Brian Gaynor: Managing to profit from property

The listed property sector was back in the headlines this week when Trans Tasman Properties announced it was selling the Auckland Finance Centre to two parties, including its founder, Sir Robert Jones.

Sir Robert has gone from strength to strength in recent years even though long-term investors in his listed company have suffered huge losses.

Robt. Jones Investments was listed in 1982 and quickly became a sharemarket star. At the end of 1986, it was the ninth largest listed company with a market capitalisation of $1.08 billion.

In April 1989, when the listed vehicle had total assets of $923 million, it bought the management company from Sir Robert for $75 million. Two years later, Robt. Jones Investments reported large operating losses and property value writedowns.

This column has argued that the $75 million payment to Sir Robert was one of the worst deals for New Zealand investors during the past 20 years. Sir Robert takes a different view. He said he was forced into accepting $75 million when two independent accounting firms valued the management contract in the $93 million to $96 million range.

Although there are differing views on the $75 million price tag, the April 1989 transaction raised the issue of listed property entities and their management companies for the first time.

Robt. Jones Investments merged with Seabil in November 1995 to form Trans Tasman Properties. This crystallised large losses for long-term shareholders of Sir Robert's company.

In June 1996, the merged company bought the Finance Centre for $81.6 million.

In November 1997, Trans Tasman put two proposals to shareholders: the formation of a trust to hold its New Zealand assets and the establishment of a separate management company to manage the trust. By this stage, the Finance Centre had appreciated to a value of $105.4 million.

The new management company was to be owned by the listed entity and run by a number of its former executives. Details of the management company were sparse but the notice of the meeting stated that the manager would be reimbursed for property management costs incurred on behalf of the trust. This suggested that the proposed management company would have minimal costs and be highly profitable.

A shortage of information is one of the main characteristics of these management companies. According to Arthur Andersen's independent experts report on the Trans Tasman proposal, there is a lack of comparative publicly available information concerning property management fee arrangements.

The Trans Tasman proposal did not proceed and the company remains internally managed. The Finance Centre will be sold for $100 million, including Sir Robert's acquisition of Qantas House for $42 million. The $100 million realisation is slightly below 1997 book value but above the 1996 purchase price.

The little information we have on management companies indicates that they are highly profitable and give huge investment returns to their owners.

As illustrated in last week's column, Kiwi Income Property Trust issued units to the public at $1.03 each in 1993 and these units are now trading at $1.11. By comparison, management company shares issued at $1 in 1993 were sold to Colonial First State Property for $57,750 each in March 2002 (yes, $1 shares were sold for $57,750). As Kiwi's total assets have increased from $880 million to $1.10 billion since then, it is reasonable to assume those $1 shares are now worth more than $70,000.

A number of investors have argued that they are happy with Kiwi because it had an annual distribution of 8.57 cents in the March 2004 year and has forecast 8.4 cents to 8.6 cents distribution in the current year. By comparison, filings at the Companies Office indicate that Kiwi's management company paid a dividend of $4900 per $1 share in 2001 and $3580 a share in 2002. The management company had net earnings of $2.3 million or $2330 a share for the 15 months to June 2003 but this was not distributed during the year.

The 2004 accounts of Kiwi Income Properties Limited, the trust's management company, were lodged at the Companies Office last Friday but are not yet available to the public.

Kiwi unit holders may be happy with their 8.4 to 8.6 cent a unit distribution but this is totally insignificant when compared with the earnings and dividend per share of the management company.

There are also huge potential conflicts of interest between the management company and the trust because the former was bought for $57.75 million ($57,750 a share) and the owners will want to grow the trust and earn more fees, whereas it may be in the best interests of unit holders to sell poorly performing assets and reduce the size of Kiwi Income Property Trust.

There have been several other developments regarding management companies in the past 18 months, including:

* Late last year, the management company of Colonial First State Property Trust (now called Macquarie Goodman Property Trust) was sold to Macquarie Goodman. The purchase price was $5.75 million, or $57,500 per $1 share. The profitability of Colonial's management company was relatively low because the trust had only $226 million of assets as at March 31, 2003. This indicates that there are huge benefits to management companies, in terms of profitability, if they can increase the size of the trust they manage.

* Twelve months ago, the Ronin Property Group, an Australian group, acquired 50 per cent of AMP NZ Office Trust's management company for $9 million. There is no public information on the profitability or capital structure of the management company.

* In August 2003, Symphony Group sold 50 per cent of Paramount Property Trust's management company to ING for an undisclosed amount. The trust and management company changed their names to ING Property Trust and ING Property Trust Management Limited respectively. The trust reported net operating earnings of $10.9 million or 8.9 cents per unit for the March 2004 year while the management company had net earnings of $169,000 or $1690 per share (it has 100 ordinary shares, uncalled and unpaid).

* Capital Properties, a company that owns its management company, has indicated that it may sell its management contract to an outside party. Based on the price that Trans Tasman paid Sir Robert, and the amount Sir Robert said he should have received, Capital Properties could realise between $35 million and $46 million.

At a meeting of the Auckland branch of the Shareholders Association this week, several individuals expressed their annoyance at the management structure of listed property entities, particularly Kiwi Income Property Trust.

These management companies have a guaranteed income, virtually no capital requirements and generate huge returns for their owners in terms of capital and dividends.

There was strong support at the association meeting for the organisation to take an active role regarding management companies, particularly lobbying for the repeal of the antiquated Unit Trusts Act 1960.

But there is no compulsion to invest in property trusts.

Thus the best advice for investors is to avoid trusts where the main objective of the manager is to retain poorly performing assets and grow the size of the trust in order to generate higher management fees.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.