Stock Review
Panic in property
14/07/2008
- Category: FEATURE
Little more than a year ago investors couldn't get enough of the listed property sector. But buyers have retreated leaving companies with surplus assets and too much debt. The house of cards is falling down and panic has set in.
Rampant overbuilding and speculation triggered the property collapse of the early 1990s. Anyone shopping in Sydney’s CBD could see a skyline littered with cranes and empty buildings, so there was no hiding the evidence when bust followed boom. But the train wreck currently unfolding in the listed property sector isn’t so tangible. Cranes are conspicuously absent and office towers are packed to the brim. So far this is a financial crisis but it shares the same root cause – excessive debt.
Instead of creating an oversupply of property in Australia, cheap money, ego and easy credit found its way into risky offshore acquisitions and funds management businesses. Investors combating low interest rates played along for a while, but these strategies have failed at the first major hurdle and managers are desperately raising cash to satisfy anxious lenders.
Early casualties
The earliest casualties were caught with too much short-term debt. When the US subprime meltdown developed into a full-blown credit crisis, once-eager bankers began reining in their exposures. Centro Properties Group, the Rubicon family of property trusts, City Pacific and MFS (now known as Octaviar), simply couldn’t repay their debts and asset sales couldn’t undo the damage. They’re not all bankrupt, yet, but boom-time investors effectively did their dough.
But this was only a primer for what was to come. During the boom, property groups such as Macquarie Office, Valad and Macquarie CountryWide expanded aggressively offshore, but valuations and distributions are now falling, and those falls are being accentuated by enormous leverage. Managers are forced sellers in depressed markets and, as we wrote in our Investor’s College feature NTA is dead, long live NTA, we expect worse to come. Cash is no longer simply king; it’s a matter of survival.
While many sought the big city lights of the US and Europe, Mirvac adopted the big bang approach to funds management by acquiring James Fielding and installing its founder, Greg Paramor, as its new chief. Such approaches rarely succeed and investments made outside the company’s core competencies, such as RiverCity Motorway, have exposed Mirvac as a patsy.
Fire sale
Now Mirvac’s residential division is vulnerable to a rapid loss of confidence. With petrol prices still rising, small hikes in interest rates have a more powerful effect. Housing starts, loan approvals and construction activity have fallen off a cliff. Stockland, Becton and FKP – and, indirectly, homebuilders AVJennings Homes and Devine – have found themselves caught between rising construction costs and selling unaffordable housing. Unsold developments could attract fire sale prices if cash is needed to meet rising interest bills.
Dangers began appearing in the property sector in 2004. After holding fire and avoiding the early casualties, we finally dipped our toe in the water recommending GPT Group on 4 Mar 08 (Buy for Yield – $2.96). Unfortunately we jumped too soon, with the company recently announcing a profit downgrade and slashing distributions to levels not seen since acid wash jeans were in vogue.
With ample sellers and few buyers, GPT’s asset-flipping strategy is now defunct. It’s a vindication for the relatively conservative buy and hold approach of Commonwealth Property Office Fund, CFS Retail and Bunnings Warehouse Property Trust. Unfortunately the market is paying a hefty premium for safety and the prices of these trusts remain unattractive.
Saving grace
Straightforward rent collection doesn’t seem so old hat any more, and GPT’s staid Australian portfolio of shopping centres, iconic office towers, big sheds and industrial parks, is the company’s saving grace.
GPT has historically been an innovator, but chief executive Nic Lyons tried to emulate Goodman Group’s success by building a global funds management business. Without a recognised brand or track record, though, European investors weren’t interested and GPT is stuck with a hotch potch of depreciating assets it doesn’t want.
Other property groups involved in the funds management gravy train wreck include Becton, Cromwell Group, Abacus Property Group and Charter Hall Group. They’ve used lashings of debt to boost returns and attract investors. But returns are now falling and, since many of the assets are second rate, the fallout could ruin their greatest asset – reputation.
Debt the major obstacle
Commonwealth Property Office is the latest to report falling valuations. It’s a natural part of investing in a cyclical business, but it doesn’t mix well with too much debt – lenders don’t tend to enjoy watching their security shrink. Most property groups have major debt maturities in 2010, so in a year’s time or less renegotiations will commence. If the credit crisis is still raging, drastic action might be necessary; and a stampede of asset sales would no doubt further undermine prices.
The alternative is to suffer dilution from issuing new securities. But whatever the tonic – higher debt, new security issuance, asset sales or lower distributions – securityholders will have paid a heavy price.
Lemming behaviour
Several companies have ’fessed up to the new reality, but many have not. The next couple of reporting seasons will reveal the truth, but chief executives are already trying to save their jobs. Claptrap like ‘the market wanted us to do that’ is no excuse. Lemming-like behaviour is how we got here in the first place; what’s needed now is some true leadership.
Depressed security prices across the sector would normally attract merger activity, but the white knights are mired in their own problems. Deals are likely to be few and far between and it could be years before the sector is purged of past mistakes. The sooner management admits the problems, though, the sooner the restoration can begin.
It seems surprising that property trusts have fallen so far yet, after reverting to Hold on GPT Group pending a full review, we have just one positive recommendation in the sector, Westfield Group. Business models have changed dramatically during the bull market and high debt levels make them difficult to unwind. It might be painfully slow, but we expect risky growth strategies to give way to rent collection and property ownership as valuations fall and distributions are cut in the period ahead.
We’ve waited patiently for several years to grab a bargain, but this isn’t the time to dive in with both feet, as we’ve learnt the hard way with GPT. For now there’s nothing left to do but watch the fallout.
Disclosure: Staff members have interests in Westfield Group, but they don't include the author, Nathan Bell.
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