GPT Group (GPT) is Australia’s largest listed diversified REIT with exposures across office, retail and industrial assets. Over the last decade, GPT allocated incremental capital into its Funds Management business and Industrial real estate.
GPT is a high-quality, active real estate manager owning predominantly A-grade property assets in large metropolitan centres. Historically, GPT has been conservatively managed regarding property development and financial leverage.
Conservative balance sheet: GPT’s balance sheet remains well hedged against the prospects of any further rises in bond yields. Balance sheet gearing is likely to remain below peer Dexus Property Group (DXS) through the cycle.
Long-serving CEO Bob Johnston has announced his intention to step away from the role in 2023. We continue to expect the Group to prioritise capital allocation into Industrial and Funds Management given the return prospects.
Investors view GPT as a REIT sector proxy GPT’s asset mix is representative of the key sub-sectors (ex-residential development) within the REIT Index. Since 2017 GPT’s total return is in-line with the S&P/ASX REIT Index*. Macroeconomic themes typically represent a larger influence on GPT’s share price vs stock-specific influences.
Investment view. We rate GPT a Buy. We see GPT as a value play within the A-REIT sector. The share price trades at a 30% discount to NTA. Investors remain concerned about the potential for a deterioration in GPT’s office and retail property valuations. In prior periods of rising bond yields, GPT’s P/NTA bottomed at ~0.7x.
Ascribing current P/NTA multiples of sector peers to GPT’s asset exposures implies a P/NTA valuation GPT of ~ 1.0x. This excludes any attribution for the A$20bn Funds Management* business and GPT’s A$8.0bn development pipeline in office and logistics.
Over the medium term, GPT’s development pipeline should be a significant driver of value to both its asset base and Funds Management business, lifting net income
Near-term company-specific catalysts for closing GPT’s valuation gap are not obvious. Macro drivers like lower-term bond yields could help significantly. GPT's +6.0% dividend can help reward patient investors.
*Includes both AMP and UniSuper acquired assets.
Business Overview
GPT Group (GPT) previously known as General Property Trust, is a diversified Australian property operator that manages and develops assets in office (38%), retail (34%) and logistics (28%). GPT has been listed since 1971. Before internalisation in 2005, GPT was managed by Lend Lease Corporation (LLC).
Historically, GPT has been conservatively managed (ex the period leading into the GFC in 2008-09). This conservatism in approach carries on today across all aspects of the business.
Traditionally seen as an office and retail-focused REIT, over the past 10 years the group has increased its logistics exposure. Like most REITs, GPT has introduced a Funds Management business to grow capital light earnings stream.
Looking into 2023/24, the market is currently assuming GPT’s earnings are flat over this time. GPT’s office assets currently have low occupancy (vs Office peer Dexus (DXS)) with income growth being challenged through both cyclical and structural headwinds at present.
GPT retail income is soft with vacancies in Melbourne CBD assets (following COVID lockdowns). This should improve in early 2023.
Logistics continues to be an area of strong growth (and capital allocation).
GPT’s investor appeal is centred around a conservative well-structured business, with modest financial leverage. With the asset mix reflective of the REIT index, GPT in our view can be considered a proxy for the REIT index.
Figure 1: GPT Earnings split – well diversified within the AREITs sector.
Development
GPT has a ~A$8.1bn development pipeline, which is planned to roll out over the next 3 years. A$1.9bn of the pipeline is positioned to increase logistics exposure with the largest development being the Yiribana Logistics Estate (Sydney, NSW).
Office development is proposed to be A$5.5bn of the pipeline with one asset underway 51 Flinders Lane, A$539m (Melbourne, VIC) and 5 in planning (Cockle Bay Park Sydney, NSW), A$1.7bn; 300 Lonsdale Melbourne, VIC A$260m; George Street Parramatta, NSW A$1.6bn; Skygarden Brisbane, QLD A$530m; 155 Walker Street North Sydney, NSW, A$870m).
The five office developments, if approved, will be developed over 2023-2028, with GPT selling down stakes to help fund the development. Phased construction stages will also limit the maximum capital drawdown needed from the balance sheet.
The planning for the office developments is occurring when the GPT office portfolio is ~8% vacant and debates around whether Work from Home (WFH) trends are permanent in a post-COVID world are common. Office vacancies in Sydney and Melbourne are currently at this cycle's high point, at 10% and 12% respectively.
