Previously, the over 30% discount to NTA for TOT was a huge safety margin considering comparable REITs. But not anymore. I agree with EarlyRetiree above, the NTA for Office REITs (even A-grade) needs to be marked down significantly. Also, TOT isn't earning its current dividend payout so while nominally the dividend is high, a proportion is coming out of NTA.
<< The withdrawal from sale of a Melbourne office building after market bids fell well short of its book value has raised wider questions about commercial property valuations as rising interest rates roil markets around the globe.Upheaval across the global banking sector – from Silicon Valley to Zurich – has set alarm bells ringing on the stability of the global financial system and where the next area of weakness will emerge. Could commercial property, and in particular landmark office towers, be the next domino to fall?
Common to the challenges faced by both Silicon Valley Bank and Credit Suisse is their investment in long-dated bonds. Long-hold illiquid assets whose value has plummeted when marked-to-market: it’s a scenario which is familiar to the owners of commercial property including office towers, whose properties trade infrequently.Throw into that mix leveraging and the rising cost of debt, along with the declining need for floor space as employees embrace hybrid working. It’s a combustible mix that points strongly towards one outcome: writedowns in value.
If there’s a canary in the coal mine, a 17-storey office building standing prominently in Melbourne’s Docklands would be a candidate. It’s owned by industry super fund REST – among its tenants is Nine, the publisher of The Australian Financial Review – which offered it for sale with expectations of $490 million last year. At 717 Bourke Street, the book value of the 42,000 square-metre building was in the order of $460 million when it was put up for grabs, industry sources say. The best offers came back around the $390 million mark. Rather than meeting the market, or at least closing the gap, REST withdrew the building from sale late last year.The failed sale may be the best benchmark yet to where values are headed in the office market.
Most market players expect a shake-out in the Australian market within months. Just as vendors in the residential market eventually capitulated, accepting a correction was under way, so too commercial property vendors will eventually need to meet the market if they want to sell.Equity market investors, always skittish, sensed the wind changing more than a year ago, sending listed property stocks plummeting more than 20 per cent over last year.As a result, some of Australia’s listed property stocks – known as real estate investment trusts – are trading at hefty discounts of 30 per cent or more to their portfolio values, a gap which remains stubbornly wide.Analysts expected the REITs to write down values harder during the last reporting season. But the capitalisation rates or cap rates – which, like yields, rise as values fall – softened only marginally in the last reporting season.
Office property cap rates expanded just 13 basis points across the sector and by 17 basis points for logistics assets, according to a Citi analysis this month.“One of the key (and perhaps surprising) takeaway this reporting period was the largely flat/up REIT book values, despite higher cap rates and the uncertain backdrop,” the analysts wrote.“We see potential for declines over the next 12 months, but limited downside to property types seeing strong income growth like industrial, convenience retail and storage.”
Among those watching the office market closely is Shane Quinn, chief executive of boutique fund manager Quintessential Equity, who says cap rates on some assets may have softened by 100 basis points already.“But the discount to valuations hasn’t yet been realised. We expect some upcoming transactions will finally show that cap rate softening. It’s softening most in assets where there is either leasing distress, that is low leasing WALE [weighted average lease expiry], or capex issues,” he said.A resetting of the cap rates applied to office towers from about 5 per cent to 6 per cent is equivalent to a 20 per cent reduction in capital value, which would in turn put pressure on loan-to-value ratios and banking covenants.“
As those cap rates reset, it isn’t just resetting the market, it’s putting potential avalanche-like pressure on those distressed assets that are now going to have to be marked-to-market again, which puts them under more pressure with their bank,” Mr Quinn said. “That means they’ll be more distressed and forced onto the market, which may force further capitulation in pricing.”While Quintessential has held back the sale of four of its assets due to a lack of buyers – they are all well-leased and will be returned to the market when it improves, Mr Quinn said – the softening conditions also represent a good buying opportunity for well-financed players.“It is good for groups like us, though, because we are capital-ready. Whether people are talking about it publicly or not, there is a lot of distress,” he said. >>
TOT Price at posting:
78.5¢ Sentiment: Sell Disclosure: Not Held
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