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GUEST OBSERVATION
Asymmetry in financial markets means that one party has better information than another.  Generally this is for the advantage of the product promoter not the investor.  It is prevalent in the property investment markets which suffer from limitations in disclosure and advice.
Bold and incisive recommendations which will enhance disclosure and provision of advice have been made by the Financial System Inquiry (FSI) panel:
<ul>
<li>Mr David Murray AO (Chair)</li>
<li>Professor Kevin Davis</li>
<li>Mr Craig Dunn</li>
<li>Ms Carolyn Hewson AO</li>
<li>Dr Brian McNamee AO</li>
</ul>
A persistent theme in submissions was limitations of financial advisers.
The panel advocates a single regulator for conduct and disclosure in financial services.  The proposed Corporation and Financial Services Commission will have the task of ensuring consistent and comprehensive disclosure by all participants including managers and advisers in the property investment markets.
Facilitation, not discouragement, of new exchange markets for property equity investments will be part of the brief of the CFSC.  A single exchange regime is recommended with the CSFC having authority to approve a new financial market which is fair and efficient.  An exchange focused on property investment vehicles becomes feasible.
Among the comprehensive proposed responsibilities of the CFSC is regulatory market conduct which will promote orderly and efficient price discovery, trading and settlement.  In an environment of new information technology the regulations must keep up with the emergence of new means of delivery such as crowd funding for investment products including property funds.
Opaque markets will be eliminated by a regime requiring high standards of disclosure.  A retreat from intensive prudential regulation to market conduct and disclosure is proposed.
An essential component of enhanced property fund markets is an efficient clearing system and structure.  Authorisation and oversight of clearing houses for clearing and settlement of transactions would be a responsibility of the CFSC.  An integral component of enhanced liquidity of private markets in property would result if a centralised clearing system for all property funds emerges from this recommendation.
Greater transparency in property investment markets through reduction in asymmetry would result from implementation of the recommendations of the Financial System Inquiry panel regarding conduct and disclosure by property investment managers and advisers.
Ken Atchison is managing director of <a href="https://atchison.com.au/" target="_blank">Atchison Consultants</a>.
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katchison-p6oi8fSFSF

Efficient clearing system and structure essential to enhance property fund market

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GUEST OBSERVATION
The property funds management industry for individual investors has undergone significant change over the past six years as a result of corporate activity and restructuring. Stability and continuity of sound management is an attribute sought by all investors and alignment of interest.
Table one, below, shows the ranking of the five syndicate and unlisted property trust managers with largest funds under management in 2008, 2011 and 2014.  It shows a total change from 2008 to 2014.
Table one - Ranking of Property Syndicate and Unlisted Retail Fund managers (click to open in new window)
<img src="/images/2014/11/26/atchison-nov-26-one.png" alt="">
Source: PIR
In addition to changes in the list of largest managers the emergence of new managers has been a feature of the industry.  This has been driven in part by regulatory changes and by departure of smaller managers thorough poor business management.
Basle III requirements have encouraged the exit by banks from property investment management.
Demands by superannuation regulators for liquidity have hampered the offering of property funds by major platforms.
Inability by owners and managers in arranging recapitalisation of funds and businesses has prompted total departure of some managers.
Many investors prefer unlisted funds over listed REITs. Investors in unlisted property have included high net worth individuals, family offices, SMSFs, dealer group syndicates and individual investors.  Significant investment visa applicants are also participating in this sector.
Offerings of property funds or syndicates in 2014 have been made by 15 different investment managers including the large managers in table one and many new managers.
When assessing new property investment products, sustainability of the investment management business has become a more significant factor.  Alignment of interest between investors and managers are sought.  Real estate attributes, performance prospects and level and structure of fees remain significant.
Ken Atchison is managing director of <a href="https://atchison.com.au/" target="_blank">Atchison Consultants</a>.
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How new property fund managers are changing the industry

