By Scott Crowe, Kim Wright, Simon Garing

Over the course of the next five to eight years, the global market capitalization of the listed real sector is expected to jump at least 60 percent to more than $1 trillion. In part, this dramatic growth is being driven by the development of REIT markets globally, particularly in Asia.

REITs allow an efficient substitutability between direct and indirect real estate investment, while overcoming liquidity issues and widening the capital base. The REIT market is well established in Australia in the form of listed property trusts (LPTs). Similar to other major markets, the Australian LPT sector has undergone a period of rapid change. Still, UBS expects the LPT sector to retain its position as a viable, stable substitute for direct investment into institutional-grade property, with enhanced liquidity.

LPTs first listed on the Australian Stock Exchange (ASX) in the early 1970s and until 1992 were usually diversified portfolios. However, today most new listings are sector-specific and many acquire off-shore assets. From less than $3.8 billion in the early 1990s, the sector’s equity market capitalization has grown to $58.3 billion. Today, the LPT Index accounts for almost 10 percent of the S&P/ASX 300 Index and is the third-largest sector, with Westfield Group the eighth-largest ASX-listed company.

LPT Activity Heats Up

A flurry of mergers and acquisitions has resulted in the number of index constituents dropping from 51 in 1999 to 27 today, and the average company size (excluding the top five LPTs) has tripled over the past five years to approximately $1.5 billion.

The sector has provided consistent robust performance, with total returns of 13.3 percent per annum over the past 10 years (outperforming the broader market by 100 basis points). The sector delivered an 18.4 percent total return in the first half of 2005.

Until 2004, the majority of LPTs were managed by companies external to the trust itself. However, M&A activity has led to internally managed groups now accounting for 83 percent of the sector. We still believe the structure, per se, doesn’t drive performance; rather, performance owes to management skill in acquiring, divesting and managing the assets and management success in building up an efficient corporate side.

The growth of Australian LPTs acquiring off-shore assets is well-known and has been driven by three main factors. The first is the high level of securitization of institutional-grade real estate domestically; more than 60 percent of Australia’s investment-grade real estate is LPT-owned. Second, has been the strong inflows from the country’s compulsory superannuation scheme and an aging population with a preference for capital stability and annuity-like income streams. UBS estimates natural underlying demand at $3 billion to $4 billion for the sector. Third, the spread between the cost of debt and property yields off-shore has grown.

Among current LPTs, the first to hold off-shore assets was the Westfield America Trust (U.S. malls), listed in 1996. Today, approximately 35 percent of the assets in the sector are held offshore (primarily in the U.S.). We believe the globalization of the Australian LPT sector will continue with further U.S. acquisition opportunities, but also acquisitions in other off-shore markets including Japan, Southeast Asia and Europe.

Australian LPT Market Capitalization (billions of U.S.$)

Source: UBS

The Future—Australia

Beyond property and economic fundamentals, a number of key themes are likely to continue to influence the LPT market over the next 12 months.

• Off-shore expansion. There is a structural undersupply of institutional-grade real estate in Australia. Therefore, Australia will likely continue to be at the forefront of global real estate investment, assuming continued growth in available investment capital.
• Capital recycling. There is a growing focus on opportunities to leverage return on equity through selling down real estate into third-party funds managed by the groups (as is increasingly the case in the U.S.), but in a protected way whereby mandates are difficult to lose.
• Continued globalization of real estate. As global REIT mutual funds are established and grow, off-shore investors are likely to be a growing proportion of the investor base of Australian LPTs. Some LPTs have seen the off-shore component of their registers (shareholders) increase to 15 percent from roughly 5 percent three years ago, a trend likely to continue. These increased global flows into Australia are likely to offset the down-weighting by Australian investors, which is being driven by asset consultants seeking to diversify away from domestic-focused managers toward global REIT funds.