Mirvac makeover
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There is now a realisation within the Australian listed property trust sector that the model that enabled the Australian real estate investment trusts (A-REITS) to be the best-performing investment class for more than a decade is broken. The new model is simpler, cleaner and safer.
Mirvac became the latest of the A-REITS to re-base both its distributions and strategies to conform to the new conventional wisdom that the stapled trusts have to live within their most certain means – the income that flows from their core business of owning property and collecting rents.
That is a quite brutal shift from the old environment where the A-REITS bundled together rental income, funds management fee streams and development profits and then paid out the lot, borrowing to fund capital expenditure and their business development.
For Mirvac, that means slashing next year’s anticipated distribution from the 32.9 cents per security it will pay this year to only 20 cents to ensure that the distribution is well-covered by the expected operating earnings from its core property trust of between $268 million and $292 million.
That will leave between $140 million and $160 million of operating earnings from its funds management and development divisions to cover corporate overheads of about $107 million, fund its development pipeline and reduce gearing.
The entire sector is moving towards the model first established by Transurban, which decided that the old infrastructure/property trust model of continuously revaluing assets and then borrowing against the higher values to fund distributions and spending beyond cashflows was no longer viable or appropriate in the post-credit-crunch environment.
One could argue about whether the Transurban move was an over-reaction, given the quality of its CPI-plus revenue growth from longlife tollroad concessions. No one is arguing about the need to re-make the A-REIT model, which previously treated cashflows of very different quality as if they were fungible.
Development profits and funds management income are, however, of obviously lesser quality than passive rental income and more leveraged to cycles of activity in the property sector. The ability to sustain leverage and continuously access debt markets in the current environment is also, of course, significantly different to what it was.
As the sector has realised that the altered industry settings aren’t a temporary phenomenon, the A-REITS have started to dismantle the financial engineering that super-charged their distributions and yields and made them so popular with retail investors.
With access to debt limited, the property market weakening, their own security values decimated and therefore the prospect of raising equity unpalatable, the 'back to the future’ trend within the sector is prudent, particularly for the groups, like Mirvac, with significant exposures to residential development.
The downside of rebasing distributions at much lower rates and retaining cash within the structure isn’t great. Mirvac’s securities were valued at more than $6 each a little over six months ago. Today they are trading at around the $2.20 level.
The market has already digested and priced in the implications of the credit crisis for the A-REITS and their future distributions and has shifted very quickly from valuing the vehicles on their yield to focusing on their core sustainable cash flows.
The industry that emerges from the credit crisis will be smaller, simpler and less leveraged – a lot more like the sector it once was, before the financial engineers took hold of it.
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