Australian Real Estate Investment Trusts (A-REITs) were recently identified by a prominent fund manager as one of his 'danger' areas over the next couple of years. I'm not so negative on the area, although I think there is a good case for not buying Scentre Group Ltd (ASX: SCG) and Westfield Corp Ltd (ASX: WFD) shares at today's prices.
Scentre Group shares are priced at 1.3 times their book value and its 'scentres' boast occupancy of 99.5%. This means that investors are paying 1.3 times what the company's properties are 'worth' (and they are revalued to market levels regularly), while having minimal scope to improve their performance, e.g., through higher occupancy.
In fact, if everything goes according to plan, Scentre Group shareholders can probably expect long-term earnings growth similar to that seen in the recent full-year results (about 3% per annum). The worst case scenario is that rising interest rates and/or weak domestic conditions hurt occupancy and profits, and shares plunge.
It's a comparable situation at Westfield Corp, the international equivalent of Scentre, although this company is somewhat protected by its diversification across several countries. Westfield Corp also has 'flagship' malls in some of the biggest cities in the world, which should help maintain high levels of sales and tenant occupancy.
Both companies carry billions of dollars in debt and are vulnerable to higher interest rates, in addition to trading at a premium to their book value. In my opinion, this means that buyers today are paying a premium price for a situation where there is minimal growth (say ~3% per annum) in the best case, and declining earnings and share prices at the worst case. I'm not a buyer of either Scentre Group or Westfield Corp at today's prices.
Foolish Takeaway
Scentre and Westfield are attractive businesses, with reliable income potential, great assets, and some of the best management in the business. I would love to own shares in these companies, but I think that they are simply too expensive right now.
