Property fund managers have learnt their fair share of lessons over the last couple of years.
The turbulence of the global financial crisis (GFC) and its repercussions on the real estate sector has undoubtedly forced managers to reconsider their investment strategies.
Both the real estate investment trust (REIT) market and the direct property sector seem to share a similar methodology for future growth, with a back-to-basics approach becoming a clear priority on their agenda.
"The cleaning out that has occurred over the last 24 to 36 months has led us to getting back to basics," The Denison Group's head of distribution Linden Toll says.
"Managers have become far more conservative and perhaps a few of the rogues have disappeared out of the space.
"The biggest problem was the buildings themselves didn't underperform, its been the managers unfortunately."
Good capital management will be paramount going forward, BT Investment Management property portfolio manager Julia Forrest notes.
"As a result of continuing global imbalances and de-leveraging, capital is probably going to get scarcer and more expensive over the medium term," she says.
"This will present a challenge for property, given it is one of the most capital-intensive asset classes."
While investors may have concerns about the capital-management skills of a number of REITs given their recent track record, Forrest argues that most management teams have learned painful lessons.
For REITs it's all about becoming boring again, according to Toll.
"It's no more about growth, this is about providing a solid income return over time," he says.
Maxim Asset Management managing director Winston Sammut agrees, noting the major REITs over the last 12 to 18 months have concentrated on getting their act together and their balance sheets back in order.
"There's been a situation where everyone seems to be going back to basics, which is really positioning the trusts back into being rent collectors where they buy a property, collect the rent, pay out the expenses and what's left over goes to the unit holders, so it's getting back to that sort of focus," he says.
Some property fund managers, such as GPT Group and Stockland, have also restructured their investment portfolios and sold some of their offshore assets, Sammut says.
"So the focus is now much more on Australia and Australian assets, and also less reliance on funds management and development, which was another area which provided some heartache over the last couple of years."
Sammut observes REIT managers are also taking a greater focus on retaining quality property.
"Prime property has actually held up very well, but it's the properties at the lower tiers [that haven't], so some of the B- and C-grade buildings, what happened is they were priced as if they were A-grade properties because there were no A-grade properties about," he says.
"So there was no differential in terms of pricing between what is and what really isn't quality. I think there's a greater focus at the moment on retaining as much of the quality property as the trusts can and perhaps trying to get rid of the lesser-quality stuff."
Adviser Edge head of property Louis Christopher agrees that the investment behaviour of property fund managers has certainly changed over the last few years.
"In 2007 the average manager was chasing alpha big time and they were willing to gear up their fund accordingly to get that additional alpha that the leverage could offer them," he observes.
"There were a few assets out there, there was a lot of competition between fund managers to buy underlying real estate and managers were willing to take risks to increase funds under management (FUM), and gearing at the time was all about getting yield-accretive gearing.
"That all changed in 2008, where gearing was a nasty word and basically it was all about survival and how to survive as a fund given that debts may not be able to be rolled over."
Consequently, this prompted a panic rush by many of the property trusts to recapitalise.
"Some of them did it at crazy prices; they really stripped back existing investors just to bring in a little bit of capital to restore the balance sheet," Christopher says.
"For example, Goodman Group, GPT and Aspen Group totally destroyed shareholder value through doing rights issues in order to survive. So we went from one end of the spectrum to the other in a fairly short space of time.
"Instead of managers asking themselves if debt was yield accretive, they looked at debt in the sense of will we be able to roll it over? Are our gearing levels low enough?"
He adds that while some managers are beginning to acquire real estate once again, they're not particularly willing to do it on debt.
"They would rather do it through an equity placement, perhaps they're still conscious of debt and that's probably a good thing," he says.
It's a similar story for the direct property market, with managers compelled to take more of a conservative approach.
"The unlisted space is very much back to basics," Toll says. "We're seeing single-asset trusts come out again, the old-fashioned syndicate I suppose, and there's no denying that they're very hard work to get them across the line."
Australian Direct Property Investment Association (ADPIA) president Robert Olde observes there are a couple of structural issues that, as an industry, the property sector needs to come to grips with.
"The perceived lack of liquidity which came to the fore during the GFC, in particular, needs addressing. I think that was more an advent of seeking to meet investor's demands rather than their needs," he says.
"I think a lot of fund managers tried to create property funds that acted like listed equities, where they were seeking to promise easy exit, cash withdrawals when in essence what we're dealing with is a very lumpy illiquid product which is really designed for long-term investment strategies.
"So we tried to get the best of both worlds. Overall I think we've come to recognise some of the shortcomings that we've created."
Olde argues that where a lot of direct property fund managers went wrong was not on the assets themselves, but it was more a case that they got too aggressive with their structuring.
"Overall a majority of managers have been forced to pare back gearing," he says.
"We've seen a lot of capital raising, an increase in fund equity components and raising additional cash reserves to meet various debt requirements from the banks because the banks are far more conservative in their lending guidelines.
"So we're seeing a more conservative approach to debt, a more conservative approach to balance sheets with more cash being held and not distributing it all back to investors."
