In the one to two decades prior to the Global Financial Crisis (GFC), Australian REITs had been a favourite investment for local institutional and retail investors alike due to their stable and rising dividends (REITs were tax exempt if they paid out >90% of income) and capital values. The long duration and real income yield of commercial property was perfect for the Australian superannuation industry. Cheap financing and rising asset values incentivised REIT managers to trade assets between themselves and pay >100% of cash income to their investors (+ healthy bonuses to themselves). Gearing ratios of 50-70% Net Debt/Equity was typical of the situation. It was one big party and everyone was involved - major property companies built them and sold them, investment banks sourced financing and marketed them, commercial banks provided the loans, superannuation majors both financed and bought them.
When the GFC hit the spike in interest rates caused commercial property cap rates to jump. Rents fell across retail, office and industrial properties and many of the REITs were breaching their debt covenants. Refinancing options were extremely limited and liquidating assets was not possible given the natural buyers (other REITs or superannuation funds) had all but disappeared. Centro Properties was one of the earliest and biggest to blow when it announced in Dec 2007 issues refinancing A$1.3bn of debt. The panic accelerated in the market thereafter. Listed REITs were required to market to market their assets and so Book values fell and their stock prices fell in a vicious cycle. At the peak of the GFC the valuations of Australian REITs were trading at 5-30% of P/TNAV (tangible net asset value).
Our fund started buying a basket of these REITs in 2008 and had >20% of our AUM invested at the peak. Our thesis was a simple existentialist argument: the REITs couldn't all go bust. The Australian banks and real estate industry would go belly up if that happened. We selected a basket of REITs with positive equity value and who still had decent free cashflow cover for their interest payments. It was a pure deep value mean reversion play. Just one REIT survivor would pay for 4-5 other investments which went to zero. Anything better than that and we would make handsome returns.
The important aspects of the execution was:
A stable and supportive investor base. Fortunately our clients were institutional monies, ironically mostly superannuation funds who understood had first hand knowledge of the situation. Our investors were prepared to deal with the temporary downside and volatility.
Liquidity. In the aftermath, there were multiple rounds of heavily discounted Rights Issues (e.g. 30-40%) forced on the REITs by the Banks. With the liquidity we took out many of the weaker hands on-market and from oversubscribing to these Rights Issues.
In the end we made a killing and liquidated out of most of these holdings at close to 1x P/TNAV (a recovering Book).
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