Simon Ranson, vice-chairman, investment bank, JPMorgan: We think that 2020 will see a return to higher levels of listed M&A activity compared to 2019, which was relatively subdued. In 2019 the only notable completed transactions in the sector were the acquisition of Aveo by Brookfield and the acquisition of Propertylink by ESR Australia. This was in part due to a strong rally in REIT security prices which meant that potential acquirers viewed targets as relatively expensive compared to just a few months earlier, especially if they were using cash consideration to make an acquisition well above NTA.
We are now observing a stabilisation of REIT security prices and the market adjusting to the new low interest rate environment which is conducive to M&A returning. Property acquirers are willing to do deals on record low internal rates of return as the property yield spread to bonds is highly attractive by global and historical standards. The cost of both debt and equity financing is extremely low and there is plenty of capital parked on the sidelines ready to be deployed.
Global players will continue to be active in the cash buyout space due to continued weakness in the Australian dollar and uncertainty prevailing in other investment markets such as the UK, US and Hong Kong.
After the success of several recent demergers in Australia, we could see local REITs potentially spin-off retail portfolios which have been hard to sell on the direct market.
Angelo Scasserra, managing director, head of real estate, Australia, Credit Suisse: The pressure from the weight of capital to be deployed in real estate is building. I’d expect this to be unleashed with more M&A in 2020 with listed targets offering quality portfolios and scale that simply aren’t available from buying in the direct market. As an M&A strategy, building a pre-bid stake has historically had a higher rate of success than not. Therefore, it’s a strategy that will frequently be used.
What are the prospects for IPOs and equity raisings?
Ranson: The market pricing of REITs at the moment is very supportive of raising equity. With over $6.5 billion of equity raised in the sector during 2019 across 25 separate deals not including block trades, there is clearly demand from investors for REIT product which provides a stable distribution yield well above the RBA cash rate.
An increasing amount of property sale and leasebacks from corporates is providing the local REITs with ample opportunities to acquire property and raise equity to finance the acquisitions. The current low cost of equity capital for REITs is also making it easier to use a higher proportion of equity in the acquisition funding mix.
On the IPO front, we think that there is pent-up demand for new listings in certain asset classes. For example, there are relatively few industrial REITs and no healthcare or hotel REITs in Australia. Owners of property in these sectors can obtain very attractive pricing for assets from the IPO market with the bonus prospect of securities trading well above NTA in the aftermarket. Recent listings such as HomeCo and Investec Australia Property Fund have performed well, which bodes well for prospective listings.
Scasserra: We believe that listed investors are seeking greater diversification in their property portfolios. The next wave of IPOs will likely be focused on emerging or under-represented asset classes which could include logistics, data centres, healthcare or student accommodation. Equity raisings will continue to in step with the quick pace of asset acquisitions being set by REITs armed with a historically low cost of capital.
Green: Sentiment to A-REIT equity turned positive quickly in early 2019 with the market responding to a falling and historically low interest rate environment. A-REITs responded with strong positive price performance with the A-REIT Index up around 17 per cent in the 2019 calendar year. Rather than a year of M&A, 2019 became the year of equity raising, with over $8 billion raised in 2019.
The appetite for the asset-backed yielding investment product remains strong moving into 2020, especially from existing operators seeking to raise new equity around funding needs. In addition, like 2019, new IPO candidates of quality management and underlying real estate (including alternate real estate asset classes) will be supported by investors who also have an appetite for new product.
Church: As long as rates remain low the prospects for both IPOs and equity raisings remain very positive. The challenge will be to find suitable assets to drive such demand. With an official cash rate of just 0.75 per cent and term deposits now lingering at a historic low levels there will be good demand from retail investors in particular for both existing REITs raising capital and new IPOs to market.
What impact will the lower-for-longer yields/rates environment have on the REIT sector and commercial property?
Green: We believe the performance of the listed A-REIT market will continue to be driven by response to bonds/interest rates movements. Falling and low interest rates have tended to trigger A-REIT outperformance. The thematic continues to be all about income yield, yield and more yield. Commercial property with strong income-generating cash flows will be actively sought.
Ranson: Low interest rates have been hugely positive for the sector and will continue to be so going forward. While headline investment metrics such as value per square metre, cap rate and IRR appear to be at all-time record levels in many property asset classes, it’s important to note that on a relative basis these investments are even more attractive now than they were several years go because the cost of financing today is lower.
