcock & Brown, which has listed real estate vehicles, has seen its share prices tumble after a profit warning due partly to revaluation of real estate assets. Babcock & Brown shares have sunk to below 4 Australian dollars, or $3.47, from almost 35 dollars in June 2007.
Office vacancy rates in Australia crept higher in July, prompting property executives to predict the global credit crunch would take its toll on rents and the value of buildings.
As the market braces for earnings announcements from REITs, investors will watch property valuations to see whether the trusts apply mark-to-market accounting.
The practice, which has gained ground in Britain, relies on indexes rather than appraisals of individual buildings, and allows companies to adjust their asset valuations faster.
"Typically in Australia, we've still got six monthly valuations," said Tim Nation, director of international investment at DTZ. "It just inherently slows down the ability for asset values to reflect where the market thinks the pricing should be."
(20min delay)