A-REIT Updates

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– A-REITs benefit from rotation to defensive positions
– Financial position in the sector has improved
– JP Morgan upgrades Westfield Retail 
– Sees improved outlook for office market

By Chris Shaw

According to Credit Suisse, there is some evidence Australian REITs are beneficiaries of investors rotating funds into more defensive positions. As the broker points out, the 12-month sector beta had fallen to 0.7 by the middle of May, down from 1.4 in January of last year. 

This may reflect greater confidence in results, as Credit Suisse notes after the last round of results in the sector earnings guidance was either reaffirmed of upgraded. In the face of this decline in sector beta, Credit Suise has reviewed the REITs from both a financial perspective and on relative performance grounds. 

For the former, while there is pressure on equities at the operating earnings level in the current operating environment, Credit Suisse notes the last REIT downgrade cycle was driven by below the line issues. Both occupancy and cap rates have held well relative to global REIT markets.

Australian REITs have in general significantly reduced their look-through gearing levels to around 30% now, down from around 38% in June of 2008. This has been done despite cap rates moving higher and properties being devalued. 

As well, Credit Suisse notes the near $12 billion in undrawn facilities is enough for the sector to meet the required spending on current developments and the more than $6 billion in debt maturing over the coming year. This suggests a solid financial position.

In relative performance terms, Credit Suisse notes there are increasing signs of a potential re-weighting from the office sub-sector, which has been a strong performer, to what appears fundamental value among high quality retail and residential names.

From a macroeconomic perspective Credit Suisse expects retail will recover ahead of industrial. There is also potential for incremental global REIT buying on any pullback in the Australian dollar, something Credit Suisse suggests would benefit high quality portfolios and well respected management teams. 

In this category Credit Suisse includes Westfield Group ((WDC)) and Westfield Retail ((WRT)), while Dexus ((DXS)) is preferred in the office/industrial sector.

Westfield Retail has attracted interest elsewhere, with JP Morgan today upgrading the stock to Overweight from Underweight. This reflects the expectation Westfield Retail will report June 30 NTA (Net Tangible Assets) of $3.26 ex 8c of deferred taxes, an outcome expected to surprise the market to the upside.

At the same time JP Morgan notes Westfield Retail is a beneficiary of lower interest rates in New Zealand and better than expected margins on a $900 million domestic bond issuance. There is also potential for the use of convertible notes to lower earnings dilution from the Sydney Citi acquisition, so JP Morgan has made some modest adjustments to earnings estimates.

These are enough to generate an increase in price target to $2.97 from $2.85, which supports JP Morgan's upgrade in rating. Westfield Retail is now rated a Buy by all seven brokers in the FNArena database covering the stock.

Looking at the Australian office market generally, JP Morgan notes the outlook has improved as vacancies nationally and expected rent growth are both better now than has been the case in recent months. 

On the flip side, JP Morgan takes the view future net absorption may be constrained by a number of factors, including continued economic uncertainty impacting on business expansion plans, low unemployment leading to a lack of potential new employees and lower work space ratios.

On balance, JP Morgan suggests it is now a reasonable time to own office buildings, as average prime cap rates of 7.2% are 30-basis points above long-term average levels. In relative terms the Melbourne and Perth markets are expected to outperform due to low vacancies and solid growth outlooks. 

Next best should be the Sydney market, while Brisbane has excess supply to work through and rent forecasts for Canberra have been downgraded both this year and next.

Best positioned in the office sector according to JP Morgan are Dexus, Commonwealth Property Office ((CPA)) and Australand Property ((ALZ)) ,with Dexus and CPA rated as Overweights and Australand rated as Neutral. Sentiment Indicator readings for the three stocks according to the FNArena database are 0.5, 0.0 and 0.0 respectively.

BA Merrill Lynch's property team have also been active, touring London, Paris and Frankfurt last week to meet with developers, landlords and brokers. The finding was market conditions in the industrial market are relatively positive, this given the warehouse sector continues to be a beneficiary of ongoing solid demand for exports. 

Germany is currently strongest in this market, followed by Eastern Europe, France and the UK. Port and trade-related markets are enjoying the better conditions, with BA-ML noting cap rates at present range from 6.75-7.75% in Germany down to around 6% near Heathrow in London.
 

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