The market is going through a phase of recalibrating to a new normal when it comes to pricing of assets. Those that have remained on the sidelines have missed out on strong capital gains over the last couple of years while those who are willing to adapt more quickly are being rewarded. This phenomenon is being experienced globally and it is not unique to Australian real estate.
Church: The low rate environment will provide continued support for current prices and underpin support/demand for securely leased real estate. Real estate as an asset class has benefited significantly from the “lower for longer” interest rate environment and this has been an elongated period as we morphed to “even lower for longer” interest rate environment to the “Arctic Summer”, ie, a sustained period of “time in the sun” for the asset class. I believe with a potential slowdown in China , the increased impact of AI and robotics on markets and employment we remain in this low rate environment for some time.
One area of that I believe managers/owners of both listed and unlisted REIT’s as well as everyday owners of real estate should be mindful of in the current market is that with the highly elevated NTA’s/asset prices with record low capitalisation rates is the amount of leverage that owners put on their portfolio/assets needs to be carefully considered.
Scasserra: The spread between capitalisation rates and ultra-low funding costs makes commercial property a tantalising target for investors. The result will be further downward pressure on cap rates, particularly in the office and industrial property sectors. However, we shouldn’t confuse “lower for longer” with “lower forever”. It would be dangerous to assume that low interest rates continue in perpetuity.
Which will be the hot classes and growth areas in commercial property? On the flip side, where may pressure come to bear in the fundamentals underlying earnings from real estate?
Scasserra: Logistics is the hottest and most keenly sought after property asset class. Listed and wholesale investors believe in the secular theme of rapidly growing third-party logistics and e-commerce and are under-allocated to this asset class. In addition, any alternative asset class that offers differentiated exposure for investors are also popular strategies, including student accommodation, storage, data centres and healthcare.
Undifferentiated retail property continues to be out of favour as some retailers struggle and occupancy costs put pressure on rents. Having said that, value investors are still picking up retail property where negative sentiment has gone too far and bargains are available.
Church: The standout asset classes in 2020 will be a combination of long WALE [weighted average lease expiry] assets where security of tenure and quality of covenant deliver through cycle certainty of cash flow and those assets that are exposed to the industrial logistics sector particularly for modern, well-located facilities that can take advantage of transport hubs particularly inter-modal style assets.
Given the international experience on retail, particularly out of the UK and the US where online retail penetration is having a significant impact on traditional forms of retail, then you can expect the market will be most discerning for this asset class. 2019 has provided some hope that the Australian retail sector may not be as dire as the offshore counterparts.
An additional area of focus that will increasingly become critically important for our sector will be sustainability and a company’s green credentials will become as important as their financial results.
Green: We continue to be slightly agnostic between the asset classes. Residential is improving, industrial logistics is the flavour of our times, office is underpinned by continued investor appetite and even retail could be seen to present good buying opportunities (particularly if underpinned by alternate uses). Another area to watch is “alternate real estate” such as healthcare, student housing and other social infrastructure as investors gain comfort on the stability of the earnings generated by these assets.
Ranson: We think that alternative asset classes which are defined as anything outside of the retail, office and industrial sectors represents a tremendous growth opportunity for investors. There is so much unsecuritised real estate that is currently owned by corporates and government which can be sold and leased back to real estate investors. Australia has some way to go in the development of the alternatives space compared to the US for example. Opportunities exist for growth in the social infrastructure, hotel, storage and multifamily build-to-rent sectors which are all in relatively early stages of development in Australia.
The underlying earnings and outlook for sub regional retail assets which are more heavily exposed to fashion and discount department stores remains challenging. However we are seeing green shoots in this space with a few recent sales at premiums to book value. An opportunity exists for retail landlords to remix vacated space from discount department stores and mainline department stores (which pay the cheapest rents) into space used for lifestyle, entertainment and convenience based occupiers which are still experiencing growth.
The Sydney and Melbourne office sector has also had an exceptionally strong three years with effective rents going up at 10-15 per cent per annum over this period. The consensus view is that rental growth and occupancy levels in these markets could normalise as new supply that is being developed begins to come online between 2022 and 2025.
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