Someone needs to tell the bean counters at Australia’s property trusts that there’s a credit crisis on. While the writedowns have been coming thick and fast (Lend Lease this week joined Australand, Mirvac and GPT in the dog box), the extent of the asset revaluations is a joke.
Property trusts value their assets based on a capitalisation rate or ‘cap rate’. The concept is simply to value the asset such that the rent received provides a return equal to the cap rate. If you’re receiving $100 rent a year and your cap rate is 10%, you value the asset at $1,000.
For years cap rates have been tumbling (see chart above) in line with falling interest rates and, supposedly, lower risk. As a result, property trusts across the board have been booking massive profits and increasing net ‘tangible’ assets.
Welcome to 2008. Interest rates are up, inflation is out of the bag and, thanks to the credit crisis, risk premiums are through the roof. That being the case cap rates should go back up by a lot more than the pathetic 25 basis point (0.25%) rises by Australand and Mirvac (Lend Lease didn’t fess up about their assumptions but the extent of the writedown wasn’t significant).
Bunnings Warehouse Trust at least went with 50 basis points, but that only takes their cap rate up to a meagre 7.08%. Whatever planet they’re on, it’s not the same one as the rest of the financial markets – who does anything for a 7% yield these days? The cap rates should be 2% higher, at least.
So why aren’t they? The problem is that if they were, truly massive writedowns would be required. Every 1% increase in cap rates translates to a writedown of about 12% in asset value. Across the 16 property entities covered by The Intelligent Investor, a 200 basis point rise in cap rates – which would only take them up to about 9% on average – would result in $30bn of losses, a figure that the managements of these trusts have chosen not to face.
But they may as well get on with it. The sector is trading at a massive discount to reported NTA, which is the stockmarket’s way of saying you’re not fooling anyone.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.