For many people, the recent poor performance of listed property trusts (LPTs) — down 28 per cent since November 1 last year — has been one of the more surprising features of the current market downturn.
LPTs have performed much worse than the property market as a whole as well as the ASX 200 index, which is also down 16 per cent over the same period.
However, it is further proof that LPTs are not pure property investments. In fact, LPTs behave much more like equities and are very much at the mercy of investor sentiment. The performance of LPTs does not reflect the true value of the underlying property assets owned by the trusts and, at the moment, most LPTs are priced well below the value of their assets.
While the main reason for the fall in value of LPTs is the equity market downturn, it is also true that some are highly geared and battling with the increasing cost of debt. Many have also diversified into what are currently seen as high-risk areas such as overseas property, particularly in the US, and into funds management businesses.
As a result, the LPT sector is being punished because of factors that have little or nothing to do with the property assets owned. These other business activities of LPTs, such as funds management, offshore investing and property development, might not themselves be bad business activities, but at the moment, anything with a whiff of risk about it is being punished.
In the current market, most LPTs would also have a problem raising additional equity and could only raise debt at significantly higher margins, if at all. As a result, LPTs are not in a position to actively acquire properties, which they need to build accretive returns for investors. Until volatility and liquidity issues return to normal, the performance of LPTs will continue to suffer.
Investors must keep in mind that LPTs are not a pure property play and, if they want exposure to real property, they should do it through a unlisted property trust or through vehicles that focus solely on property and not on other investments.
All indicators for the health of the Australian property market are pointing in the right direction. The economy is still strong and the Reserve Bank is focused on tackling inflation. The property market is characterised by low vacancies and high rental growth, and supply and demand for property is under control — in fact, in some markets’ demand well exceeds supply.
So, as investors emerge from the safety of the bunker they retreated to when markets started to become volatile and start looking for opportunities, those who are cashed-up should find good opportunities in unlisted property trusts.
Unlisted property trusts with low gearing and large unused debt facilities are perfectly positioned to take advantage of the many acquisition opportunities we expect to see over the next three to six months. As financing continues to tighten, many property owners may need to sell their better quality properties at the insistence of their lenders to reduce debt.
With a few exceptions, the value of property in the Australian market has not materially changed in the last year and is still providing good income yields. It is often forgotten that the value of a property is determined by its income and its capitalisation rate. In Australia, rental growth remains strong and many leases have rental increases linked to the consumer price index. If rentals are increasing at 4 per cent per annum, then, as a rough guide, the increase in valuation each year as a result will offset any reduction in value caused by an increase in the capitalisation rate of 0.25 per cent per annum.
People looking to invest in bricks and mortar through a trust should follow a few simple rules.
Firstly, make sure the investment is a pure property investment and not directly impacted by share market volatility.
Secondly, look for diversity — geographically and by sector. Unlisted property trusts owning quality properties in good locations with reliable tenants and low gearing come into their own during periods of market volatility.
Thirdly, look at the substance of the organisations that manage the trusts, their past performance and the experience of their property management team.
Fourthly, along with ownership considerations, look at the manager’s investment philosophy, the liquidity of the trust and its source and level of gearing.
And finally — but perhaps most importantly — keep in mind how all of these points will play out in the longer term. Unlisted trusts with cash at their disposal and low levels of gearing are the ones that will ride out any squeeze — and the ones that can take advantage of excellent buying opportunities.
Despite the difficulties that some companies faced last year and some continue to face, there is still strong demand for high quality property investments. We are not in a property slump, and the misfortunes of some will be to the good fortune of others.
Martin Hession is head of property at Australian Unity Investments.