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GUEST OBSERVATION
Analysis of value of Australia residential property is a focus for individuals as owner occupiers, for investors from Australia or overseas, for financiers and for developers. 
Quantitative easing in developed countries is a factor driving higher housing values.
A recent IMF report concludes that Australia ranks third among developed countries in the ratio of house prices to income and fifth on the basis of house prices to rents when assessed on an historical basis.
<img src="/images/2014/07/04/imf%20july%204%20onbe.jpg" alt="">
Source:  IMF
This clearly implies that Australian residential property prices are at least fully valued. IMF state that detecting excess valuation is more art than science.
In a recent working paper released by the Asian Development Bank, they noted that housing prices nearly doubled in Hong Kong and India over four years 2008 – 2012.  ADB concluded that prolonged quantitative easing made a significant contribution into capital inflows into Asia Pacific.  Capital inflows prospectively had two outcomes being either rising currency or higher asset prices.  Housing prices rose most strongly in economies where currencies did not appreciate.
This analysis supports the view that part of the drive behind strong Australian house prices has been quantitative easing in developed countries.  Australia has been viewed as an attractive investment destination on a relative basis.  Very low or zero interest rates in US, Japan and Europe has prompted international capital flow into Asia Pacific including Australia.  These flows have been in part directed into residential property.
As a result the RBA is in a bind. Despite falling commodity prices the AUD remains strong reflecting capital flows.  Should the RBA raise interest rates seeking to contain residential property prices the AUD will strengthen.  An alternative currency management policy or specific policies directed at reduced lending for residential property or restrictions on ownership are required.
Quantitative easing by the major developed countries has effectively driven Australian housing prices higher.
While quantitative easing continues, Australia will be vulnerable to excessive capital flows into investment assets including residential property unless the Australian dollar rises again.  A rising Australian dollar is unlikely while commodity prices remain weak.
Only when quantitative easing ceases will any excess in residential property values be removed.  This will start in 2015 with the US.  In the interim high residential property values will persist.
Ken Atchison is managing director of <a href="https://www.atchison.com.au/" target="_blank" rel="nofollow">Atchison Consultants</a>.
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Australian house prices are being pushed up by other countries' economic policies

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In addition to listed REITs which own property in the US there are also mortgage REITs which own mortgages and mortgage backed securities.  Assets of mortgage REITs total US$500 billion.  They have a market cap of US $60 billion compared with a market cap of US $550 billion for property REITs.  
In the current interest rate environment mortgage REITs borrow short-term and invest in longer term mortgage backed securities.  They are potentially highly sensitive to interest rate changes.  Gearing employed has been beneficial as borrowing rates kept falling.  Gearing has meant that returns have been strong.  
The quantitative easing (QE) policy adopted by the Federal Reserve in the US has involved purchases of mortgage backed securities which has accentuated the strong return. When QE tapers and borrowing costs rise then the returns will decline. Federal Reserve Governor Stein, US Financial Stability Oversight Council and now the IMF have highlighted this vulnerability.  Mortgage REITs are not the subject of regulatory oversight of capital adequacy.  
When interest rates rise, the risk of falls in market value will increase.  Greater gearing means greater risk. Average gearing is 8.5 times.  
In Australia debenture issuers which share some attributes with mortgage REITs are regulated by ASIC.  Following failure in the sector, ASIC have foreshadowed tighter controls, including a minimum capital ratio adequacy of 8%.  
Failure of financial institutions in the global crisis arose from inadequate equity capital, being excessive gearing, systemic risk of sectors in the financial systems and inadequate liquidity.  
Counter cyclical prudential regulations including capital adequacy are the preferred response supporting public pronouncements about mortgage REITs.
 
<hr>
 Ken Atchison is managing director of <a href="https://www.atchison.com.au/" target="_blank" rel="nofollow">Atchison Consultants</a>.
 
 
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The vulnerability of unregulated US mortgage REITs: Ken Atchison