Despite its lacklustre performance over the past few years, industry professionals believe property still remains an attractive investment vehicle. However, convincing investors of this and regaining their confidence in the asset class is the overarching challenge fund managers face at present.
"I think property is still an attractive class, but convincing people that it's an attractive class is part of the problem," Zenith Investment Partners' senior investment analyst Dugald Higgins says.
Forrest shares this sentiment. "Property offers plenty of appeal to investors, however given its performance over the last two years it may take investors some time to get comfortable with the sector and management teams again," she says.
"The sector has spent the last two years recapitalising and addressing its debt issues as well as focusing on its core competencies, such as rent collection, asset and development management."
As a result, Forrest says the sector is stronger and more resilient to future economic shocks and pressures.
"The beta on the sector appears to be trending down and, as such, hopefully property will provide the diversification benefit that was always intended," she says.
Nonetheless, at the moment it's not only investors but also financial planners that are cautious of property as a reliable investment, Toll says.
"Talking to financial planners specifically in that space, there was a lot of bewilderment when they were investing into structures that they believed were boring and from which an income stream and cash return would happen over time," he says.
"The frozen funds with no income at all have certainly proven a problem for them. So, I think in the unlisted space it's about regaining the confidence of investors and proving to investors that people do know what they're doing.
"When done properly, property is a fabulous asset class. So I think that moving forward we'll get the confidence back of investors. It's still a higher income-earning asset class than others that investors need."
Christopher points out that real estate overall should be fairly attractive to investors because both the Australian REIT (AREIT) and the global REIT market are trading at discounts to the underlying net-asset backing.
"So you can invest in the AREIT market now and you're buying into assets now on the market which are trading at a discount to what they would sell if the underlying real estate was directly selling to the marketplace," he says.
"Now that's a good thing; it means that potentially most investors are buying assets on the cheap."
However, he adds the flow of FUM to the property funds-management sector has not recovered greatly since the end of 2007.
"Yes, we've seen some inflows going into property securities funds that invest in the AREIT market or global REITs," he says.
"By and large, FUM flows haven't been very strong and have been particularly weak when it comes to investing in direct property funds and hybrid property funds, which of course many are still frozen.
"So what FUM flow has been coming in has predominantly been coming into those funds that invest in listed property trusts or the REITs."
For those financial advisers, superannuation funds and investors who are looking to invest in the property market, Forrest says they are currently weighing up whether to get their real estate allocation through listed or unlisted means.
"The performance of the AREITs over 2008 and early 2009 failed to provide the diversification benefits that real estate was supposed to provide," she says.
"This was a result of high gearing, diversifying into operations such as development, funds management, mezzanine debt markets, and overseas markets - the US, UK and Europe - at the wrong point in the cycle and paying too high a price."
As a result, AREIT managers raised a large amount of capital at an extremely expensive price, and Forrest says a majority of these managers continue to manage those same trusts.
"However, by now choosing direct over indirect property, investors may be throwing good money after bad," she says.
"REITs with exposure to foreign markets will see income and asset values rise over time as vacancy falls and rents gradually increase. Take, for example, Westfield with its US shopping centres. Given the mild downturn in Australia, buying physical domestic assets is unlikely to see material earnings upside.
"A number of AREIT managers are highly skilled in asset, property and development management."
It seems further consolidation is also on the cards for both the listed and unlisted property sector.
"Absolutely everybody is looking around for a deal at the moment on both sides of the fence," Toll says.
"I think what we're all trying to work on, though, is deals that aren't done on the smell of an oily rag; you can make something out of nothing if you like - that's what we're all looking to do.
"There's no doubt that some groups will have to do something and I can assure you there's a few of those looking around at the moment to make things happen."
There are some great opportunities available to lock in assets for the future, according to Toll. He says it's just a matter of matching cash to the assets.
"I think there are some fabulous opportunities there because it's not just the less reputable developers who are struggling to get cash, it's the really good ones, so there's scope in the unlisted space," he says.
"If you can match the cash to the assets then I think we should all see this as a huge opportunity to get into things.
"I think the biggest lesson is we need to make sure we communicate better with investors because it strikes me that right across the board there's a whole lot of heads buried in the sand and that's not good enough. Effective communication is something we need to get better at."
Australian Unity Investments head of property Martin Hession says consolidation in the direct property market will be difficult for some companies because of their debt issues.
He points out that Orchard will be one such company that, rather than go bankrupt, it will just consolidate into other businesses.
"For example, ING are doing due diligence on the essential healthcare fund that Orchard have got, and there's a Queensland company doing due diligence on the rest of Orchard so it will disappear," he says.
"To consolidate some of these businesses, some of them have got huge debt issues.
"What happens is if you go in and buy these things or take them over, the bank is sitting there saying, 'we'll agree to this provided you recapitalise the business', so you've got to pull in millions and millions of dollars, and who's got that money to pour in?"
A number of fund managers in the unlisted sector may also look to strengthen their focus in their core areas and specialise in asset classes, according to Olde.
"Fund managers will seek to ensure that they remain specialist managers and not spread themselves too thin across a number of different asset classes," he says.
