Investa Office Fund is a real estate investment trust. The Fund is an owner of investment grade office buildings and receives rental income from a tenant register comprising predominantly of Government and blue chip tenants. IOF has investments located in CBD markets throughout Australia and select offshore markets in Europe.
IOF’s clean balance sheet, attractive valuation and prospects for a commercial property market recovery are some of the reasons behind our favourable view on the stock
Commercial Property Market
The commercial property sector hasn’t seen much love in recent times, due to its underperformance relative to residential property.
Australian commercial property has been plagued by persistently high vacancy rates and falling rents due to concerns of excess office space relative to demand.
However, 51% of IOF’s Aussie portfolio is in the Sydney/North Sydney market, with a further 20% in the Melbourne market.
These two cities are expected to lead a commercial property market recovery if, as expected, business conditions continue to improve.
IOF anticipates leasing markets to stabilise and improve towards the end of 2014. The group’s acquisition of the Piccadilly Complex in Sydney late February is ideally timed to take advantage of this recovery.
Piccadilly is comprised of two office buildings totalling ~42,000sqm located on Pitt and Castlereagh Streets, The complex has a long weighted average lease expiry (WALE) of 5.3 years, 93% occupancy and fixed annual increases in office rents.
IOF has a healthy balance sheet. 1H14 net debt to equity ratio was 29%; the lowest among its peers in the A-REIT sector.
The look-through gearing ratio of 23.8% was also below management’s 25% – 35% target, providing financial flexibility for the group to increase capital investments.
In 1H14 IOF had a high occupancy rate of 96% with a WALE of 5 years. Net profit rose 4% to $56 million whilst funds from operations (FFO) climbed 8%.
Following the likely sale of the Bastion Tower in Brussels this year, IOF will have an Australian-only portfolio.
Management can therefore focus exclusively on developing assets like 567 Collins Street Melbourne and 800 Toorak Road Melbourne.
Portfolio refurbishments are likely to boost FFO and drive a 4.2% increase in the FY14 distribution to 18.5 cents – equating to a healthy yield of ~5.8%.
IOF’s 1H14 net tangible asset (NTA) per share was $3.24, and its last price of $3.33 represented only a 3% premium to NTA.
The median premium among its peers in the A-REIT sector was 10.2%, highlighting a big discrepancy.
Such a discount is unjustified in our view given our belief the commercial property market is near cyclical lows and a recovery is expected.
In 1H14, there was a 3.4% increase in the book value of IOF’s domestic portfolio, despite the generally weak state of Australia’s commercial property market and the sale of its Dutch Office Fund asset.
We anticipate an improving commercial property market to lead to greater asset revaluations over 2014, boosting IOF’s NTA in the process.
The stock trades on a 12-month blended forward P/FFO ratio of just 12.9x. This makes IOF one of the cheapest A-REITs among its peers, representing good value around its current levels in our opinion.