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Colonial First State Global Asset Management (CFSGAM) is a subsidiary of the Commonwealth Bank (CBA) and manages more than $140 billion in funds including $20 billion in listed property funds. 
The two listed funds are CFS Retail Property Trust (CFX) and Commonwealth Property Office Fund (CPA). 
CBA has proposed that the management rights of CFX and CPA be internalised and that wholesale property funds and shopping centre management rights of CFSGAM be purchased by CFX. 
Provided the payment for the management rights is not excessive, the internalisation proposal should succeed. 
The Gandel Group, which owns 15.5% of CFX and has first right over the stake in CFX owned by CBA (and owns of half of Chadstone Shopping Centre), presumably will be supportive. 
Internalisation is a positive for CFX as is estimated it will improve earnings by 2% to  2.5% because of the size of the platform and the potential cost savings generated. 
Costs savings through internalisation would also increase earnings by between 2% to 2.5% for CPA. 
The most important driver behind the proposed exit of the CFSGAM property business by CBA is the increased capital requirements for holding equity investments under Basel III. 
More demanding capital requirements are being imposed by APRA on equity investments by banks. 
Internalisation of management and sale of the investments in CFX and CPA by CBA will prospectively enhance return on equity of the bank albeit marginally. 
CFSGAM manages $20 billion in property assets across Australia and New Zealand, including 44 shopping centres and 38 office buildings. 
Seventy percent of the assets are in three listed vehicles being CFX, CPA and the Kiwi Income Property Trust which is listed in New Zealand. 
The Australian listed funds are: 
<ul>
<li>CFX which specialise in retail property and has assets of $8.4 billion, a development pipeline of $1.3 billion and market capitalisation of $4.8billion. 
</li>
</ul>
<ul>
<li>CPA, which specialise in office property and has assets of $3.7 billion and market capitalisation of $2.7 billion. 
</li>
</ul>
CFSGAM also manages unlisted property funds and assets. 
It is proposed by CBA that these management rights be sold to CFX.  The funds and assets are: 
<ul>
<li>CFSGAM property retail partnership which is an unlisted fund with $1.2bn in retail asset and four investors, including CPPIB and the Future Fund. 
</li>
</ul>
<ul>
<li>Private Property Syndicate which is an unlisted diversified fund with $550 million in assets. 
</li>
</ul>
<ul>
<li>The DPIF Office and Industrial Funds which are in wind-down. 
</li>
</ul>
<ul>
<li>Co-owned assets managed on behalf of third parties valued at $2.7 billion. 
</li>
</ul>
Sale of the management rights for the unlisted funds and assets to CFX introduces a clear conflict for the CFX management team. 
It also raises the question whether investors in these unlisted property funds would countenance a shift of management into a listed entity where alignment of interest will be uncertain. 
Principal focus of management of a listed property trust will be increasing net operating income, measured six monthly, where increasing assets and funds under management will be factors driving performance.  This contrasts with the focus of unlisted property investors seeking long term total returns on assets. 
If CFX proceeds with acquisition of the management rights for unlisted property funds and assets it would be detrimental for unitholders as the lack of management alignment with investors would place at risk the continuing retention of the management rights of the funds. 
Soon after CBA announced the plans for listed trusts, Dexus brought a 14.9% of stake in CPA, raising speculation about a full takeover. 
CPA and CFX will be susceptible to takeover in the belief that new management will be more successful because of greater skills or economies of scale.  Certainly the share prices will be underpinned. 
Approval of internalisation of management of the listed CBA vehicles is expected and will enhance earnings provided the price is reasonable.  CFX at current price yields 6.8%.  CPA yields 5.6% on a 75% payout ratio.  Both represent fair value with prospects of growth in distribution. 
A hostile takeover offer for CPA after internalisation of management is a real possibility. 
CFX in contrast is less certain until there is clarity regarding the purchase of unlisted property trust and asset management rights.  If they are not acquired by CFX then the prospect of a takeover offer at the current prices will strengthen.
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The implications for the Commonwealth Bank bringing its property trusts in-house

