Down under but not down and out

For years, Australia’s listed property trusts (LPTs) have been going global. And until recently it seemed like a good idea, offering diversified revenues, lower borrowing costs and yield enhancement opportunities. But as the credit crunch has wreaked havoc in the LPT market, it’s generally those trusts that ventured offshore that have been hit hardest.

Australia’s listed propety trust market – or A-Reits, as the Australian Securities Exchange re-christened it this year to fit in with global terminology – is made up of 69 trusts with a combined market capitalization of A$103 billion ($99 billion) as of April 30, according to the ASX. It’s a sophisticated market that has gone through many changes, from expansion, to consolidation, to changing business structures and rising gearing. One key trend is that the assets that make up the trusts have become more global: today international holdings make up 44% of the sector, according to UBS, with the US alone accounting for 33%.

The drive overseas has been a long time in the making – Westfield, the biggest and arguably most successful property trust in Australia if not the world, has been in the US since 1978 – but has been pushed forward by several trends in recent years.

"We will probably see lower leverage and more conservative structures" John Freedman, UBS

Then there’s the fact that domestically, in Australia’s high interest rate environment, earlier this decade the cost of debt started to exceed the yield available from the property that could be bought with it. "Offshore, that wasn’t always the case: there was often a positive spread," says Freedman. And additionally, offshore acquisitions gave managers the opportunity to structure their foreign exchange arrangements in a way that enhanced the yield. "In that market at that time, yield was highly sought after in whatever form it came," says Freedman. "It encouraged the offshore move as well."

Stephen Hiscock at specialist property fund managers SG Hiscock & Co in Melbourne recalls: "It started initially with the move to the US; then when the pricing got difficult to justify it moved to Europe and Japan, and it really stopped 12 months ago when the cost of funding exceeded the initial yields and made it less of a compelling argument. The only place where it continued to be compelling was Japan" – and three Japanese LPTs appeared on the ASX in 2007 alone.

Hiscock says, the move offshore both "served the LPT sector well and did it a disservice. It was two-pronged." On the positive side, it provided an outlet for growing allocations to LPTs, absorbing excess liquidity. "And by far the bulk of tie-ups Australian managers have had with overseas managers have been with highly reputable organizations with high-quality assets," says Hiscock.

But there is another side to it. "Where the whole thing came undone was partly the higher levels of gearing taken on board, and obviously the credit crisis stopped everything in its tracks," Hiscock says. It’s not that international holdings are punished more than domestic ones per se – anything with high gearing has been hit – "but as a general rule the international ones have borrowed more, because borrowing in offshore-denominated currency served as a natural currency hedge, and initially the cost of debt was quite low compared with the initial yield available on the properties," he says.

For some, the strategy has worked well. Westfield Group has a market cap of A$34.6 billion, much of it achieved by sensible and successful expansion into the US. "Those groups who exported their intellectual property, their skill set, like Westfield, have done very well," says Freedman. "Those who didn’t have any real intellectual property in real estate have done less well."

A struggle for some

Two in particular have struggled. Centro Properties Group is a retail property investment group with more than 800 shopping centres, most of them in the US. It has two listed property trusts, Centro Properties Group and Centro Retail Trust. Last year it had A$24.9 billion in funds under management worldwide. The group also has a direct property syndicate division, and two direct property funds, both of them open-ended and unlisted, as well as two open-ended wholesale funds. In short, it was a big and successful business.

But in December, Centro said it had been unable to roll over A$1.3 billion in short-term loans expiring in February, and the time since then has been made up of a stock market rout (dropping 77% in a couple of days), a change in chief executive and a constant battle with various lenders to gain more time to pay back debt. An agreement in early May to extend two facilities (A$2.3 billion owed to Australian lenders and $450 million owed to US private placement noteholders) to December makes it look more likely that Centro will survive, but the process has been painful. "Every day it survives and the credit market settles down it has a greater chance," says an analyst. "But at some point, in order for the banks to get their debt back, you have to unwind the structures involved there. At some point you have to detangle the spaghetti."

Another LPT that has hit the headlines for the wrong reasons is Rubicon. Part of Rubicon’s problem has been its parent: it is owned by Allco, which ran into its own sub-prime-related debt problems and has defaulted on margin loans. But Rubicon itself, which runs LPTs investing in assets in the US, Europe and Japan, also has problems. "The rapid and unanticipated dislocation of credit markets globally has placed considerable pressure on the funding structure of RAT [Rubicon America Trust]," Rubicon announced on February 29. In particular, the collapse of the CRE CDO market (commercial real estate collateralized debt obligations) hit Rubicon hard, since its strategy had been to refinance its CRE warehouse facility through issuing CDOs.