Brian Gaynor: One giant step for property investors

Vital Healthcare's properties include Ascot Hospital ... now investors want to operate on its management structure. Photo / Dean Purcell

Disagreements over the proposed internalisation of management contracts for Argosy Property Trust and Vital Healthcare Property Trust are great news for investors.

These are positive developments because external management structures, which have been dominant in New Zealand, have had a negative effect on the performance of the NZX's listed property sector.

In an external management structure, investors hold units in a property trust but the trust is managed by a separate limited liability company.

The management company usually has a completely different ownership structure from the trust.

Vital Healthcare Property Trust is a good example of this.

The trust owns specialist medical and healthcare property valued at $517 million. It has 25 properties and 131 leases in New Zealand and Australia, including Ascot Hospital in Auckland and Epworth Eastern Hospital in Melbourne.

The trust has around 4600 unit-holders. The ACC holds 9.1 per cent, OnePath (NZ) 7.8 per cent and BT Funds Management 5 per cent.

Vital Healthcare Property Trust is managed by Vital Healthcare Management Ltd, which is owned by OnePath, a fully owned subsidiary of ANZ National Bank.

These management companies are a gold mine for their owners because they require little capital, their return on capital is enormous, and they can create significant wealth for shareholders.

Vital's management company has total capital of only $100,000, yet it had after-tax earnings of $872,000 for the nine months to last September, nearly $1.2 million on an annual basis.

Unfortunately the management company's disclosure is poor, as its employees are paid by OnePath and these figures are not disclosed.

The other important issue is potential conflict of interest between the owners of a trust and its management company. This is mainly because of the fee structure.

Management companies receive an annual fee based on the value of the listed entity's assets.

As well, they may collect an incentive fee based on the increase in the total value of the assets whether through acquisitions or an increase in property values.

Vital and Argosy pay annual fees of 0.75 per cent to their management companies based on average total assets throughout the year.

However, they have different performance fee structures.

Vital's management company is paid 10 per cent of the average increase in the gross value of assets over the previous three years, excluding equity raised.

Argosy receives 10 per cent of all returns in excess of 10 per cent of total shareholder returns (share price movements plus dividends).

Vital and Argosy both have caps on their performance fees.

A conflict of interest between the property trust and the management company occurs because a trust's unit holders want higher earnings and dividends, while the owners of management companies benefit from an increase in assets under management through acquisitions.

On April 19, the independent directors of Vital Healthcare Management, Bill Thurston and Graeme Horsley, announced that they were looking at a proposal to internalise the management structure of the trust.

Thurston and Horsley are directors of the management company; the trust has no directors.

Two days later, the independent directors said a payment of $14 million would be made to OnePath as part of the internalisation of management proposal.

The announcement was frustratingly vague as the independent directors did not explain how the $14 million was determined.

Under the internalisation proposal some or all of the OnePath employees who now manage the trust will become employees of it.

On June 22, Ascot Property Management - which was formed only two days earlier - wrote to the trust's unit-holders encouraging them to look at a proposal under which management could be internalised for $4.5 million compared with the previous proposal of $14 million.

The $4.5 million comprises $3.1 million to be paid to the current manager and a $1.4 million success fee to Ascot.

Ascot said the $14 million payment was exorbitant, the independent directors had a conflict of interest and they had not kept a promise to reduce fees.

On July 13, the ACC, BT Funds Management and the Guardians of New Zealand Superannuation, representing 15 per cent of the units of the trust, formally requested that the management company convene a meeting of unit-holders for the purpose of passing a resolution under which the current manager would cease to hold office.

The independent directors responded by saying they were confident of negotiating a lower price than $14 million with OnePath.

Unit-holders are waiting a further announcement, but it looks as if they will benefit from the shareholders' activism initiated by Ascot, the ACC, BT Funds Management and the Guardians of New Zealand Superannuation.

On April 19, Argosy Property Trust announced a proposal under which its management would be internalised through the payment of $32.5 million to the management company, also owned by OnePath.

Argosy Property Trust has a $949 million portfolio of 74 retail, commercial and industrial properties.

Argosy's internalisation proposal was greeted with optimism, although the $32.5 million payment was criticised as being too high, as it represents 3.4 per cent of assets under management of $949 million.

Australian internalisation management transactions have cost around 1.5 per cent of assets under management.

DNZ Property Fund then waded into the fray with a proposal to "merge" with Argosy.

This proposal had a touch of irony as DNZ's internalisation management transaction cost $32 million or 4.8 per cent of assets under management of $670 million.

Argosy is considered to have a better portfolio than DNZ.

On June 8, ACC, the Guardians of New Zealand Superannuation and BT Funds Management, which own 9.6 per cent of Argosy Property Trust between them, requested that the management company convene a meeting of unit-holders to pass a resolution under which the current manager would cease to hold office.

On July 15, Argosy announced that the payment to OnePath for the internalisation of management was being reduced from $32.5 million to $20 million.

Unit-holders will be asked to approve this internalisation process at the trust's annual meeting which will be held late next month.

The announcement went on to state: "Argosy Property Management Limited (the "manager") was yesterday afternoon served with legal proceedings by DNZ Property Fund Limited which relate to the alternative resolutions proposed by DNZ and other unit-holders. The proceedings seek a separate unit-holder meeting to be held before the annual meeting of the trust. It is not the manager's intention to put unit-holders to the cost and inconvenience of a separate meeting very shortly before the annual meeting."

DNZ has applied to the High Court to require the trust to hold a separate meeting before the annual meeting.

The High Court is expected to make a decision on this on or after Tuesday, when DNZ's application will be heard.

Whichever way one looks at it, the shareholders' activism in relation to Vital Healthcare Property Trust and Argosy Property Trust sounds the long-overdue death knell for external management of listed property trusts in New Zealand.

This is a very positive development, because New Zealand investors have a strong bias towards property, but external management creates huge conflicts of interest,with far too much value leakageto the management company andpoor corporate governance structures.

Hopefully we will now see more internally managed property businesses list on the NZX.

* Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management, which holds units in Vital Healthcare Property Trust and Argosy Property Trust on behalf of clients.