REITs recovery continues but future growth is still a challenge

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Real Estate Investment Trusts (REITs) around the world continue to show signs of recovery but the asset class still faces some challenges, especially around raising fresh capital. We highlight Australian REIT (A-REIT) management team strategies to enhance returns in the year ahead.

In Australia, REIT management teams are focused on strategies to enhance future returns following a two-year period of strengthening balance sheets by restructuring debt and selling assets, especially assets held offshore.

The EY’s Global perspectives: 2012 REIT report shows that of the six REIT jurisdictions examined in the report, Singapore had the best return performance in the year to June 2012. The one year rate of return for Singapore REITs (S-REITs) exceeded 21.8%, a performance which put the country’s US$30 billion REIT sector ahead of Japan (17.4%), Australia (15.6%), the US (15.6%), the UK (14.8%) and France (11.85%).

The global financial crisis had a severe and lengthy impact on security prices relative to net asset values in the REIT market. However, the prevailing trend is clearly upward. But even as the cost of capital improves, the challenge remains for REIT teams to drive future growth through astute acquisitions, careful asset management and well-timed dispositions — all within an appropriate capital structure.

Coming out of a period of recessionary pressure, the big challenge for REITs this year will be how to sustain growth. Many will continue to focus on internal growth, and acquisitions will once again be in focus in a competitive market that is also seeing continued interest from offshore buyers.

A-REITs recent focus on paying down debt and selling assets worldwide nearing completion

Over the past few years, A-REITs have restructured their balance sheets by paying down debt and selling assets worldwide. From the end of 2009 until early March 2012, A-REITs covered by SNL, a provider of business intelligence services, sold 1,039 properties worth US$16.2 billion.

A large component of this sell-down has been a retreat from offshore investments. Some A-REITs have also been buying back their shares with proceeds from their asset sales. The divestment of offshore portfolios across the sector is now close to completion and improving equity values are shifting the focus to acquisitions.

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Investor confidence slow to return but gaining momentum

While domestic investors have been cautious about investing in A-REITs, a rally in REIT security prices in the second half of 2012 would suggest sentiment is changing. Some offshore investors demonstrated an interest in capitalising on the Net Asset Value (NAV) discount that has been implicit in A-REIT share prices. Last year, two large A-REITs were acquired by consortia that include offshore players.

In an ongoing effort to restore investor confidence, A-REITs continue to improve operating efficiencies and de-risk their business models, by reducing their offshore exposure or narrowing their strategic focus to property classes where they have a core competency. The reduction in the discount to NAV at which many A-REITS are now trading suggests that these initiatives, together with the impact of share buybacks, are starting to pay dividends.

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Diversity of debt sources remains a challenge

Larger players report that financing today is more available from a wider range of financiers, at lower margins and for longer durations. However, diversity of debt sources is still a concern to the approximately one-half of Australia’s REITs that are not rated and therefore do not have access to bond markets as a funding alternative.

Some smaller A-REITs have higher debt loads and among these, some are struggling to service their debt. For the major REITs, the issue is more about loan maturities. When debt markets began to dry up, this increased the pressure on them to pay off or refinance the loans, leading to some of the highly dilutive capital raisings that occurred at the height of the financial crisis.

In the course of refinancing existing debt or, if they so decide, taking on new debt, REITs are trying to stretch out the maturities over a longer period of time to mitigate the maturity risk.

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A-REITs will continue to focus on internal opportunities to enhance returns in 2013, but acquisitions activity is also set to increase

Today, only a few well-capitalised A-REITs experienced in investing abroad continue to seek opportunities in global markets. However the majority of A-REITs are focusing on growth within the Australian market, going back to basics, concentrating on clearly defined sectors that complement core competencies and generate reliable income streams, mainly from rentals.

Australia’s commercial property markets are reasonably healthy and are generating stable cash flows for A-REITs and other owners. The industrial property sector is improving and attracting more investment interest. Some retailers are struggling, but this has not yet had a significant impact on the market for investment in institutional retail properties.

The outlook for the REIT market is more positive. The ability of A-REITs to grow externally through property acquisitions or development is increasing and internal growth is still on the rise. In contrast with the early days of Australia’s public REIT market, when newly minted REITs were just starting, A-REITs are now experienced in operating through boom times and hard times, at home and globally. And they will apply that experience in making strategic decisions about how to grow in 2013 and beyond.

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