Jenny Ruth: Kiwi project offers short-term pain and jam tomorrow

A few eyebrows were raised when Kiwi Income Property Trust announced that its development of the nation's largest shopping centre will yield only about 7 per cent on completion.

That's probably about 6.5 per cent after the Commonwealth Bank of Australia-owned manager takes its fee.

"I'm not interested in buying an asset for that yield," one fund manager muttered.

To put that in perspective, Jeremy Simpson, an analyst at Forsyth Barr, says the average gross yield from the listed property sector for 2006 is 8.4 per cent.

While Kiwi's investment in a 19.4 per cent stake in Capital Properties has been criticised, investors prefer companies such as Kiwi to own properties, not investments at the $1.15-a-unit price Kiwi paid. The stake is forecast to yield 8.7 per cent in 2006 and 9.6 per cent in 2007.

(At the $1.35-a-unit price AMP paid, the 2007 yield is only 8 per cent.) You can get almost as good a return on bank deposits as that on the Sylvia Park shopping centre. In fact, Westpac is offering 7 per cent on deposits over $10,000 for a 10-month term, a much less risky proposition.

So, is Kiwi's manager acting in the best interests of its unitholders in developing Sylvia Park?

For the trust's manager, chief executive Angus McNaughton, the answer is an emphatic yes.

"We're not about developing for day one. Property is a long-term gain and we're developing something that will stand the test of time for the next 20 years," he says.

It would be possible to develop a centre with a considerably higher initial yield but the manager doesn't think that's in Kiwi's best interests.

Sylvia Park will have four anchor tenants, The Warehouse, Pak N Save, Foodtown and a 10-screen Hoyts multiplex cinema and eight "mini-major" tenants with stores between 400sq m and 2500sq m.

McNaughton said if he was trying to maximise yield, he wouldn't have all those mini-majors and would have more specialty stores instead.

Rather than building the planned raised and open-air carparking, he could have opted for a traditional multi-storied parking building and saved millions on the $363 million development. And you wouldn't bother with the planned extensive landscaping or in building an internal road within the centre, as Kiwi's manager has planned the centre will comprise five individual buildings.

He says that although the anchor stores will occupy 49 per cent of the centre they will contribute only 13 per cent of the rent. The mini-majors will occupy a further 15 per cent. "They don't pay a lot of rent, but they really drive the foot traffic."

And once the foot traffic is established, Kiwi will be able to start ratcheting up the rentals on the 180 specialty stores.

Rather than being based on sales, most leases will rise by the consumer price index plus 2 percentage points each year. After three years, Kiwi will get the greater of either that formula or whatever the market rents are, capped at 5 per cent.

As well, the Sylvia Park site in Auckland's Mt Wellington is unique, he says.

Kiwi has owned the site for about 10 years and started work on getting the necessary re-zoning and consents a bit over five years ago.

The Southern Motorway and Mt Wellington Highway intersect the site, as does the main north-south rail line, and the centre will be the only one in New Zealand to have its own railway station.

"You just can't get a site that's more accessible, certainly not in the New Zealand market. I would say it would be unlikely that Kiwi would be able to have a stake in an asset like Sylvia Park again. There are no opportunities to acquire assets like this," McNaughton says.

In fact, there has been an opportunity to buy into Sylvia Park for some time. Kiwi's manager has been courting potential joint-venture partners since the middle of 2004 but then surprised the market with its decision to go it alone.

McNaughton says the offers "didn't recognise the unique elements of the site. As each day goes by, we believe the sites going to be more valuable."

He rejected my suggestion that potential partners weren't prepared to accept a 7 per cent yield. "In New Zealand, its probably a little low but 7 per cent is probably a good yield in Australasian terms. Some centres in Australia are 5.25 per cent."

He says Kiwi's manager is still open to the possibility of taking on a joint-venture partner.

With 62,000sq m of lettable area, the centre will be the country's largest by a country mile. The next largest centres are the Riccarton, St Lukes and Kiwi's Northlands centre in Christchurch. Northlands is 41,000sq m.

Further down the track, Kiwi's manager plans to add low-rise office buildings and there's the possibility of residential development. McNaughton says the company will secure tenants before it starts building office buildings. There's also a possibility of having a tertiary education facility on the site. It will also have community facilities.

Already, there are 700,000 people within a 20-minute drive of Sylvia Park who spend $5.6 billion a year on shopping. The area is experiencing strong growth. A housing development in the former Mt Wellington Quarry which Fletcher Building is working on is planned to have up to 8000 residences.

Australia-based industry researcher Dimasi Strategic Research estimates that retail sales in the area will rise 4.7 per cent a year through to 2016.

Incidentally, McNaughton reckons this growth will mean that other nearby centres, including St Lukes and Botany, won't be badly affected by Sylvia Park's opening.

Kiwi's investors can take comfort in the fact that the manager has de-risked the project as much as possible with capped construction costs and having already secured the anchor tenants. There's a 5 per cent contingency for unforeseen costs.

The manager has also retained reserves so it can continue to offer stable distributions through the construction period. Based on its forecast earnings for 2006, that will still only be a yield of about 7.6 per cent.

It's also possible that Kiwi is being unduly conservative in forecasting a 7 per cent yield from Sylvia Park. Its $9.9 million redevelopment of its North City centre in Porirua was budgeted to achieve a 9.5 per cent yield in the year ended March and actually achieved 14.2 per cent.

The first stage of Sylvia Park will open in mid-2006.

So Kiwi's manager is offering unitholders short-term pain and jam tomorrow. The unit price since the announcement suggests investors are underwhelmed: they have fallen from $1.18 to $1.13.

Who, what, where

Kiwi Income Property Trust HQ: Level 2, The Ferry Building, 99 Quay Street, Auckland.

Profile: The trust owns a $1.26 billion portfolio of office buildings and retail centres throughout New Zealand.

Results: The trust reported a 7.3 per cent rise in net profit to $52.7 million for the year ended March.

Management: Angus McNaughton, chief executive of Commonwealth Bank-owned Kiwi Income Properties, Gavin Parker, chief financial officer, Mark Luker, development general manager, Karl Retief, retail portfolio manager, John Lesquereux, commercial portfolio manager and Evan Vertue, Sylvia Park project director.

Market capitalisation: $796.8 million.

Major shareholders: ING with 9.65 per cent, Axa with 6.46 per cent and Commonwealth Bank with 5.8 per cent.