Significant Re-pricing Ahead For Industrial Assets

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An implied flat 4% capitalisation rate on the $3.8bn bid for Milestone’s unlisted Australian industrials portfolio marks an inflection point for the valuation of REITs with industrials assets exposure

-Acquisition of Milestone Logistics at unprecedented flat 4% capitalisation rate to have broad implications
-Value of industrial assets will rise significantly if priced at similar 4% rate
-Banks are re-weighting loan-books to capture logistics tailwinds
-Overweight ratings for three industrial REITs leveraged to industrial dynamics

By Mark Story

A watershed deal purported to be the biggest ever direct real estate transaction in Australia has signaled what some brokers expect to be a tectonic shift in the re-pricing for the industrial asset class.

As first revealed in the AFR on 18th April, one of Asia Pacific’s top logistics real estate investors, ESR, has agreed to pay around $3.8bn for Blackstone’s Milestone Logistics unlisted Australian industrials portfolio comprising warehouses, distribution centres and business parks. The deal is expected to be completed prior to June 30.

The US fund management giant, Blackstone has opted to sell Milestone to ESR rather than proceed with an IPO on the ASX.

Had Milestone listed, it would have been the largest listed logistics portfolio by size in Australia or New Zealand, with 1.4 million square metres of gross lettable area. Tenants include Australian retail major Woolworths, shipping firm Toll Group and Caterpillar dealer WestTrac, plus Michigan-based Lineage Logistics — the world’s largest cold storage firm.

It’s understood the bid implied a flat 4% capitalisation rate, which assumes ESR expects to make about 4% a year on the assets. Valuation work was done by Savills. There was no external financial adviser or investment bank involved.

Commenting on the deal, Phil Pearce CEO of ESR Australia told AFR’s Street Talk that one of the attractions to Milestone was site coverage on the portfolio which at 38% is really low. “When we build out a warehouse, typically it would take up 50 to 60 per cent of the site,” Pearce was quoted.

Re-weighting to logistics

ANZ Banking Group ((ANZ)), Japan’s MUFG, Singapore’s United Overseas Bank and Asian heavyweight Standard Chartered are expected to stump up north of $2bn to help ESR take control of the logistics sites.

This suggests to brokers that banks (also long retail and office sector buildings) are following big traditional Australian property investors, and re-weighting their loan-books to capture some of the tailwinds behind logistics sites. The most notable of these tailwinds is the continued ascent of e-commerce over the past year as consumers changed shopping habits to get through the covid pandemic.

Adding to the headwinds for the office sector is a substantial reduction in demand for office space in the short term. Reduced expectations over the medium term are expected to see vacancy rates increase above 10% in Sydney/Melbourne over the medium term.

JP Morgan believes this benchmark sale (of Milestone’s asset) reflects exceptional demand for the (industrial) asset class and a significant re-pricing in Australia’s industrial property sector. The broker notes, the average industrial cap REIT for the listed REITs was 5.2% as at December 2020.

Before this transaction, JP Morgan had been assuming a further 20% of upside to Industrial book values. The broker has Overweight rating on the three industrial REITs it believes have the most leveraged exposures to the continued positive industrial dynamics.

These include: Pure play Centuria Industrial REIT ((CIP)) – with $2.6bn portfolio on 5.0% cap rate – listed fund managers Goodman Group ((GMG)) – $17.8bn of Australian industrial assets under management (AUM) – and Charter Hall Group ((CHC)) – $12.2bn in AUM.

Broader implications for industrial property

Morgan Stanley believes an implied flat 4% capitalisation rate on the Milestone bid, coupled with downward pressure on industrial property cap rates are relevant data-points for the stocks with industrials exposure in the broker’s universe.

While Morgan Stanley acknowledges that its calculated impact is a blunt exercise, given no two properties are the same and valuation can be impacted by numerous factors, the broker’s data-points suggest the industry is at the very least heading towards a 4% cap rate.

Morgan Stanley believes the impact on Net Tangible Impact (NTA) for stocks with industrials exposure (it covers) if those assets were to be valued at 4% cap rate would be:

-Centuria Industrial REIT 34.1% (NTA $4.45/s);
-Charter Hall Long Wale REIT ((CLW)) 11.8% (NTA $5.26/s);
-Stockland ((SGP)) 11.6% (NTA $4.22);
-Dexus ((DXS)) 6.9% (NTA $11.72);
-GPT Group ((GPT)) 5.8% (NTA $5.89);
-and Mirvac Group ((MGR)) 3.1% (NTA $2.66).

The broker has also estimated a change in total AUM if Australia’s industrials cap rate at 4%, for listed fund manager Goodman Group 6.8% ($55,300m); and Charter Hall Group 6.2% ($49,291m).

GPT Group rotates into logistics

In light of e-commerce’s ascent in a post-covid world, GPT Group also plans to rotate more into logistics. Given GPT’s expanding development pipeline and recent track record, UBS is now factoring the REIT to spend $1bn on logistics over the next five years.

While GPT's asset allocation as at December 2020 was in line with strategic weightings of retail 40%/office 40%/logistics 20%, UBS expects this to be reset going forward with logistics up to 33%.

Based on UBS estimates, logistics will reflect 28% of assets in 2025 (versus 16% in 2019).

To help deliver on this outcome, UBS suspects asset sales are likely to remain on GPT’s agenda, with potential divestments opportunities including Australia Square (less than 3% FCF yield) together with Sydney Olympic Park ($100m).

Reflecting 12c for logistics development pipeline and lower cap rate on the logistics portfolio, GPT’s net asset value (NAV) has increased to $4.80. UBS retains a Neutral rating on the stock, and has increased the price target to $4.80 from $4.55.

UBS notes, despite increasing allocation to logistics, GPT's exposure to retail where leasing spreads declined around 20% in the second half, and office assets (in particular Melbourne) with increased leasing risk in future years overshadows the increasing logistics allocation.

Relative to other diversified property groups, GPT’s logistics exposure ranks behind Stockland, but is now ahead of Dexus.

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