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Stockland and Mirvac are two of the largest Australian listed property companies with market capitalisation of $8.1 billion and $6.3 billion respectively. 
Both companies have suffered from losses through residential development exposure over the last 18 months. 
Small companies which specialise in residential property development include AV Jennings, Cedar Woods, FKP and Peet have also experienced difficult trading conditions and reported significant losses. 
Weak housing and apartments prices, rising construction costs, and low volumes of residential sales across <country-region><place>Australia</place></country-region> have contributed to the losses experienced.  
The chart below shows the movement in residential prices in Australian major cities over 10 years to March 31, 2013.
<img alt="atchison_residential_prices" height="217" width="470" src="/images/stories/2013/larry_uploads/atchison_residential_prices.jpg">
But signs of recovery have emerged.
Perth and <place><city>Sydney</city></place> residential markets showed greater resilience over the last three years than other states. The outlook for market in <city>Sydney</city> is positive, whilst <city><place>Perth</place></city> is stable. 
<city><place>Sydney</place></city> prices had been flat for most of the period since 2004 despite a persistent supply shortfall.  Indications of encouraging building approvals and home loan approvals have emerged in 2013.  Vacancy currently below 2% and improving employment will support demand. 
<city>Perth</city> is the centre of the strongest population growth in <country-region><place>Australia</place></country-region>.  Shortfall in supply persists despite the slowing activity in the resources sector.  New construction is emerging and is needed as the vacancy rate is low at 2.4%. 
In <city><place>Melbourne</place></city> the housing market is characterised by an oversupply of dwellings with significant construction of new dwellings since 2009/2010 and lagging infrastructure investments which will facilitate residential developments.  Strong price rises in 2010 have prompted the growth in supply. 
After strong interstate migration to <state><place>Queensland</place></state> from the southern states for a number of years immigration has slowed particularly as the Gold Coast market collapsed in the global financial crises.  Demand arising from improving employment prospects is now emerging. 
Whilst unemployment and interest rates remain low and population growth from overseas migration continues, fundamentals will improve for developers.  Affordability is assisted by the low mortgage interest rates after a 2% fall in official cash rates. 
In a strategic review conducted by the new CEO of Stockland, Mark Steinart, residential development will be smaller but remain a material part of the business.  It might contribute around 15% of earnings.  An improvement in the residential property outlook will assist Stockland. 
Mirvac similarly has reduced the significance of residential development for earnings as it grows the core real estate asset holdings.  Contribution from residential development of 24% of earnings is expected. 
Outlook for Stockland and Mirvac earnings will benefit from improving economic and property fundamentals which increases profitability for residential development.  The principal driver of return for both is from rent from core property holdings.  Variability of earnings will be greater than REITs that do not engage in development but less than companies that are solely residential property developers. 
Smaller specialist residential developers will benefit directly from emerging improvement in residential property development and are already experiencing some improvement in share prices.
Ken Atchison is managing director of <a target="_blank" href="https://www.atchison.com.au/" rel="nofollow">Atchison Consultants</a>.
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Better residential development outlook good news for some A-REITS: Ken Atchison

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After an extended period of little acquisition, listed property trusts in Australia have commenced buying real estate on terms which will enhance earnings yields.  
In the year to April 2013, REITs have achieved a return of 34%.  This strong performance has reduced the cost of equity capital.  Prospective listed property earning yields have fallen from 8.4% to 6.9% in the past year.  Over the same time interest rates have been reduced.  Official interest rates have fallen from 4.25% to 3.0%.  Interest rates on corporate debt have been reduced by 1.6% from 5.6% to 4.0%.  
Capitalisation rates or yields on property assets in contrast have barely moved.  Weighted average cap rates have been stable at 7.4% for all property over the past year.  Earnings yields, RBA cash rates, corporate bond yields and cap rates over the past five years are shown in the following table.
<img alt="atchisonmay8one" height="122" width="470" src="/images/stories/2013/05/atchisonmay8one.gif">
In 2009 earnings yields were well above cap rates.  Now they are lower than cap rates so that acquisition of property at current yields provide higher earnings for REITs. This will occur whether funded by cash, new equity capital or new debt capital.  
Initial acquisitions which have been made include:  
<ul>
<li>
<city>Westfield redevelopment at Mt Gravatt in </city><city>Brisbane</city>
</li>
<li>
Dexus acquiring an office building in Brisbane
</li>
<li>
Commonwealth property increasing holding in a Sydney office building
</li>
<li>
Charter Hall in due diligence on a Perth office property purchase
</li>
<li>
Mirvac considering an office portfolio purchase
</li>
</ul>
The difficulty faced by the listed property trusts is competition from international investors.  
<country-region>Australia </country-region>accounted for 45% of international direct capital into real estate in the Asia Pacific region in 2011 and 2012.
Ken Atchison is managing director of <a rel="nofollow" href="https://www.atchison.com.au/" target="_blank">Atchison Consultants</a>.
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Ken Atchison

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