For the listed property space, Higgins says it's gotten to the point where if the sector was going to massively consolidate further, it would most likely have already happened by now.
"But it's difficult to tell - I mean the question is who's got the money to do it and be in equity or debt? Because equity is going to be hard to come by in the short term because they've already taken it all and debt's going to be even harder," he says.
Christopher says it will be the larger REITs that are better positioned to eye acquisition opportunities of smaller fund managers.
"We are going to see acquisitions occur from some of the larger funds on some of the smaller funds in terms of trying to take over their funds management on the cheek. It will be all friendly but the two sides will need each other," he says.
"There are fund managers out there who are surviving on just one or two products and they've been doing it very tough now for over the last two years. If we were to go into another downturn where there's just no FUM flow going into the sector, it will be very difficult to see how these managers will continue to fight."
He points out there has already been some consolidation with domestic property security fund managers.
"But we have been surprised, though, that it hasn't continued. At the moment there are over 30 different retail domestic property security funds out there," he says.
"That's quite a lot and, given the narrow stock universe that the Australian market represents, it's difficult for many of the fund managers to differentiate themselves."
Hession says the smaller AREITs are most likely going to find it difficult to secure bank accommodation.
"They're probably going to find it hard to raise equity, so they're going to have to merge with one of the bigger boys somewhere along the line," he says.
However, if there were any positives to come from the GFC Hession argues it was that the banks stopped lending to property developers.
"That meant we didn't have all this speculative development going on which would have led us to an oversupply situation a bit like we had in the 1990s," he says.
"The lack of credit stopped all the speculative development but it also meant people couldn't obtain loans if they wanted to buy a property, so therefore if you wanted to sell a property there were no buyers out there, you could only sell them at what were distressed prices."
For those investors looking for opportunities in the current property market, Higgins says commercial real estate is at a key investment phase of the cycle. He says this year and 2011 will be where the buying opportunities are offering themselves.
"Generally speaking the values have bottomed out, some of the better stuff is starting to recover, for a lot of the more mediocre assets it will be stagnant for them for a while, but this is the period in where you can really set yourself up to capitalise on the upswing of the next cycle," Higgins says.
"What it means for the REITs is that they're not in a hell of a position to do much over the next couple of years because underlying real estate is not going to take off like a rocket.
"So these guys have spent a lot of their time cleaning house, they've done massive capital raisings which have been savagery dilutionary to existing investors' holdings. But they have cleaned themselves out and had to take that pain in order to set themselves up to grow in the future."
However, Higgins adds the problem these REITs are going to have going forward is the fact that they've destroyed a lot of investor trust.
"It is going to take a considerable period for them to get that back and it's going to be difficult also purely from the point of view that, while yields have generally stabilised, we've probably finished all the dividend cutting and they're not yielding particularly highly in comparison to the risk-free rate," he says.
"When you can walk across the street and get a 12-month term deposit from the bank on 6 per cent, it perhaps doesn't look all that attractive. So they're just going to have to work their way through that."
Meanwhile, Higgins notes that the direct property sector has felt the pain more slowly. "But it's arguable that the slow-motion train wreck is just as painful at the end of the day," he says.
"You could argue that some fund managers out there are a lot better at extracting value from investors rather than from real estate, and that they were good money managers but not good real estate managers.
"So that sector is going to need a bit of a clean out, and the issues revolving around frozen funds will be a painful one for investors."
The current property landscape consists of two different camps, according to Higgins.
"You have a large number of funds pre-GFC that pushed the envelope too hard and it blew up in their face and now they're stuck," he says.
"Then there's the new property funds which have come to market since all that's happened and they're probably pretty reasonably placed to pick up assets at, if not a discount, at a much more fair value to what was going on pre-2007."
"Now those guys again are going to have to do a lot of fence-mending with investors; those investors have got long memories and so do their advisers. But we see that there are definitely opportunities around if you structure your vehicles properly."
Looking to the future, Toll says what really needs to happen is the banks need to free up cash so people can get back into investing into property.
"I wouldn't say it's going to be business as usual, I think there have been good lessons learnt and so I think that we'll see a conservative approach," he says.
"But I think over five years we'll see some very strong groups who've been put together in this period of time with great assets on board and in a strong position."
Meanwhile, Higgins says the two biggest challenges for REITs over the next five years will be where the stock and the deals are going to come from, as well as mending investor confidence.
"Getting that investor trust and sentiment back is going to be a huge PR problem for them," he says.
"It's doable, but it's going to be slow and painful. A lot of it depends on what happens in the other asset classes too.
"It's hard enough to work out what they're going to do in the next 12 months, let alone the next five years, but if they just keep their heads and chug along doing what they're doing now, I think that they'll get back to that point of paying out stable, reasonably attractive dividend yields."
However, Higgins says capital growth is probably going to be pretty limited in the short term for some REITs.
"Some of the better-quality players are going to start to see capital growth levels in their stock prices edge up a bit," he says.
"A lot of these guys are only back to trading at net tangible assets (NTA) and there's a lot of contention about whether or not REITs should or shouldn't trade at a premium to NTA, because we've seen them do both twice."
