Australia | Nov 21 2011
– Rate cut cycle a boost for Australian REITs
– Current discounts to NTA may return to historical premiums
– Sector dividend yields remain attractive
– Citi and Credit Suisse update on preferred exposures
By Chris Shaw
A likely beneficiary of the Reserve Bank of Australia's (RBA) move to lower the cash rate to 4.5% at the start of November notes Citi are Australian REITs, as the change in official interest rates will mean investment spreads increase.
This is expected to support asset values, while also offering potential growth opportunities in the sector. For residential developers there should be improved affordability, something Citi expects will increase the potential pool of buyers.
The cut in rates may also boost consumer sentiment, something Citi suggests may be of benefit to retail landlords given a potential boost to net operating income as a result. The office sector is likely to see the smallest impact, though even here Citi notes there will be a boost from a lower cost of funds.
Given a solid history of around 7% outperformance by the Australian REIT sector in previous rate cutting cycles, Citi suggests there is potential for the sector to again perform better than the broader market.
This could be seen in a tightening in the discounts to net tangible asset (NTA) backing, from what Citi estimates is a discount of around 10% at present. A premium to NTA is not unrealistic, given a long-term average premium to NTA for the sector of around 5.8%.
While lower interest rates suggest a lower required return for investors, and therefore lower cap rates, Citi notes the data show lower interest rates are actually associated with higher rather than lower cap rates.
Assuming further rate cuts, and Citi notes these are being priced in by the bond market at present, an improvement in residential indicators is likely. As Citi points out, the Westpac-Melbourne Institute's Time-To-Buy index increased by 23% on average during the past three rate cut cycles. At the same time, housing finance commitments rose 6% on average in year-on-year terms in the 12-months following the first rate cut of an interest rate down cycle.
In terms of relative sector performance, Citi notes historically the retail REIT sector outperforms its office peers in both rate cut and rate hike cycles but more markedly during the former. Office REITs have relatively few benefits from a cycle of easing interest rates, Citi noting net absorption, vacancies and rents have all deteriorated in previous rate cutting cycles.
From an earnings perspective Citi suggests there will be little impact on FY12 settlements from the recent rate cut, with FY13 to show a more pronounced effect as it will take some time for an improvement in momentum.
By FY14 Citi sees scope for margin improvement in the sector, as a stabilising of prices could feed through to higher prices per square metre and a preference for larger sizes.
In the Australian REIT sector Citi rates Abacus Property ((ABP)), Australand Property ((ALZ)), BWP Trust ((BWP), CFS Retail ((CFX)), Charter Hall Group ((CHC)), Charter Hall Office ((CQO)), Commonwealth Property Office ((CPA)), Dexus ((DXS)), Goodman Group ((GMG)), Mirvac ((MGR)), Stockland ((SGP)), Westfield Group ((WDC)) and Westfield Retail ((WRT)) as Buy.
Neutral ratings are ascribed to Charter Hall Retail ((CQR)), GPT ((GPT)) and Investa Office ((IOF)).
The focus of Credit Suisse has been on dividend yields in the Australian REIT sector, as the broker notes the forward yield currently stands at around 6.4%. This compares to a forecast average cash rate of 3.88% for the same period.
One key in any such analysis is the cost of debt, but as Credit Suisse notes the cost of debt in Australia is converging towards globally depressed levels, while investor appetite for yield is growing. This improves the potential for Australian REITs to enjoy increased attention
As debt has become cheaper some Australian REITs have refinanced and Credit Suisse sees this as increasing the likelihood earnings in the sector prove to be at least resilient. Earnings risk now appears skewed to the upside in the broker's view.
Upcoming REIT dividend season should draw attention to the yields on offer in Credit Suisse's view, with the majority of the sector expected to trade ex-dividend on December 22. Dividends are likely to be declared sometime next month.
At the same time as dividend season for the REITs should attract attention, Credit Suisse notes earnings growth forecasts for the broader equity market continue to be pushed out. This is improving the relative attraction of REITs, especially as lower payout ratios increase the scope for property companies to redeploy retained earnings and so lift future payout ratios.
In particular, Credit Suisse sees Charter Hall Retail and Stockland as the pick of stocks to watch for those investors chasing dividends at present. In general, Credit Suisse notes Australian REITs tend to outperform on an absolute basis leading up to the ex-dividend date, while also outperforming on the ex-div date itself before underperforming in absolute terms post the ex-date.
In terms of preferred plays in the sector, Credit Suisse continues to favour Westfield Retail, Westfield Group and Dexus from a value perspective. All three stocks are rated Outperform by the broker.
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