GPT is confident that the projects will deliver accretive target IRRs, given the quality and location of the developments. The projects have >50% lease pre-commitments at present, which helps de-risk the development phase. Despite the prospects of rising office vacancy rates, GPT believes that premium, modern, quality floor space will present an attractive product offering even if the office market is weaker (>15% vacancy rates) in the middle part of this decade. WFH home trends necessitate the need for higher-quality offices to maximise in-office interaction.
Funds Management
Over the past 11 years, the group has explored avenues to increase its fund management portfolio. FUM has increased from A$5.6bn (2011) to A$14.6bn, having grown at a CAGR of ~10%. Funds management represents ~6% of the earnings bases but is expected to grow with the recent mandate wins.
The most recent movements have been in winning the AMP Capital Retail Trust (ACRT) mandate, winning the UniSuper mandate and partnering with QuadReal to lift logistics exposure. The new mandates are expected to lift GPT’s FUM to ~A$20bn.
Figure 2: FUM growth over time. Recent AMP and UniSuper mandates are expected to lift FUM level to ~A$20bn.
Balance Sheet
GPT’s gearing currently sits at 27.3%, the low end of the 25% to 35% target gearing range. GPT remains conservative versus its peer DXS at 30-40%. Management has indicated they will avoid going over the mid-point (30%) at this part of the cycle. This gives GPT some flexibility in managing against the prospects of high cap rates, which will have the effect of lifting gearing.
If property values were to fall quickly, GPT does have options to accelerate the recycling of assets to raise money for the balance sheet.
Share Buy-back
A share buy-back in our view is unlikely given current market conditions. This a similar theme that we have seen with most of the REITs. Despite GPT trading at a significant P/NTA discount, in our view, it is unlikely the Group will launch a share buyback in the immediate future.
GPT argue that the development pipeline carries the same IRR as doing a buyback at present. In our view, with evidence that the property cycle is turning, GPT is likely to keep its capital management options open rather than risk being forced back to the equity market to raise capital if the cycle got nasty from an asset valuation perspective.
GPT last undertook a share buy-back in 2020-22, buying back ~1.7% of shares on issue under a 5% on-market buyback program.
Interest Rate Hedging
GPT’s interest rate hedging is now one of the strongest in the sector, at 71% hedged for the next 2.5 years as of mid-2022. This is likely to take the group through the rate hike cycle, minimising any impact of further upward moves in bond yields over FY23/24E.
Despite the hedging, interest costs are expected to more than double from FY21 to FY24E. The net impact is that distribution growth is expected to be flat over the same time.
Figure 3: Interest rate hedging at 71% over the next 2.5 years. Offers strong balance sheet protection against the prospect of further increases in interest rates.
Cap Rate Sensitivity
The GPT share price currently implies GPT is trading at a ~30% discount to Net Tangible Assets (NTA), 5-10% points wider than the A-REIT sector, which currently trades at a 20-25% discount to NTA.
GPT’s cap rates would need to lift by 1.75%, or from 4.8% to 6.6% for the discount to completely close (assuming the share price remains static).
The most recent valuation of GPT’s assets, showed cap rates remaining flat in the 6 months to June 2022. Back in 2011, when bond yields were at similar levels, GPT’s cap rate peaked at 7.2%
Our estimates suggest that every 1% point of cap rate expansion lowers NTA by ~18%, and lifts GPT gearing by ~6%. This raises a key question about whether the share price is correctly anticipating a rise in cap rates.
There is little evidence of transaction values falling in response to current market conditions. Cap rates for prime A-grade property have not yet moved in this cycle. This is despite high leasing incentives/vacancy rates in the office. Office cap rates, which are more sensitive to the economic cycle (vs retail/logistics) in the last cycle peaked at just over 7% for A-grade CBD assets.
In our view, cap rates will move higher from current levels, but remain well below prior peaks largely due to both cash rates and 10-year bond yields are likely to peak below before prior cycles. Perhaps half the discount to NTA will be closed by higher cap rates in this cycle.
For GPT, the response to higher cap rates is to; a) conservatively manage the balance sheet, and b) focus on value accretive developments.
Whilst a lift in cap rates by 0.50% would take gearing to the mid-point of the balance sheet range, GPT does have options to accelerate asset recycling, and phasing the start of new developments which help mitigate a tighter balance sheet.
