The Australian real estate investment trust (A-REIT) market has a history dating back to 1971, when the first property trust was listed on the Australian Securities Exchange (ASX).

It’s now very large, well established and sophisticated, with approximately 70 percent of investment-grade properties Down Under securitized.

There are also several A-REITs of global significance, including the world’s largest industrial developer and one of its biggest shopping mall owners.

The sector has also seen its share of significant ups and precipitous downs.

The S&P/Australian Securities Exchange 200 A-REIT Index established its all-time closing high of 2,575.6 on Feb. 22, 2007. It finished 2007 at 2111.2 after trending lower to 2419.7 by Dec. 11 then collapsing into 2008. By Dec. 31, 2008, the index measured 899.5. It finally bottomed on Mar. 9, 2009, at 546.9.

Two-thousand twelve was good to the sector, as were 2009–after the Mar. 9 bottom for most global equities–and 2010, though 2011 was relatively unkind. Last year A-REITs, as represented by the S&P/ASX 200 A-REIT Index, posted a total return in US dollar terms of 34.64 percent. That was a turnaround from the 1.24 percent loss for 2011 and it re-established momentum set in 2009, when it was up 37.5 percent, and 2010, when the gain for the sector was 13.49 percent.

A-REIT management teams are now focused on strategies to enhance returns following a two-year period of strengthening balance sheets by restructuring debt and selling assets, especially assets held offshore. They’re taking advantage of historically low debt costs, helping to diversify their funding sources away from the banks, and extending their average debt duration.

Most A-REITs are in a stronger financial position than they were entering the 2007-to-2009 period, though memories of their steep losses during the global recession and financial crisis continue to linger. Falling debt costs support REIT performance both through a reduced interest cost and by potentially driving compression of capitalization rates. “Cap rates” are determined by dividing a property’s net operating income by its purchase price.

And most A-REITs have gone back to basics by concentrating on clearly defined sectors of the market that complement their core competencies and generate reliable income streams, mainly from rentals.

A-REITs have yet to win back the full trust of the investor community and many of their shares continue to trade at discounts to net asset value (NAV), although recent months have seen that price gap continue to close.

One major reason for the continuing discount is that investor confidence in A-REITs has been slow to return, and A-REIT share prices slow to recover.

Many A-REITs moved beyond the traditional passive income model to take on higher-risk investments, mainly in overseas properties, in the years leading up to the global meltdown.

In general, however, A-REITs are better capitalized, have more financing options, own higher-quality assets and have less risk exposure than they did five years ago.

Good to Go

Sydney-based Goodman Group (ASX: GMG, OTC: GMGSF) is the largest industrial property developer in the world and the second-largest owner and manager of distribution facilities and warehouses, behind US-based Prologis Inc (NYSE: PLD).

It’s also a good poster child for the adventure A-REITs have endured over the past five years, its unit price falling from lofty heights amid unprecedented global fear brought on by the Great Financial Crisis, its balance sheet now shaped up as management has taken advantage of the record-low borrowing rates that calamity hath wrought.

On Feb. 13, 2007, the A-REIT closed at AUD33.76, an all-time high. By March 9, 2009, it had plumbed the depths to an all-time low of AUD0.70. Since this nadir, however, the unit price has ridden a strong up-trend.

It recovered from the March low to post a 23.4 percent total return in US dollar terms in 2009, though this figure was boosted considerably by the sharp appreciation in the Australian dollar versus the greenback as global risk appetite re-emerged during that wild year. In local terms Goodman Group was down 3.2 percent.

The following year, 2010, was another one of strong recovery for the aussie and Goodman Group as well, as the A-REIT posted a US dollar total return of 22.8 percent and a local return of 7.2 percent. Two-thousand eleven was a year of consolidation, as the aussie was basically flat and Goodman Group posted a negative total returns on the ASX of 7.1 percent and in US dollar terms of 6.9 percent.

Goodman’s portfolio includes industrial properties worth AUD20 billion and a development pipeline worth more than AUD10 billion. During the past year the company expanded into the US and also deepened its participation in China’s logistics market.

Like others in the sector, Goodman Group’s business was more highly leveraged than it is now, as it expanded globally during the peak of the market before 2007.

