Take a tip from market yield

By BRENT SHEATHER*

The market in bank deposit rates is reasonably efficient - usually there is not much difference between the big players unless one has a specific need for funds of a certain maturity.

Property is a little different. Every building or portfolio of buildings is unique in terms of age, tenant, rental agreement and other factors. The various property markets are fragmented and information on buying and selling activity is not reported through a centralised exchange.

As the size of the transaction increases, the participants migrate from almost exclusively retail investors at the under $1 million level to mostly institutions over $20 million.

Academics tell us that, in theory, property valuation is a function of interest rates determined in the bond market plus a margin for risk determined at least in part in the stockmarket.

The price of listed hotel companies such as Host Marriott in the US more than halved after September 11.

However, the buyers and sellers of small commercial properties, say less than $1 million, are often small-time investors whose key valuation benchmark is likely to be what the money could have earned in the bank.

In this sort of market real estate agents probably add some value in the decision-making process in terms of ensuring some level of continuity.

But they can be no more relied upon to advise that prices are over-extended than stockbroking analysts in the dotcom boom.

Registered valuers are most commonly used to price small properties but these buildings often don't merit detailed analysis and there can be quite substantial differences in valuers' opinions.

Various studies have criticised this method as being both backward-looking and out of touch with the risk premiums determined in the more liquid capital markets.

If Mum and Dad-type investors are going to buy property directly a useful, free and independent cross-check of valuations is provided by an analysis of securitised market yields, both locally and abroad.

By most measures the NZ property market is booming at the moment, particularly the residential sector in Auckland, but there is also solid demand for retail, office and industrial buildings from private and institutional investors.

The extent of this activity is a little surprising because all the theory suggests that rational buyers would minimise risk by owning a portfolio of buildings spread over different sectors in different countries.

Why would the prudent trustees of a family trust commit a substantial part of their assets to one building in one town with maybe a couple of tenants, concentrate their currency exposure in New Zealand dollars and run the risk of it being declared wahi-tapu into the bargain? Are these people mad?

Possibly, but an important factor that encourages ownership of real as opposed to listed property is the perennial worry that a listed property company will disappear under a mountain of debt and development risk - as per Chase and various other property companies of the recent past.

Real property is a tangible asset and if you own it yourself you don't run the risk of waking up one morning and reading that your local pride and joy has been mortgaged to the hilt, converted into a property developer or sold and the proceeds invested in Pakistan or such like kamikaze venture.

Control is a big issue for some people, especially those who bought property shares during the 1984-87 listed property bubble.

The other place to look for an explanation of non-risk minimising behaviour is pricing - maybe the yields available via direct investment are much better than what is on offer through the securitised markets.

Unfortunately the information is inconclusive. Actual sales show a very wide spread, for example in the retail sector in the last few weeks 19 shops in Mairangi Bay sold to a family trust for $2.2 million to yield 9.5 per cent, six Mt Eden shops sold for $2 million to yield 7.4 per cent, and a retail development in New Lynn sold on an 8.9 per cent yield.

CB Richard Ellis advises that the average yield on prime retail in Auckland is 8.97 per cent, but prime is only the very best retail assets and they likely enjoy a lower yield because of better rental prospects and lower risk. In the listed market locally Kiwi Income (KIP) has 42 per cent of its portfolio in high-quality retail assets. Its shares yield about 8.5 per cent.

Westfield Trust shares provide a purer benchmark for the retail sector, owning a portfolio of prime super-regional centres.

Westfield shares yield 7.2 per cent, a full 200 basis points less than the Mairangi Bay shops, but this doesn't necessarily make them a less attractive option. Australian property accounts for 85 per cent of the portfolio, the Westfield centres dominate their catchment, the portfolio is virtually impossible to duplicate with a blue-chip tenant base making it much less risky than 19 shops, and their sales growth and overall return track record (10.7 per cent a year for 10 years) are pretty impressive as well.

In the industrial sector CB Richard Ellis advise that the average yield for prime buildings is 9.4 per cent.

Last year Restaurant Brands sold and leased back for terms of 12 years 51 KFC properties with yields averaging 8.5 per cent a year, with one building in Taupo selling at a truly amazing 6.86 per cent yield.

It is possible that the KFC rent in Taupo is about to skyrocket but even 8.5 per cent seems fully priced - let alone 6.9 per cent in Taupo, when prime industrial portfolios here and in Australia are available on the stockmarket at around 9 per cent and that is after all fees and with no ongoing management hassles.

In Tauranga, a top retirement destination, people are apparently falling over themselves to buy quality industrial properties with yields as low as 7.5 per cent. With Property For Industry locally and quality Australian, US and Dutch companies yielding 8 to 9 per cent with no hassles, 7.5 per cent in Tauranga could be a bubble.

Adding weight to this view, Bayleys advises that in Auckland properties in the $500,000 to $1 million range are the most sought-after.

In the office sector listed companies with prime portfolios such as AMP Office Trust sell for yields of 8.5 per cent reflecting, according to manager Rob Lang of AMP Henderson, the high quality of the trust's physical assets implying sustainable product demand and the low risk of the tenant base (Westpac, The Treasury, Glaxo etc).

Bayleys reports the market for Auckland CBD strata offices offer yields in the 8 to 11 per cent range.

Typically in the investment markets the higher the risk the higher the required return - a dodgy property with a tenant who might go bust any minute usually has a high rental yield.

In New Zealand, provincial property typically has a higher yield than Auckland or Wellington, reflecting the market's view of its lower growth prospects. It is important when valuing property to determine, if you can, their rental growth prospects.

If you can't be bothered with direct investment, the stockmarket potentially provides an excellent low-risk platform for individuals of moderate wealth to buy into the benefits of property ownership despite the fact that the property sector appears to attract more than its fair share of dodgy operators.

In the US the real estate investment trust sector's market capitalisation has increased more than 15 times. There is no reason why the same sort of growth cannot happen here.

* Brent Sheather is a Whakatane sharebroker. He owns shares in AMP Office Trust (NZ), Capital Properties, Kiwi Income Property Trust, Property For Industry, Host Marriott, Boston Properties and Westfield and is a former member of the NZSE.