Choosing Among REITs

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-A-REITs strong in April
-Low rates support move to A-REITs
-Sector appears more stable now
-Focus on yield, earnings and location
 

By Eva Brocklehurst

Australian listed real estate investment trusts (A-REIT) had a strong month in April, up 8.2%, and outperforming the broader market, which was up 4.5%. Attractive dividend yields and earnings continue to support valuations. Furthermore, with expectations of more official rate cuts on the way, the chase for yield remains well entrenched. The average A-REIT yield compressed around 25 basis points in April but remains 200bps above the 10-year bond yield. This theme has further to play, in BA-Merrill Lynch's view. The analysts believe the big picture rotation from bonds to equities seems to be taking a form of rotation from fixed interest into bond-like equities, underpinning A-REITs.

The strong performance of the A-REIT sector in 2013 is not like the growth-led bubble it was in 2006/07, in Merrills' view. It's mostly about low rates and hunt for yield, although earnings growth still matters too. Moreover, the sector's defensiveness is much improved with lower gearing, improved debt duration and diversity, and less offshore and currency exposure. Balance sheets are better positioned at "all in" lower rates. Merrills applies dividend yield and the spread to bonds and foreign REIT markets on valuing A-REITs. On this basis, the potential for the sector to trade to the long term average spread to bonds of around 133bps implies a further 60bps of yield compression (thus unit price upside).

JP Morgan finds the sector is changing. All seven stocks under coverage with material office exposure are now trading at premiums to net tangible assets (NTA). Buy-backs are no longer happening so much and dividend reinvestment plans look set to be switched on. Equity raisings are looking earnings accretive. JP Morgan notes recycling assets was a sensible thing to do when REITs were trading at a material discount to NTA but now that access to capital has improved, acquisitions are more likely to be funded from equity and debt. Selling down stakes in high quality assets looks unnecessary. Capital partnering is still alive, nevertheless, and REITs are buying assets in ventures with wholesale capital partners.

Where are individual stocks placed in the scenario just outlined? Macquarie favours Dexus Property ((DXS)), Investa Office ((IOF)), GPT Group ((GPT)) and Charter Hall ((CHC)). While a recovery in demand for office space is probably 12 months away there is significant appetite for direct prime real estate in Australia that should push valuations higher, in the broker's view. JP Morgan prefers Dexus and GPT in terms of the office sector, while Mirvac ((MGR)), too, is in there because the broker is overweight Sydney, higher-quality portfolios and well-leased portfolios.

JP Morgan views development as the main driver of direct market performance and prefers those with exposure to Sydney and Perth over Melbourne, Brisbane and Canberra. The broker also cites a preference for exposure to prime, modern stock with large floor plates over secondary stock. In this case, despite being a pure office play, Commonwealth Property Office ((CPA)) has big challenges with expiries in Melbourne and Adelaide.

Goldman Sachs notes the best performers in April were Federation Centres ((FDC)), Dexus, GPT and Charter Hall, all recording double digit share price gains. There was no core theme. One is a diversified REIT, one is focused on shopping centres, one on office and the other on funds management. Moreover, to complicate matters, these were not the best yield plays. Goldman notes they currently have prospective average yields of 5%, marginally below the sector average.

In large cap REITs Merrills' picks are Westfield Retail Trust ((WRT)) and Lend Lease ((LLC)). In the retail malls, Macquarie prefers GPT and Westfield Retail, given the higher sales productivity and foot traffic typically generated in their centres. Goldman has a Buy rating on Shopping Centres Australasia ((SCP)). Despite low rent growth from a static portfolio, the broker believes it is a relative value opportunity. It has the highest dividend yield in the sector and trades at substantial price/earnings and NTA discount to peers.

For Merrills, Westfield ((WDC)) requires a US/Europe development pipeline to kick off interest while the buy-back underpins the current market. The broker notes Goodman Group ((GMG)), Federation Centres and Dexus have good deal flows which could lead to further upgrades. Goldman notes Westfield has the second lowest yield among the major A-REITs under coverage. It is also not delivering strong earnings growth. With this, and the excess capital from asset sales funding a buy-back, it could be that Westfield may raise the pay-out ratio to provide a more attractive yield in future. Goldman is waiting to see and has a Sell rating in the meantime.

In terms of residential REITs, Macquarie rates Mirvac a Hold, although it has exposure to the intensification theme with projects such as Harold Park, Yarra Edge and Green Square. Stockland ((SGP)) is given a Sell rating, with 72% of its pipeline in the more challenging markets of Queensland and Victoria. Merrills thinks similarly. The broker recently downgraded Mirvac because it was trading above valuation, although concedes there may be some opportunities further afield. Goldman contrasts the yield from Stockland with that of Mirvac, finding Stockland's yield superior. Stockland is paying out more than 100% of earnings in FY13 but Goldman finds this is an anomaly, as cash coverage is better than reported profit. Nonetheless, the broker does not expected dividend growth from Stockland and has a Hold rating on the stock while rating Mirvac a Buy.
 

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