But during the Great Financial Crisis it refinanced AUD2 billion worth of debt and in August 2009  embarked on a AUD1.8 billion capital raising, with sovereign wealth fund (SWF) China Investment Corp (CIC) investing AUD500 million.

CIC recently sold a 6.9 percent stake in the Goodman Group for AUD519 million, an investment that saw the sovereign wealth fund more than double its money. The Chinese SWF still holds about 10 percent of the A-REIT.

During the GFC Goodman was managing about AUD16 billion of assets globally, and none of its operating units defaulted or had emergency equity raisings.

Since the end of the GFC Goodman has cut its debt-to-assets ratio in half, to about 29 percent, and doubled its cash coverage of debt service to about five times. Goodman Group, according to founder Greg Goodman, is now one of the best-capitalized and financed real estate trusts in the world.

The short-term debt situation is more than manageable, with a AUD130 million revolving facility up for renewal in August 2013 but nothing else until AUD208 million on a term loan must be rolled over in September 2015.

The A-REIT posted a payout ratio of 69.3 percent for fiscal 2012.

Goodman Group’s good run on the Australian Securities Exchange (ASX) continued in 2012. The best-performing A-REIT among the eight now under How They Rate coverage, Goodman Group posted a total return in US dollar terms of 61.2 percent.

The stock is pricey at these levels–it closed at AUD4.43 on the ASX on Jan. 11, equivalent to about USD4.67 in US dollar terms at the prevailing Australian dollar-US dollar exchange rate. And it’s trading at a steep premium to net tangible assets per security of 66.9 percent.

The dividend history since December 2009 has been stable, though the stock now yields 4.2 percent, below average for A-REITs.

The stock has attracted considerable institutional attention because it’s recognized as a “best in class” investment. Pension funds, for example, usually include it among potential repositories for capital when they look to put money to work in industrial property.

The A-REIT has posted strong operating results, and guidance for the current year is strong as well. Goodman Group posted a 4.2 percent increase in net profit to AUD408.3 million for fiscal 2012, and management’s outlook for fiscal 2013 is for 13 percent growth in operating profit to AUD524 million.

Goodman Group is likely to be an active player in any consolidation that takes place in the A-REIT sector in 2013, as it seeks to expand its industrial property portfolio.

It and other industrial-focused A-REITs stand to benefit from the emerging online retailing sector. Goodman Group, for example, is weighing opportunities including the development of suburban logistics facilities and 24-hour parcel collection stations. Industrial A-REITs would also benefit from increasing demand for warehouse space.

We’re boosting our buy-under target on Goodman Group to USD4, equivalent to about AUD4.20 on the ASX. Wait for a pullback.

Dexus Property Group (ASX: DXS, OTC: DXSPF), which is exiting the US industrial property market in favor of focusing its portfolio on Australian office space, could make an interesting match with Goodman Group.

During its third quarter Dexus leased or renewed a total of approximately 200,000 square meters of space across 87 transactions, increasing occupancy from 93.4 percent at June 30 to 94.7 percent as of Sept. 30, 2012.

Occupancy by area for the office portfolio decreased 0.9 percent but at 96.2 percent remains 4.5 percentage points higher than the national average of 91.7 percent. Occupancy by area for the industrial portfolio increased from 91.7 percent as of June 30 to 94 percent on Sept. 30, 2012.

During the third quarter Dexus issued AUD180 million in medium-term notes over four transactions. The average all-in yield was 5.75 percent at an average duration of 5.8 years. Debt duration following these transactions increased from 4.2 years at June 30 to 4.3 years, while the average cost of debt declined to 6 percent.

Debt-to-assets as of Sept. 30 was 29.3 percent.

Management reiterated guidance for earnings, or funds from operations, for the year ending June 30, 2013, of AUD0.0775 per share and a distribution of AUD0.058 per share. Distribution guidance represents an 8.4 percent increase on the fiscal 2012 level.

Dexus Property Group, which is yielding 5.6 percent as of this writing, is a buy under USD1.05.

