Life after Centro

Liquid Real Estate, Euromoney magazine, March 2008

For the last five years or so, commentators have frowned at Australia’s listed property trust sector, which has consistently outperformed every other major asset class in the country, and said: this can’t last. And for the last five years they’ve been wrong.

But not anymore. After a decade in which staid old property trusts beat mainstream equities time and again, the market has fallen dramatically, and rolling five-year returns from LPTs are below the broader market for the first time this century. And how: the LPT sector is down over 25% in the three months to January 31, logged a negative calendar year return (-8.4%) for 2007, and there may be worse to come. It’s a far cry from the 34.1% the sector delivered in 2006.

A large part of the problem has to do with selling triggered by the difficulties afflicting Centro Properties Group, which in December announced it had been unable to roll over A$1.3 billion of soon-to-expire short term loans, triggering a 77% fall in the stock and a suspension of applications and withdrawals. Centro itself is surviving – it announced on February 15 that much of its debt had been extended to the end of September – but the effect on the market has been profound. The LPT sector took an 11.5% hit on December 17 alone, the day of the original Centro announcement.

Some feel it has been a long time coming. “We’ve been saying for a while that we’re very cautious on LPTs,” says Anton Tagliaferro, founder of Investors Mutual, a leading Australian fund manager. “The gearing has increased quite substantially over the last 10 years. But the world has changed: It’s gone from 12 months ago, when there was plenty of debt at cheap prices, to today where it’s very hard to get loans and if you do get them you’re paying a much higher margin. LPTs have gorged themselves on debt in Australia, and it’s a major issue.”

The days when Australian LPTs were all passive rent-collectors, promising a solid and reliable yield but probably no capital growth, are long gone. Over the years, as more and more Australian property has been securitised, they have increased their borrowings, their overseas purchases and the risk profile of their activities, entering areas like development and fund management. A benchmark annual survey by BDO Kendalls found that average gearing climbed for 12 consecutive years to 42.1% in 2006, although it did drop modestly to 41.1% in 2007.

What happens next is debatable. The positive view is that the rest of the market has been oversold. “If you look at the sector as a whole there’s an 8.5% yield ex-Westfield [easily the biggest LPT] and you have to say to yourself, is a lot of the bad news already factored into the pricing?” says Simon Jones, co-head of Macquarie Real Estate Capital, which has four LPTs in Australia alongside others in Singapore and Seoul.  At an operational level, he says, trusts have consolidated in recent years to a group of strong managers, with leasing levels of at least 95% commonplace. “I don’t think we are going to see the falls in terms of occupancy and demand that are reflecting in some of the pricing in the stock market.” He thinks “some of the smaller, more highly geared trusts might be having some difficulties on the debt front” but “on the whole I don’t think there’s a wholesale issue relating to the level of gearing at the moment.” He is adamant Macquarie’s trusts are in good shape to deal with downturns in valuations or markets.

The other view is that more and more trusts are going to struggle to roll over their debt. “The sector is in a bear market that is going to last a while,” says Tagliaferro. “Many LPTs in Australia have aggressively revalued their properties and geared, and that’s going to take some time to unwind. We’re certainly not rushing into any of them.” Interest rates are rising in Australia with economists expecting more to come. And if another trust hits the same refinancing challenges as Centro has, expect another plunge in the markets.