Company profit reporting season: property wrap-up
After each company profit reporting season we present a summary on how the investments in clients' property investments have performed (apologies to those without a property allocation; Investment Matters will return to general equity related matters next week). This week we will also provide our current thoughts on property investments more generally.
The following table contains a summary of the performance of each of the listed REIT investments in which we invest for clients. (Note: there are also some unlisted investments - property and infrastructure related bonds, as well as one property related hybrid.)
The objective of investing in property (with First Samuel anyway) is to obtain a sustainable income, with some capital growth over time to act as a hedge against inflation. We expect lower returns but with lower risk than, say, from equities. Thus, in the current environment, we are proceeding with caution.
You may have noticed the limited number of investments in the table above. Also, clients' property allocation has a current cash weighting of around 29%. This reflects our current caution in relation to listed property.
Issues we hold concern about include:
* Interest rates are going up - which places pressure on earnings, and on the balance sheet of the higher geared REITs
* Valuations of property being influenced by comparative valuations, including purchases by cashed-up overseas buyers - and not enough by fundamentals (e.g. the net present value of future earnings)
* Future rental growth will be constrained, which is tied to underlying economic growth being benign
* REITs are paying out too great a portion of earnings, meaning there is no fat for capex or absorbing pressures from interest rates increases and / or rental income declines
The caution summarised above hasn't changed materially from what we have expressed in the recent past. What is different now? The interest rate environment is starting to tighten. The global interest rate environment is a key driver of this. This has yet to flow though in any significant way - to the profit line in particular. There are a few examples, however, were we see it starting it influence. For example, the Centuria Industrial REIT took a more conservative outlook in relation to its forecast distribution, with one of the cited reasons being it was looking at a higher interest rate on its upcoming refinancing (we also believe there was an element of re-baselining under the new management).
Also this reporting season we are seeing real pressure on rental income coming through, most prominently in the retail (shopping centre) REITs. Retailers themselves are under pressure, and tenancies are quite a competitive beast with retailers prepared to move. Therefore shopping centre owners have been under pressure in relation to the rent they are able to command from their tenants.
It was a reasonable reporting season for the property investments in client portfolios. We remain conservatively positioned in relation to property - until we see better risk adjusted returns once more.