Portfolio Property

AE Portfolio Conservative Holding Australand Property Group (ASX: ALZ, OTC: AUAOF) recently rejected a AUD2.8 billon offer from GPT Group (ASX: GPT, OTC: GPTGF) for its industrial and commercial property divisions. Australand is also rumored to be the object of fellow A-REIT Mirvac Group’s (ASX: MGR, OTC: MRVGF) acquisitive desires.

These could be the first signs of a new round of consolidation in the Australian property space.

Australand’s share price has rallied from AUD2.77 on Nov. 16 on the ASX to a close of AUD3.39 on Jan. 11 in Sydney. The A-REIT closed as high as AUD3.51 on Dec. 20 but has settled down of late, particularly on news that major shareholder CapitaLand Ltd (Singapore: CAPL, OTC: CLLDF, ADR: CLLDY) intends to conduct a strategic review of its investment in the A-REIT.

Singapore-based CapitalLand, one of Asia’s biggest residential and commercial property developers, owns 59.3 percent of Australand’s outstanding units.

Australand has retained Macquarie Capital, Fort Street Advisers and King & Wood Mallesons in an advisory capacity regarding CapitalLand and, presumably, the A-REIT’s alternatives as what appears to be shaping up as an auction for its assets unfolds.

Conditions for takeovers in the A-REIT space are very favorable right now. Many private equity groups, pension funds and other institutional investors with ample cash to spend are hunting the world for returns better than the microscopic yields available from fixed-income securities.

In an environment of historically low interest rates, property yields look increasingly attractive. Funding costs have declined dramatically, while at the same time the strength of the Australian dollar has created a window of opportunity for offshore companies to cash out exposures to Australian assets on compelling terms.

Acquirers can achieve greater scale and diversity, which would further reduce funding costs.

CapitalLand, which is backed by Singapore’s sovereign wealth fund (SWF) Temasek Holdings, might be evaluating its Australand stake in terms of booking a big gain and redeploying capital elsewhere in Asia.

With a market capitalization of about AUD2 billion and an attractive portfolio of industrial properties Australand may be just the first target for consolidators.

On Dec. 14 Australand management announced that the A-REIT’s final distribution for the year ending Dec. 31, 2012, would be AUD0.11 cents per stapled security, bringing total distributions for the year to AUD0.215.

The final distribution will be paid Feb. 8, 2013, to shareholders of record as of Dec. 31, 2012. Shares will trade ex-dividend on Dec. 21. Management will announce full-year 2012 results on Feb. 7, 2013.

Australand posted an operating profit after tax of AUD68.2 million for the first half of 2012, up 5 percent from the prior corresponding period, while statutory net profit after tax rose 6 percent to AUD89.7 million.

Total revenue for the half surged by 41 percent to AUD393 million. Operating earnings per security were AUD0.118.

Management reported comparable rental growth for the period of approximately 3.2 percent, while occupancy was 98.7 percent. The A-REIT’s portfolio has an average lease life of 5.7 years. High occupancy, long leases and fixed rental growth provided good earnings distribution coverage visibility.

Australand continues to manage its capital position prudently, with gearing of 32.6 percent–or total debt-to-total assets–within management’s target range of 25 percent to 35 percent. The A-REIT has no further corporate debt maturities until September 2013 and has adequate liquidity to fund development.

Management recently reiterated guidance for growth in operating earnings for 2012 of 3 percent to 4 percent over 2011.

Australand Property Group, which as of Jan. 11 is trading 27.5 percent above our USD2.80 buy-under target, is a hold. CapitalLand may be motivated enough to exit Australia that it sells to GPT or Mirvac–or another party–at a level that makes sense for it but not for everyone else on Australand’s shareholder roll.

US investors who’ve held the stock from our initial recommendation in March 2012–if this is you you’re sitting on a better than 40 percent gain in US dollar terms–should strongly consider booking at least a partial profit and letting the remainder of your position run through the consolidation game.

Much of that gain has been generated over the past month, after GPT Group made its offer and rumors Mirvac Group’s potential interest hit the newswires.

GPT offered to buy all but Australand’s residential property division from the group and was pitched at a AUD140 million premium to the assets involved at a time when Australand’s securities were trading at a discount of about 13 percent to the book value of the underlying assets. Australand’s discount to net tangible asset value (NTA) has narrowed to about 1.1 percent

The assets involved represent about 70 percent of Australand’s revenue base, which would have left it as a pure residential property group.

