From four cylinder reliability to supercharged V8

At the end of August 1998, the ASX Property Trust Index, as it was then described, was sitting at 1,273 points. By the end of August 2008, 10 years later the same index (but under a different name) was at 1,431 points.

It would be tempting to con­clude that nothing much had hap­pened in property trusts in the intervening 10 years. Yet in reali­ty the sector experienced a dra­matic rags-to-riches-to-rags story arc that has left investors per­plexed, and hurting.

Back in 1998, as our invest­ment house was making its first investments, Australian listed property had recovered from one of the worst property expe­riences since the Great Depres­sion; in the early 90s property values in Australia and around the world had plummeted.

Struck by the twin evils of over-building and a declining demand as major recession started to bite, office tower vacancies averaged over 30 per cent nationally and shopping centres were struck by declining turnovers and retailer bankruptcies.

Listed property arose from the great investment phenomenon of the late 80s, the unlisted proper­ty trust, which had been struck down by increasing levels of redemption in an asset class where liquidity was restricted by the nature of the assets. There were only three options: sell the assets at depressed prices; lock the trusts down for a number of years; or list them on the stock exchange.

In 1998, the listed property trust (LPT) sector still resonated with the last of those strategies. Trusts from the Armstrong Jones stable, BT, Advance and Westpac were still listed, although within a few short years would disappear com­pletely as they were taken over, merged or privatised.

But we were in simpler times. For example, the only stapled trust was Stockland, which had been a stapled entity for almost a decade. The remainder were purely prop­erty-owning vehicles and externally managed. What a difference from today, where the bulk of market capitalisation comprises internal­ly-managed, stapled structures with diverse non-property owning interests, such as land subdivision, funds management, development and construction.

So what was the catalyst for change? Something seemingly remote from property: the tech wreck.

In the late 90s and very early in 2000, stock markets ignored almost all asset classes except for technology stocks. We had dis­covered the Internet and we were enthusiastic about its prospects as a new business medium.

Those who dived in lost considerable amounts, but out of the ashes of the tech market crash rose a more conservative attitude from those who had been burnt, or nearly burnt.

Predictable cash flows became important, backed by hard assets, and commercial property delivers that in spades.

So the property boom began, and it ran continuously with only minor hiccups until December 2007.

The problem with extended booms is that a lot of bad prac­tices become institutionalised. And in a boom investor expectations continually increase and manage­ment has to put in place strategies to meet those expectations or be taken over, or worse still, ignored.

With interest rates at their low­est levels for years and banks keen to lend, there was an immediate avenue for delivering enhanced earnings growth; borrowing to buy assets that were yielding more than the cost of debt. Gearing levels soon rose from an average of less than 20 per cent of gross assets to an average of over 40 per cent.

Trusts that couldn’t enhance their distribution growth became targets for those who could. In turn, to protect their status, exter­nally managed trusts stapled in order to protect themselves from attack and be able to access non-rental earnings to boost earnings growth.

And when we started to run out of Australian property assets that could be positively leveraged, we moved to overseas jurisdictions to appease our ever increasing appetite for property. By late 2007, overseas property represented around 40 per cent of all A-REIT (Australian real estate investment trust) assets.

The success and performance of A-REITs during the post-tech wreck years then attracted a new form of investor. Previously the domain of the private investor, either directly or through proper­ty securities funds, we saw new players take over as the dominant price drivers. Overseas property securities funds started to take major positions, as well as hedge funds and arbitragers which had never previously taken any inter­est in a previously stable and low risk sector.

A-REIT volatility increased away from its traditional defen­sive characteristics to volatility levels that were greater than the overall market.

This volatility by the end of 2006 had started to create some exaggerated market movements, giving the A-REIT market the look of a turbo-charged V8 fishtailing along a narrow road.

In retrospect, there were all the indications of a nasty crash.

The first signs of real trouble came on December 17, 2007, when Centro revealed (after a three-day trading halt) that it had been unable to renegotiate a short-term debt rollover with its bankers. Centro prices tumbled and the A-REIT sector dropped 11 per cent in a day.

Since then, A-REIT prices have returned to levels of a decade ago. In addition, investors are now questioning the intrusion in the past few years of higher gearing, non-rental income and overseas investment.

The mood is now shifting back towards Australian-domiciled rental focused trusts.

What does this shift mean for investors? Hopefully, a renewed focus on property providing pre­dictable long-term cash flow rather than a short-term punt will return the listed sector to more sustainable levels next decade. The lessons learnt from the previous 10 years should ring alarm bells if we find our­selves in boom times again.

Howard Brenchley is founder and chief investment officer of APN Funds Management.