property markt in crisis, page-74

UBS have constructed a Real Estate Sector Strategy research note, highlighting the risks for the sector associated with falling property values. A summary of the key points is provided below.

UBS is expecting some cap rate decompression to start coming through in H2 CY08 in domestic markets (not withstanding a partial offset by rental growth which is still occurring). The "cap rate" is the discount rate used to determine the present value of a stream of future earnings. Typically this will be an appropriate risk-free return plus a premium to reflect the risk of that specific investment. Cap rate decompression refers to the increasing level of risk premium being priced into valuations of property assets.

We have already seen cap rates move upwards in the offshore markets (US, UK). In this environment, stocks with high levels of gearing are highly sensitive to falls in property values. We expect to see a steady stream of asset sales in an effort to de-risk balance sheets. In addition, while there have been some cuts to distribution in the recent results season, we expect this theme to continue as the higher debt costs start to bite and corporates come to the realisation that their distribution policy needs to better match the tougher environment.

The UBS analysis shows that Record Realty (RRT), Macquarie Countrywide Trust (MCW), Macquarie DDR Trust (MDT), Reckson New York Property Trust (RNY), Australian Education Trust (AEU) and Tishman Speyer Office Fund (TSO) are the most in need of de-risking their balance sheets. Conversely, Westfield Group (WDC), CFS Retail Property Trust (CFX), Mirvac Group (MGR), Dexus Property Group (DXS) and Stockland (SGP) look the most secure with limited risk from property devaluations.

In the current investment environment we would recommend clients review their exposure to the listed property trust sector in light of the above analysis. In particular, those clients who hold RRT, MCW, MDT, RNY, AEU and TSO may need to re-evaluate the prospects for these companies and the risks that holding a position presents.

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