GPT has no interest in the residential property division. It wants Australand’s AUD2.3 billion of office and industrial properties to reduce its exposure to retail property, which is now almost 60 percent of its portfolio. GPT is trading at a discount of about 6 percent to NTA and currently yields 5.4 percent.

Management recently guided for 7 percent earnings growth for 2012 and a payout ratio of 80 percent of realized operating income.

Strong results from the A-REIT’s leasing efforts helped it to a solid third quarter of 2012, despite relatively subdued market conditions in all three of the sectors in which it operates–retail, office and logistics and business parks. Occupancy increased across the portfolio to 99.4 percent, and management noted rental increases for the majority of its properties. All this supports income growth.

Management declared a distribution of AUD0.047, which was paid on Nov. 16, 2012. The cash distribution for the nine months to Sept. 30, 2012, was AUD0.142, up 10.1 percent over the prior corresponding period.

GPT’s balance sheet is in good shape, with low gearing of 21.4 percent, up slightly from June 30, 2012. In July GPT priced an increase of AUD100 million to its AUD150 million, seven-year fixed-rate medium-term note issued earlier in 2012 and followed up with a private placement of an additional AUD50 million in medium-term notes in in August.

GPT will report full 2012 financial results on Feb. 14, 2013. Unlike most A-REITs–it’s the only one under AE How They Rate coverage that does so–GPT pays its distribution on a quarterly basis.

Mirvac, with a residential property business of its own, could take on the entire Australand portfolio but would probably have to do it through a stock-for-stock merger or else embark on a significant and deeply discounted equity raising. Mirvac currently trades at a discount of about 11 percent to NTA and is yielding 5.7 percent.

Mirvac, during its fiscal 2013 first-quarter operating update, reaffirmed its full-year operating earnings per share guidance range of AUD0.107 to AUD0.108 and distribution guidance range of AUD0.085 to AUD0.087per share.

The A-REIT reported portfolio occupancy of 98.3 percent and a portfolio weighted average lease expiry of 7.2 years. Mirvac secured 53.2 percent of fiscal 2013 expiring leases through Sept. 30, 2012.

The A-REIT’s Investment Division delivered “robust performance” despite subdued market conditions, as its high-quality properties and advantageous positioning served it well. Mirvac is overweight in the office sector and is focused on sub-regional shopping centers driven by non-discretionary spending.

As of mid-2012 Mirvac is paying its distribution on a semi-annual basis as opposed to a quarterly basis.

The A-REIT posted a total return in US dollar terms of 35.8 percent in 2012 but remains well below its pre-GFC high of AUD5.50.

GPT Group is a buy under USD3.60. Mirvac Group is now a buy under USD1.55.

The Biggest Yield in A-REITs

Stockland (ASX: SGP, OTC: STKAF) posted the lowest US-dollar total return in 2012 among A-REITs under AE How They Rate coverage, though its performance was hardly scoff-worthy at 20.2 percent.

It’s now the highest-yielding among those property trusts we cover at 7 percent.

Stockland’s status as the laggard among our A-REITs is explained by its focus on retail and residential property development.

In its update for the first quarter of fiscal 2013 management noted that barring an “unlikely” improvement in its key Victoria market, underlying earnings per share for the full year will come in at the lower end of previously announced guidance of 10 percent to 15 percent below fiscal 2012 levels. The decline in the first half of fiscal 2013 will be even greater, given the “large skew” to the second half of its residential business.

Management also reiterated, however, its confidence that earnings will improve beginning in fiscal 2014, driven by major new retail developments and a strong residential pipeline, with new projects commencing settlements in fiscal 2014 and fiscal 2015.

This confidence underlies management’s decision to maintain its fiscal 2013 distribution at AUD0.24 per share, though doing so will result in a payout ratio above that established by company policy.

The balance sheet, still supported by solid cash flow bolstered by rental income from its commercial property portfolio, is in good shape, with a debt-to-assets ratio of 20 percent. Balance-sheet ratios remain well within A- metrics. Management expects to reduce its cost of debt for fiscal 2013 to 6.2 percent, better than previous guidance of 6.5 percent.

