moving forward with stability and confidence

Trust us: property gets prudent August 31, 2009

Article from: The Australian

WHEN Westfield boss Peter Lowy called an end to the traditional 100 per cent payout to enable the shopping centre giant to build a war chest of retained earnings for strategic growth, he introduced a new regime, not just for the company but the entire Australian listed property trust sector.

It signals a new era of conservatism for the battered and bruised industry as it picks itself up and clears away the debris after another reporting season characterised by massive losses and even bigger asset writedowns and impairment charges.

Back of the envelope notes suggest that in the latest reporting season, LPTs have written off more than $14 billion in asset valuations, with Centro, Dexus, Westfield, Stockland, Goodman and GPT writing off more than $12bn between them.

Most LPTs have either eliminated their distribution altogether or reduced it from 100 per cent. While many investors had assumed this was a one-off while the companies repaired their ravaged balance sheets, Westfield's decision to reduce its payout to between 70 per cent and 75 per cent from 2010 -- to build up retained earnings to an estimated $500 million a year -- suggests something more permanent.

And Lowy's comments that asset values have probably bottomed out spurred Charlie Aitken at Southern Cross Equities to declare that the worst was over for the LPTs. "That's from the biggest player in the sector and completely contrary to current analyst views," he said.

"As I scour through the Australian equity market I see no sector where I am more likely to double my money over the next five years than the listed property trust sector. In fact, I see LPTs as a strong buy on a one-minute, one-day, one-week, one-month, one-year and five-year view. After the meltdown comes the melt-up," Aitken said.

Warming to his theme, he continued: "If there is one sector I am totally maximum el toro on, it's Australian LPTs. We have made good money in Westfield, GPT and Stockland off the lows; now it is time to make real money in the rest of the sector where the mispricing is even greater. In highly aggressive, absolute return-based portfolios, I would have 30 per cent of my money in Australian LPTs. That's how bullish I am on this call."

With gearing levels falling after LPTs raised more than $14bn in fresh equity in the past nine months, and most externally managed LPTs trying to internalise their management rights and abandon their bungled offshore strategies, it won't be too long before the sector looks like what it was in the early 1990s: low-risk vehicles with 10-15 per cent gearing ceilings.

After a punishing two years, where risky strategies resulted in the death or delisting of some LPTs, massive losses, and billions of dollars of investor cash to save them from collapse, this new-found prudence is the only way they can win back shareholder support.

The recent round of equity raisings has reduced gearing substantially. On UBS numbers, Westfield's gearing is 34.8 per cent, Stockland's 20 per cent, GPT's 21 per cent, CFS Retail's 25.6 per cent, Goodman's 34.1 per cent, Dexus's 28.8 per cent and Mirvac's 17.7 per cent.

Westfield's leadership role in reducing distributions from here on, coupled with a decision to raise $US2bn of debt rather than equity, signals the next stage in the LPT cycle: a thawing in credit markets, which means M&A activity will soon return -- and not just in the listed sector.

Most LPTs are still trading at a big discount to net asset backing, making it cheaper to buy the trust than the real estate. There is also a growing list of wholesale unlisted vehicles that are desperate to sell assets or be taken over because of liquidity and debt issues.

In the case of the unlisted wholesale property sector, the situation is serious because it hasn't had the immediate fix of a rights issue that was available to listed vehicles.

This build-up in the property market goes some way to explaining the recent poaching in the investment banking sector. Earlier this month Merrill Lynch poached 10 members of the UBS property team, prompting UBS to poach most of JPMorgan's real estate team.

To date there hasn't been much M&A activity due to a poison pill embedded in the debt facilities of most LPTs, which has stopped at least five full-blown takeovers in the sector. This so-called change of control provision, which causes the debt facilities to become immediately due and payable on a change of ownership, would have been used by the banks to take back their money.

But as credit markets slowly thaw, the banks will increasingly overlook this clause and allow the mergers to proceed.

The change of control provisions are understood to have stopped at least two big companies launching a takeover offer for GPT in recent months.

Stockland has set itself up to be in the box seat when credit markets change by taking a cornerstone investment in GPT. With GPT now sorting out its messy joint venture with Babcock & Brown, it won't be long before the stalking begins.

The other big-ticket takeover target is thought to be Mirvac. It is cashed up and its share register is relatively open after a cornerstone investor, debt-stricken Middle East group Nakheel, recently dumped its 12 per cent stake.

Two years ago the then chief executive of Mirvac, Greg Paramor, was a keen seller after approaching companies including Leighton Holdings and Lend Lease. In December 2007 Lend Lease and Mirvac admitted they were having talks but the deal failed. At the time Mirvac's shares were trading at $6.20, compared with the current share price of $1.41. It is understood Leighton was also approached but rejected the offer on the basis that Mirvac's asking price was too high. Leighton has a big stake in listed property group Devine.

In the meantime, Mirvac is looking at buying out the remaining 66 per cent in the $300m Mirvac Real Estate Investment Trust -- a trust Mirvac manages that holds a $1bn portfolio.

Then there are the smaller, smashed-up LPTs still to be rationalised. Top of the list are Macquarie and ING, whose external model needs to be overhauled.

As a Melbourne LPT investor said: "After years of excess it is now time for REIT managers to add value by sound property management and astute acquisitions. We still need another phase of rationalisation to clean up the sector. The financial engineering of the past should be abandoned. There will be capital for good managers making EPS-accretive acquisitions through mergers and acquisitions or individual property acquisitions."

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