Update – Australian unlisted direct property funds


The Australian unlisted direct property market has not escaped the credit squeeze, impact of rising interest rates, corrections in the global property markets and sharemarket volatility. These adverse factors have ultimately contributed to a reduction in property investment values over the past two years. Peter Flynn, Senior Investment Analyst, provides an update of direct property sector.

A mixture of structural drivers (through higher interest rates and scarcity of capital), together with more moderate economic growth and cyclical forces (through reduced rental demand) has negatively impacted the Australian property market. In addition, there has been a change in market sentiment and potentially higher risk in property investment markets.

Many funds have frozen distributions over the past two years, due to the need to reduce debt (to comply with bank loan-to-value covenants) and also pay higher interest rates upon refinancing. Liquidity is an issue with the majority of funds freezing redemptions over the past two years. Fund managers that have not suspended distributions, are only distributing free cashflow, with no income support applicable.

Large open-ended funds continue with ongoing efforts to reduce debt, mainly via asset sales, internal restructuring and revised investment strategies. Debt refinancing continues to remain more onerous and expensive for fund managers negotiating with banks.

Underlying property markets are now showing early signs of stabilising as current valuations (revalued late 2009 to June 2010) are now more realistic and the threat of fire sales recedes due the A-REIT capital raisings over the past 12-18 months. Office and industrial rents are expected to remain relatively stable over the next 12 months, until the economy and property markets demonstrate signs of a sustainable improvement.

In general, property funds with a higher gearing ratio and/or secondary grade property portfolios (with B-grade assets, substantial vacancies or off-shore exposures), have recorded a lower level of performance over the past year to June 2010, compared to funds with A-grade assets and well leased properties.

The following table provides a brief overview of the average range for key investment metrics in the direct unlisted property fund sector:

* if applicable

Lonsec considers that in this current environment, it is appropriate to focus on investing in funds with quality properties, managed by experienced personnel with a good ‘track record’, together with utilising conservative capital structures (gearing ratio). Experienced fund managers will focus on managing the property portfolio and extracting any added value from assets, by efficient strategic and operational management and refurbishment programs.

Fund managers with robust balance sheets may be in a position to take advantage of the potential lower priced quality investment grade property over the next 6-12 months, due to the current subdued Australian property investment markets. In addition, Lonsec considers that there will be opportunities for fund managers seeking to acquire existing fund management groups/companies, coupled with further industry consolidation.

IMPORTANT NOTICE: The following relate to this document published by Lonsec Limited ABN 56 061 751 102 (“Lonsec”) and should be read before making any investment decision about the product(s).

Disclosure at the date of publication: Lonsec receives a fee from the fund Manager for rating the product(s) using comprehensive and objective criteria. Lonsec‟s fee is not linked to the rating outcome. Costs incurred during the rating process of international funds, including travel and accommodation expenses are paid for by the fund Manager to enable on-site reviews. Lonsec does not hold the product(s) referred to in this document. Lonsec‟s representatives and/or their associates may hold the product(s) referred to in this document, but detail of these holdings are not known to the Analyst(s).

Warnings: Past performance is not a reliable indicator of future performance. Any express or implied rating or advice presented in this document is limited to “General Advice” and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs („financial circumstances‟) of any particular person. Before making an investment decision based on the rating or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances or should seek further advice on its appropriateness. If our General Advice relates to the acquisition or possible acquisition of particular financial product(s), the reader should obtain and consider the Product Disclosure Statement for each financial product before making any decision about whether to acquire a product.

Lonsec‟s rating process relies upon the participation of the fund manager. Should the fund manager no longer be an active participant in the Lonsec rating process, Lonsec reserves the right to withdraw the document at any time and discontinue future coverage of the Fund(s).

Disclaimer: This document is for the exclusive use of the person to whom it is provided by Lonsec and must not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by Lonsec. Conclusions, ratings and advice are reasonably held at the time of completion but subject to change without notice. Lonsec assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, Lonsec, its directors, employees and agents disclaim all liability for any error or inaccuracy in, or omission from, this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

Distribution* (Pre-tax yield)

Tax Benefits (Tax Deferred)

Annual Fees & Expenses (MER)

Gearing Ratio





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