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Analysts at Forsyth Barr have asked if returns from the listed property sector are too good to be true in a falling interest rate environment.
Jeremy Simpson and Matthew Leach studied the big premium NZX-listed real estate entities are offering compared to fixed-interest investments and said that even if some property businesses suffered rising vacancies and other woes, they still offered attractive returns.
But they predicted the sector's ability to pay high returns would eventually change, particularly if market volatility continued.
In a report titled "Dividend sensitivity - too good to be true?" the analysts showed how cheap the real estate stocks were compared to their share or unit prices and how good the returns were.
Rob Lang, of AMP NZ Office Trust, said Forsyth Barr's was not the only favourable property sector report.
Many major broking houses had reports highlighting the good returns from listed property trusts (LPTs), he said. Macquarie Research Equities had an "outperform" on his trust, upgraded earnings per unit forecast 3 per cent to 8cpu and put a 12-month price target on the units of $1.20.
LPTs easily bettered bank interest rates and were more attractive than riskier real estate alternatives.
Lang asked why investors would be interested in new property syndicates with single tenants and single assets when LPTs were paying such high dividends.
"I thought those syndicates had had their day," he said, referring to the tortured history of the Waltus and Urbus property syndicates.
The syndicates, now being widely promoted, were only paying about 10 per cent.
"Most LPTs are yielding 11, 12 or 13 per cent and that spread between bank deposit rates which are sub-5 per cent or sub-6 per cent is unusually high," Lang said.
Shareholders Association chairman Bruce Sheppard criticised the LPT sector generally and warned against it.
He said reading research reports without taking into account the somewhat unusual structure of LPTs or the future of their businesses was flawed.
"The NTAs are the asset values unencumbered by a management contract," Sheppard said. "The discount has always been an issue with these stocks as the management arrangements, in essence, encumber the assets by the unbreakable costs of management which are often not value for money."
LPTs appeared to be good value now but he questioned how long this would last because the sector depended on rents flowing regularly, and current rates were unrealistic, particularly in large shopping centres.
"The divided yields are currently attractive and may well be reasonably sustainable until the tenants start falling over which is likely, especially for retail funds which all have grossly over-sold retail space and are a disaster just waiting to happen."
The Forsyth Barr report found the eight listed businesses which have property as their core activity were all trading at significant discounts to net tangible asset backing but were also paying high returns which the analysts said favoured big income earners.
"Listed property offers investors a very attractive yield given the pull-back in share prices and the tax benefits of the PIE regime. While there is a downside risk to the sector-average 15 per cent gross yield, the large premium to falling interest rates and the relatively defensive cash flows mean the sector has attractive income attributes, in particular for high taxpayers.
"We continue to have a defensive bias in our stock selection preferring larger, well-diversified vehicles and less geared vehicles - Kiwi Income Property Trust and Goodman Property Trust - and an exposure to the healthcare sector with ING Medical Properties."
The analysts highlighted "considerable uncertainties" about how bad property values, vacancies and rental levels would get during the next one to two years.
"In this environment it is difficult for the listed property sector to rally, even with its very attractive yields relative to interest rates and an unprecedented level of risk premium already factored in," the report said.
"We believe the sector has defensive qualities relative to broader equity market but it is not without risks."
But the analysts expressed concern about rising costs.
"A key driver for the sector dividend downgrades has been increasing costs (mostly interest and tax) pegging back forecast distributable profits plus a more cautious view on the level of dividend payout. Some listed property vehicles have been distributing more than 100 per cent of operating cash flows/distributable profits, which is not sustainable," the report said.
Interest rate changes hit AMP NZ Office Trust's half-year result, which last week declared a loss.
The report questioned whether LPTs could continue to pay high returns and cited the potential for portfolio valuations to sink, which would breach banking covenants.
"Most at risk of a gearing breach at the listed property vehicles with the higher gearing levels such as ING and Kermadec," the report said.
"Goodman Property Trust is the most development-focused and given its high level of capitalised interest associated with its large land bank, the board could also be tempted to lower dividend payout rates in the future should property values pull back substantially and liquidity remain right. Generally the New Zealand sector remains unique with its relatively lower debt levels and largely simple and transparent property-owning business model."
But the report raised the prospect of LPTs here adopting a dividend regime based on adjusted funds from operations, which is largely in place now for major listed property markets internationally.
"Essentially this is the lowering of dividend pay-out rates to make an allowance for maintenance capital expenditure. Unlike other markets where there have been more spectacular listed property debacles, there has not been a push by institutional investors to have it adopted here."
But adopting this regime was logical and inevitable and the change could be forced by a significant increase in gearing due to falling property values.
"Our view is that we would be supportive of this as it would help correct dividends to a more truly sustainable long-term level."
