Australia’s real estate investment trusts bolster their foundations

This reporting season is providing an insight into one of the sectors that is, on paper, most vulnerable to financial market and system instability, if vulnerability is measured by the extent of the windfall provided by historically low interest rates.

Over the past week the heavyweights of the A-REIT sector have been reporting their results and, while there are more to come, the results are relatively reassuring.

Take the Mirvac announcement today. Its operating earnings were up six per cent to $482 million. Gearing was 21.9 per cent, its cost of borrowings was five per cent and, once it completes its recent US private placement, the maturity of its debt will increase from four years to 5.4 years.

Earlier this week, GPT announced a six per cent increase in funds from operations for the June half. Gearing was down from 26.3 per cent to 24.4 per cent. Its weighted average cost of debt was down from 4.6 per cent to 4.3 per cent and the average maturity of its borrowings lengthened from 5.1 years to 5.9 years.

Goodman Group grew operating profits nine per cent, had gearing (on a “look-through” basis) of 24.6 per cent with an average maturity of 4.5 years. Shopping Centres Australasia today reported a 25 per cent increase in funds from operations, gearing of 34 per cent, an average weighted cost of debt of 3.7 per cent and an average debt maturity of 5.7 years.

The picture the flurry of results is providing is pretty consistent. At an operational level, the A-REITs are generating solid earnings and rising distributions to satisfy income-hungry investors. They are also taking advantage of the ultra-low rate environment to lower their borrowing costs and push out the maturities of their debt.

The trusts have been among the biggest beneficiaries of the low-rate environment. Over the past 12 months all the bigger trusts have seen the prices of their securities increase by more than 20 per cent, ranging from about 22 per cent for Mirvac and Shopping Centres Australasia to 39 per cent for Scentre Group.

They are all trading at big premia to their net tangible assets — as a sector, the A-REITs trade at a premium of more than 40 per cent to NTA.

Given that their valuations have been driven by interest rates that are, thanks to the novel policies being pursued by the key central banks, at historically low levels and that it is the level of those rates that has forced investors to pay up for yield, there is a question mark about their longer term sustainability and the vulnerability of the A-REITs to a change in the rate environment.

In the midst of the financial crisis, of course, the A-REITs were hit particularly hard. They were overly leveraged, the maturities of their borrowings were too short at a moment when international banks were panicking and there were some, like Centro and GPT that had been excessively financially engineered.

In the lead-up to the crisis, the A-REITs were trading at about twice their current premia to net tangible assets.

They all survived — even Centro, although it took a long time to sort out its extraordinary complex structure and affairs — because of the quality of their underlying assets, which ultimately enabled them to raise very large lumps of equity and refinance their debts.

Today the sector is far less geared, there is little obvious financial engineering, the trusts are taking advantage of the rate environment both to lower their finance costs and extend the maturities of their debt and are producing solid rather than spectacular (read suspect quality) operational performances.

That doesn’t mean they would be immune to a severe downturn in the economy, or that the value of their securities would be unaffected by a change in the rate environment or a renewed bout of global volatility and fear.

The focus on balance sheet strength and sustainable and relatively high-quality earnings, however, means the foundations of the sector are very different to what they were before the financial crisis.

The security holders might be vulnerable if the interest rate environment were to move against them but the post-crisis risk-aversion of the A-REITs themselves means they ought to be in a much stronger position to weather any significant change in the external settings.