Australia | May 14 2013
-Adds 7 office assets
-Increases office exposure
-Time will tell, in brokers' view
-Stock fully priced
By Eva Brocklehurst
Property heavyweight Mirvac Group ((MGR)) will acquire seven office assets from GE for $584 million. The portfolio offers an initial passing yield at acquisition of 7.8% and Mirvac expects the yield to increase to 8.4% on a fully let basis. Just over two thirds of the acquisition is represented by two A-grade assets in the Perth and Melbourne CBDs with the balance being five assets in Sydney, earmarked for re-development. The transaction is expected to be accretive from FY14.
The deal is to be funded via an equity placement to institutions of $400 million. Debt and a share purchase plan for retail investors will provide the rest. The two feature properties are Allendale Square, Perth, acquired for $8,224 per square metre, which compares well with similar transactions, in Credit Suisse's view, and 90 Collins Street, Melbourne, at $7,999 per square metre. The Collins St site appears expensive given the vacancy rate of 55%. In its favour, in the broker's view, is that $19m can be incorporated for the value of capex, incentives and rental guarantees. In terms of the five Sydney CBD sites the price is seen as reasonable, at $183m, given the 7.8% initial yield and re-development potential. There are three Pitt Street sites which have potential leasing area of 30,000 square metres and could support $480m in end-value development. Credit Suisse envisages upside through site amalgamation.
Credit Suisse finds the key risk is the lease up of 90 Collins St, before rent guarantee expiries in two years. This would make the deal earnings neutral but that's unlikely in the broker's view. Earnings visibility is improved given the capital flexibility and an expanded pipeline. Mirvac had the capacity to fund the deal via the 50% sell-down of 275 Kent Street, Sydney, but the equity raising was down at a marginal 3.2% discount and now enables the company to fund greater share of an expanding development pipeline and/or pursue new opportunities. Mirvac continues to fund 50% of each of its office developments, alongside third party capital. Partial equity funding is reflective of the capex required to be spent on value adding, in JP Morgan's view, as well as the improved cost of equity that Mirvac is trading on.
Time will tell, in UBS' view. The broker believes the portfolio faces significant near-term leasing challenges. There is the expiry risk in the lower quality Sydney assets and a competitive Melbourne market. Nevertheless, it should give Mirvac an opportunity to demonstrate the benefit of an integrated property platform. The downside is that assets are sitting vacant prior to re-development in Sydney, as well a perceived need to pay higher-than-forecast incentives in Melbourne. The broker models spending of around $250-300m per annum on commercial developments and maintenance over FY14-16, with gearing gradually stepping up to to the top of the company's target 20-30% range. The deal reinforces UBS' expectations that the company is diluting the earnings contribution from residential assets and focusing on increasing the trust and re-stocking commercial development projects. Office is expected to be a more prominent part of the company's trust, increasing to 63% from 58% of total assets.
JP Morgan also believes it is too early to say whether the acquisitions are a good buy. Proof will be in the execution. The broker does like the office portfolio, development capability and earnings growth. This is underpinned by an improved residential return, albeit from a low base. The acquisition increases the office average capital value per square metre, because of the high capital value rates in Perth and relatively high rate for Melbourne, being in a desirable location.
The broker thinks Mirvac should be able to add value to 90 Collins St and also be able to find a pre-commitment for the planned development of the Pitt St/Underwood St assets in Sydney, albeit several years down the track. The remaining 210 and 220 George St assets in Sydney will be refurbished. They may present leasing challenges as they could back onto a construction site (Pitt/Underwood), but this is not large in the scheme of the portfolio, in JP Morgan's opinion. Allendale Square may be well leased but the broker notes it is an old asset and could be in need of substantial capex.
Mirvac carries four Hold ratings on the FNArena database and two Buy – Credit Suisse and JP Morgan. The consensus price target is $1.73, suggesting just 0.1% upside to the last share price. It is a fully priced sector, in Credit Suisse's view, so Mirvac offers relative value. The broker notes the stock has the highest three-year earnings growth rate in the sector, driven by higher residential margins, turnover and the completion of its commercial development pipeline. The database dividend yield indicates 5.0% for FY13 consensus earnings forecasts and 5.3% for FY14.
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