Stockland is trading at a discount to NTA of nearly 7 percent. A relative underperformer but also undervalued, Stockland is a buy under USD3.50.

Mall Rats

Westfield Group (ASX: WDC, OTC: WEFIF, ADR: WFGPY) is Australia’s largest A-REIT with a market capitalization of AUD240 billion. It has interests in and operates one of the world’s largest shopping center portfolios, which comprises 124 regional shopping centers in Australia, New Zealand, the US, the UK and Brazil valued in excess of USD59 billion.

It houses approximately 25,000 retailers in more than10.5 million square meters of retail space.

Westfield manages all aspects of shopping center development, from design and construction through leasing, management and marketing.

As the Australian retail sector has entered difficult times Westfield Group’s US portfolio has provided a solid balance. Its US shopping center portfolio encompasses approximately 63 million square feet of retail space in 12 states, which it leases to nearly 9,000 specialty retailers. Westfield runs malls in Northern California, Chicago, southern Florida, Los Angeles, New Jersey, New York, San Diego and suburban Washington, DC.

The secret to Westfield Group’s success is the ability to charge tenants more rent because its malls boast consistently higher foot traffic and higher retail expenditure. For every AUD100 spent in a specialty store, for example, Westfield Group takes a AUD15 cut.

During its trading update for the third quarter of 2012 management reiterated its forecast for full-year funds from operations of AUD0.65 per share and a distribution of AUD0.495 per share.

The group’s global portfolio as of Sept. 30, 2012, was 97.7 percent leased, up 40 basis points compared to the same period in 2011. The US portfolio was 93.7 percent leased, up 120 basis points. The Australian/New Zealand and UK portfolios were both over 99.5 percent leased and Brazil was at 95.6 percent. For the 12 months to Sept. 30 comparable specialty retail sales were up 8.4 percent in the US, 1.2 percent in Australia, 1.8 percent in New Zealand and 14.5 percent in Brazil.

Westfield Group is currently yielding 4.7 percent and is trading at a 54.6 percent premium to NTA. Hold.

Westfield Retail Trust’s (ASX: WRT, OTC: WTSRF) principal investment is a joint venture with Westfield Group and other third parties in a shopping center portfolio that includes 54 shopping centers in Australia and New Zealand. It’s the largest domestic-focused A-REIT, with assets of about AUD12 billion.

It’s a virtual pure play on the Australian dollar as well as the Australian consumer.

For the six months ending June 30, 2012, the A-REIT posted net profit after tax of AUD416.9 million, or AUD0.1365 per share. Distributable earnings were AUD282.7 million, or AUD0.926 per share, an increase of 2.8 percent over the prior corresponding period. Westfield Retail completed 1,400 lease transactions during the period and reported an occupancy rate of 99.5 percent. Comparable net operating income, meanwhile, grew 3.3 percent.

Management declared an interim distribution of AUD0.0925 per share, in line with its policy to allow for a payout of up to 100 percent of distributable earnings.

Management also reiterated 2012 full-year forecast for distributable earnings and distribution per share of AUD0.1875.

Trading at an 11.3 percent discount to NTA and a yield of 5.9 percent, Westfield Retail is a much better value than its bigger affiliate Westfield Group. Westfield Retail Trust is a buy under USD3.

New Kids on the Block

We’re adding potential Australand suitor GPT Group to How They Rate coverage this month.

We’re also adding Commonwealth Property Office Fund (ASX: CPA, OTC: CWHPF), which manages a portfolio comprising 26 office assets with a gross asset value of AUD3.7 billion as of June 30, 2012.

CPA, as it’s widely known, has a geographically diverse portfolio, located in capital cities and suburban locations throughout Australia.  The average unexpired lease term of the portfolio is 4.9 years based on income and the total average vacancy rate is 3.8 percent, also based on income.

During its fiscal 2013 first-quarter trading update management reaffirmed full-year earnings guidance of AUD0.086 per share and its target payout ratio of 75 percent of funds from operations, which would equate to approximately AUD0.064 per share. CPA will announce results for the first half of fiscal 2013 on Feb. 21, 2013.