This article is from the Australian Property Journal archive
The 2006 financial year result are in and leading research firm Property Investment Research has compiled a list of the star and worst performers.
The 2006 financial year has come to pass with the LPT sector producing another round of results that were on the whole rather impressive. The S&P/ASX 300 Property Trust Accumulation Index showed a total return of 18.1%; 10.5% capital and 7.6% income return for the past financial year. Surprisingly mirroring the returns of the previous financial year.
The star performer for the year was Macquarie Goodman Group (MGQ) with a total return of 53.7%, (of which 47.1% was capital growth). This performance significantly biased the total returns from the Industrial LPT sector, which without MGQ would have been 9.9%.
MGQ’s strong result was due to positive market sentiment arising from aggressive growth of its assets under management, up 310% to $28.5 billion over FY06 as a result of organic growth within existing funds, newly launched funds and the pursuit of other businesses such as the acquisition of Arlington.
The worst performer of FY06 was Rubicon America Trust (RAT) with a total return of 1.4%; yield of 11% and capital growth of -9.3% as a result of market sentiment.
With the exception of BJT, five out of the top six LPT’s in terms of total returns were stapled securities. They all returned over 30% to their loyal investors over the year, with the majority of the returns coming from capital growth. This highlights the importance of the business component to the market place in terms of the price they are prepared to pay for a security and hence the resulting amount of capital growth.
Within the Office sector Investa Property Group (IPG) achieved the highest total return of 21.6%.
IPG’s underlying performance was more or less in line with previous management guidance; weak residential (mainly NSW) but satisfactory Trust performance with profits from asset sales helping maintain its distribution level. Market speculation over IPG being an acquisition target was primarily responsible for the increase its security price over the period, which was up 12.9%.
The retail sub-sector showed the weakest return in FY06 with Westfield Group (67% of the retail subsector) achieving a total return of just 3.7% (-2.3% capital growth) dragging down Retail sub-sector performance. Excluding Westfield, retail’s performance was 19%, in line with the LPT sub sector.
WDC’s performance was impacted by cooling consumer confidence in the US, as a result of rising interest rates, increasing oil prices coupled with highly geared households. Centro Properties Group (CNP) achieved the best return for the subsector (30.7% total return with 23.9% capital growth). CNP’s strong performance was fuelled by a strong result in its services business (primarily it’s burgeoning funds management business) as well as recording a healthy result within its property portfolio (4.7% comparable income growth).
In fact taking Westfield out of the equation, the LPT sector returned a healthy 24.3% This highlights the impact of having such a dominant constituent in an index.
As mentioned, the impact of the USA portion of the portfolio was seen as the main driver in Westfield’s lacklustre price performance. By contrast Carindale Property Trust (CDP) whose sole asset is a half share in a Westfield centre in Queensland, Australia returned 27.5% for the year. It would appear that the Northern star that has shone so brightly for Westfield in the past may now be on the cusp of becoming a black hole.
In another display of weighting dominance, the Hotel and Leisure sector performed very well.
However due to Thakral dropping out of the index, this sector only has two constituents. One of those is Macquarie Leisure (MLE), which comprises a massive 73% of that sector in the index. MLE has for the previous two years been the top performing LPT in terms of return. This year it slid to fifth, whilst still providing a very healthy 34.3% return (26.9% growth). The dream run of the owner of Dream World appears to be slowing, although given the very aggressive growth nature of the Macquarie management model anything is possible over the next year.
The prior financial year’s prize for the best example of proving that there are lies, damn lies and statistics went to the Grand Hotel Group (GHG) for proclaiming a massive EPU growth rate of 414% as a result of including property revaluations in their reported profit. However this financial year, GHG’s example was followed by all as a result of the implementation of IFRS (International Financial reporting Standards). Overall PIR has estimated that on average (per trust) approximately 50% of IFRS consistent revenue was made up of property revaluations.
Nevertheless, we were happy to see most LPTs separately report a measure of underlying earnings excluding IFRS items such as property revaluations, straight lining of rental income* and unrealised changes in the fair value of financial derivatives.
On the other hand PIR is disappointed to report that more than half of the LPTs in the index dipped to some extent into capital reserves to fund distributions, a trend that we have now reported on for the third financial year in a row.
