Listed property trusts had delivered "excellent" share price gains over the past few years as investors sought the attractive yields in the low-interest-rate environment.
The performance had started to unwind as bond yields recently rose from historic lows, he said.
Craigs saw a place for listed property trusts in long-term portfolios but Mr Timms believed the share price trajectory would continue to be dictated by the movements in bond yields.
"We see further downside risk over the next few years. For this reason, we prefer property companies offering higher earnings growth through complementary income streams, such as development or funds management."
Low interest rates had been beneficial to listed property trusts in two main ways. They provided a lower cost of debt, a significant positive for earnings as property trusts generally had higher debt levels than other sectors due to their stable asset base.
Secondly, investors had driven share prices higher as the interest rates on offer from alternative investments, such as term deposits or bonds, had fallen.
It appeared interest rates had hit bottom, he said.
That meant the two benefits driving the share prices of listed trusts to record highs and that delivered substantial gains to investors, would not be available over the next few years.
Valuations were expected to fall back to levels closer to long-run averages as bond yields climbed. As existing debt facilities expired, refinancing would drive higher interest rates with little ability to pass through to tenants, given the high proportion of prevailing leases with terms typically of three to five years in length.In order to minimise the downside risk to share price performance, Craigs recommended property trusts offering higher earnings growth and lower debt levels.
Higher earnings growth could help to bridge the gap to high valuations and lower debt levels would reduce the difficulties from rising debt costs.
Lower debt levels would also be the key should the property market turn and the value of the underlying property assets started to fall, Mr Timms said.
As experienced in 2008 and 2009, the property companies with higher debt skated closer to their banking covenants as the value of their assets reduced and some had to undertake highly dilutive equity ratings.
Several Australian listed property companies offered higher growth as a significant proportion of their earnings streams were derived from development, construction and/or funds management. The share prices of those companies tended to move more in line with the broader equities index than other listed property trusts.
"This is beneficial in the current environment and provides a good alternative for those investors willing to sacrifice some yield for higher earnings growth and potentially more downside share price protection."
At a glance
• In New Zealand, Vital Healthcare and Precinct Properties both offer higher earnings growth than peers, have low debt levels and pay dividends covered by free cash flow.
• In Australia, Lend Lease and Goodman Group offer solid earnings growth, have high quality global businesses and are the market leaders in their respective fields of urban redevelopment projects and commercial properties.