Figure 4: GPT asset devaluation estimates at 1% cap rate expansion.
CEO/Strategic reset
GPT CEO Bob Johnson has recently announced his intention to leave GPT after taking on the CEO role in 2015. This opens the possibility for a ‘strategic reset’ for the Group.
In our view, the current focus on lifting the logistics exposure, large-scale A-grade prime office development and building up the fund’s management business will remain. The addition of the AMP and UniSuper mandate takes the FUM strategy to a genuine scale and brings GPT in line with DXS AUM.
Shifting to a capital-light model has become a common theme seen among many of the A-REITs to lift ROE and provide an alternative income stream. GPT may look to accelerate the FUM strategy. DXS by contrast earns 15% of its income from FUM-based activities.
Valuation considerations
Despite being a diversified REIT with an asset exposure broadly reflecting the REIT Index, investors perceive GPT as an office play.
The share price has closely tracked Dexus (DXS) and the large US Office REIT Index over the last three years.
Investor concerns around office valuations (from rising bond yields) and the threat that working from home presents to the office demand picture weigh on investor demand. The key is whether WFH proves to be structural.
The combination of both cyclical (rising bond yields) and structural (work from home – although this is open to debate) has opened a 30% discount to net assets. DXS has almost double the exposure to office and trades a 40% discount. The market is sceptical that asset value can hold in the face of higher interest rates and the structural debate on WFH.
In our view, for the GPT share price to improve, one or more of these issues needs to be resolved in the eyes of investors. The most likely over the coming 6 months is the prospect of falling long-bond yields.
Figure 5: GPT and US office REIT sector comparison
Share price attributes zero value to the Funds management business
In our view, the share price is currently giving no attribution for GPT’s funds management business. The business generates ~A$55m p.a, which is expected to grow to >A$70m by end of FY24E.
Applying a market multiple to GPT’s FUM earnings would value this business at A$1bn or ~50cps. GPT has been relatively slow vs peer large cap REITS to embrace the FUM strategy.
We expect the GPT to look at ways to accelerate FUM growth which is current represents ~10% of Group earnings.
Despite being a diversified REIT with an asset exposure broadly reflecting the REIT Index, investors perceive GPT as an office play.
Figure 6: GPT and peer office REIT DXS trade the widest discount to net assets within the REIT sector.
Investment thesis
We rate GPT a Buy. GPT operates a diversified portfolio of office, retail and logistics assets across Australia. The Group has a long and successful track record of development, ownership, and management of largely A-grade property assets. GPT’s portfolio exposure mirrors the A-REIT sector. Historically, the GPT share price has closely mirrored moves in the sector.
We see GPT as a value play within the A-REIT sector. The share price trades at a 30% discount to NTA. Investors remained concerned about the potential for a deterioration in GPT’s office and retail property valuations. In prior periods of rising bond yields, GPT’s P/NTA bottomed at 0.7x.
Ascribing current P/NTA multiples of sector peers to GPT’s asset exposures implies a P/NTA valuation GPT of ~ 1.0x. This excludes any attribution for A$20bn Funds Management business and GPT’s A$8.0bn development pipeline in office and logistics.
Over the medium term, the GPT development pipeline should be a significant driver of value to both its assets and Funds Management business.
Near-term catalysts for closing GPT’s valuation gap are not obvious, apart from lower bond yields. The +6.0% dividend can help reward patient investors.
Risks To Investment View
Upside risks
- Share buyback is activated
- Office/Retail (Melbourne) markets show faster than expected improvement across vacancy, and leasing spreads leading to rental growth
- Strong than expected development returns
- Office market fundamentals improve, particularly in Sydney where the vacancy rate is double the pre-covid levels
- Development pipeline delivers stronger than expected returns.
Downside risk
- Property cap rate expansion in response to rising bond yields, lowering property valuations
- Lower tenant demand across retail, office and industrial assets
- High office lease incentives fail to moderate
- Higher debt costs
- Economic downturn, resulting in labour shedding and lower consumer activity
Figure 7: GPT’s falling ROE reinforces the push into higher areas like funds management.
Figure 8: GPT price to book at the bottom end of the historic trading range
Figure 9: GPT dividend yield approaching 6%, like prior levels of share price weakness
Figure 10: GPT dividend yield typically sees upward pressure when bond yields are rising