Table 2 shows the top ten offenders.
The biggest offenders include Babcock and Brown Japan Property Trust (BJT) and Multiplex Group (MXG). BJT was one of the star performers of FY06, achieving a total return of 49.2% including 41.0% capital growth. BJT boosted underlying earnings from capital by approximately 123% to be able to achieve a distribution level of 9.76 cents per unit, which was in fact 4% higher than the Product Disclosure Statement.
The main reason BJT had to dip into capital to pay out distributions was as a result of the $30.8 million management performance fee (against a net rental income for the trust of $40.5 million) accrued for the period.
Table 3 shows the performance fees accounted for a massive 111% of BJT’s underlying earnings (PIR’s estimate, excluding IFRS items and pre performance fee).If BJT had not accrued this performance fee it would have only dipped into capital by about 27.0% of earnings….still massive but much less than 123%.
BJT highlights a common problem among the LPT sector with performance fees often based on unit price performance with respect to an index benchmark (usually the S&P/ASX 200 or 300 Property Trust Accumulation Index or a composite including one of these indices) rather than underlying operating performance. BJT’s performance fee is a two tiered fee based on asset operating performance and total return outperformance with respect to the S&P/ASX 200 Property Trust Accumulation Index.
In addition BJT is not required to earn out any previous underperformance before claiming a performance fee for the current period. Given that there is no guarantee that price reversion will not occur in the following period, this clearly highlights a misalignment of interests between management (who are given short term incentives in this case) and unitholders who tend to worry about the longer term return of their holdings.
In contrast Macquarie Leisure Trust Group (MLE) did not dip into capital to fund distributions and could thus afford to pay the manager for its strong 34.3% total return for FY06 (26.9% capital growth). MLE pays the manger a base fee, incentive fee linked to underlying earnings and a performance fee benchmarked to the S&P/ASX 300 Property Trust Accumulation Index and the S&P/ASX Small Ordinaries Index (50%).
Multiplex Group (MXG) topped the dippers list (Table 2). MXG’s overall result for FY06 was weak as expected by PIR with its 25.5 cent distribution per security wholly funded with a transfer from capital. PIR’s estimated profit pre-abnormal items was -$298 million, with a $255 million loss recorded for the Wembley Stadium Project….so far.
PIR estimates that there is still some residual risk stemming from the fact that the project is still not complete, despite many press releases over the year assuring investors that completion is nigh.
Currently we are seeing each side in this remorseful construction calamity playing the blame game, however this does not alter the fact that the main game cannot be played in the stadium.
LPTs Geographical Exposure
The following charts depict geographical property exposure of Trust portfolios owned by LPTs as at 30 June 2006 and in late 2004. Overseas exposure of LPTs has increased from approximately 30% in late 2004 (Chart 1) to approximately 41% as at 30 June 2006 (Chart 2) as a result of LPTs increasing their exposure to the USA, up 8%, and more than doubling their exposure to Europe. LPTs have been chasing relatively more attractive yield versus interest rate spreads in the USA and more recently in Europe. The shift to Europe is gaining momentum after consistent interest rate rises on the part of the US Federal Reserve have made acquisitions in the USA increasingly less attractive.
Over FY06 trusts like JF US Industrial Trust (JUI), BJT and APN/UKA European Retail Trust (AEZ) have been active on the acquisitions front, more than doubling their market caps over FY06 and have contributed to the increased overseas exposure. BJT has increased its property assets over the period by 103%, while JUI’s and AEZ’s property assets have increased respectively by 226%, and 42%; both as a result of property acquisitions and positive asset revaluations.
Chart 2 includes Rubicon America Trust as well as Rubicon Europe Trust which listed in December 2004 and 2005 respectively and thus were not included in Chart 1. This highlights that new trusts comprising overseas property assets have entered the market to satisfy demand for securitized listed investment in non-Australian property assets.
Basically the returns for the sector over the past financial year were solid, (despite some giant size bites of management fees in some trusts) and well above what many people would expect from a boring but safe investment sector. The disappointing returns from the retail sector, which were compensated for by the industrial sector, highlight the importance of holding a diversified portfolio.
By John Welch, head of research & Carolina Contreras, REIT Analyst, Property Investment Research.*
