Brian Gaynor: Taking a risk at the Park

Sean Wareing and Angus McNaughton wouldn't win any popularity contests at present.

The chairman and chief executive of Kiwi Income Property Trust's management company have angered a large number of the trust's substantial unit holders over the $538 million Sylvia Park Development.

Unit holders are concerned that the huge Mt Wellington retail and office development is far too risky and could have a negative impact on the trust's sharemarket performance over the next few years.

The widespread discontent with Wareing and McNaughton has reignited the long-standing argument about the role of development projects in property investment companies.

In 1993, Kiwi Income Property Trust was promoted as a low-risk property investor when units were first sold to the public. Its stated objective was "to provide unit holders with above-average returns with below-average risks". This required the trust to buy property with secure long-term leases and to avoid major developments as they are inherently risky.

The word income was included in the trust's name to convey its low-risk, non-development objectives.

When Kiwi decided to develop the landmark Vero building in 1997 the project was put into a separate listed trust called Kiwi Development Trust. The development trust's prospectus stated: "Although project development offers the potential for high returns, this activity is not the purpose or focus of Kiwi Income Property Trust."

When units were offered to the public, the development trust had commitments from tenants representing 34 per cent of the building's projected annual income.

The Shortland St project did not meet expectations. The development trust predicted that its units would be worth $4.08 on completion yet, when it was taken over by the income trust in 2000, the units were valued at between $2.60 and $2.75 compared with the $3 a unit subscribed by investors.

The Vero building generated net rental income of only $18.08 million in the March 2004 year compared with the prospectus forecast of $18.55 million per annum on completion.

In October 1995, Kiwi Income Property Trust purchased an 11.8ha site at Sylvia Park, Mt Wellington and, three years later, bought an adjacent 9.1ha.

The trust continually reiterated that it would require major tenant agreements before proceeding and seek a joint-venture partner to reduce its risks.

In its 2004 annual report, the trust stated: "Given the potential scale of the project, and a desire for the trust to maintain a prudent market diversity and development risk profile, the manager is exploring the potential of a joint-venture partner for the project."

In January, Kiwi Income Property Trust held an extraordinary general meeting to amend its borrowing limits from 35 per cent to 40 per cent of its gross value. In a power point presentation, the management company demonstrated that a debt-funded property acquisition with a 9.5 per cent per annum yield would enhance unit holders' returns.

The presentation implied, although it didn't specifically state, that Kiwi was looking for a 9.5 per cent return on new investments. This would enhance returns as the average yield on its total portfolio at the time was 8.35 per cent.

There were a number of reasons why the release of the Sylvia Park details on May 18 was a huge shock to institutional and property savvy investors.

These included:

* Leasing commitments are low.

* It hasn't attracted any new and exciting anchor tenants.

* Kiwi hasn't been able to find a joint venture partner.

* The projected return is a mere 7 per cent.

The Sylvia Park development, which is expected to cost $538 million, is divided into two main stages. The retail stage will cost $363 million and the office development $175 million.

Construction of the retail area, which will comprise nearly 200 retail tenants and 3000 car parks, has begun and will be completed in mid-2007.

The office project, which will comprise five buildings with six to eight floors each, will start in 2007 and is due to be completed in 2010. The development represents nearly 50 per cent of the trust's total assets when land values are taken into account. This is a huge risk, particularly for an organisation supposed to be a low-risk property investor.

At this stage, Kiwi has only secured its four anchor tenants - The Warehouse, Pak'N Save, Foodtown and Hoyts Cinema. The projected annual rental from these is just $3.3 million or 13 per cent of the anticipated annual retail rental of $25.4 million. By comparison, Kiwi had annual rental commitments of $6.2 million before it started the Vero project. This represented 34 per cent of the building's anticipated annual rental income of $18.5 million.

There is nothing wrong with the four anchor tenants but they are already well represented in Auckland. Why wasn't Kiwi able to attract Wal-Mart or Aldi, the German retailer that is well established in Australia, or Ikea, the huge Swedish furniture retailer?

It is difficult to understand how the trust will be able to attract 180 plus specialty retailers to Sylvia Park when it hasn't been able to attract any new or exciting anchor tenants. These must generate annual rental of $22.1 million or 87 per cent of total retail income. The inability of McNaughton to attract a development partner is also a major disappointment, particularly as there is a huge amount of investable funds looking for a home in Australasia.

It appears that McNaughton was negotiating with Multiplex, the diversified Australian property group that has experienced major problems with its Wembley Stadium construction contract in London.

But Multiplex has been able to negotiate better deals in Australia. This month, the ASX-listed company bought 50 per cent of the World Shopping Centre in downtown Sydney, which opens next week.

The purchase price equated to a yield of 7.25 per cent and the vendor has provided a two-year rental support facility over the carpark and vacant retail areas.

Kiwi has disclosed the yield on the Sylvia Park development is a mere 7 per cent, before deducting management fees of 0.55 per cent. This compares with the projected yield of 9.5 per cent on the Vero building and the 9.5 per cent highlighted at the trust's extraordinary general meeting in January. The low projected yield was a major shock to institutional investors because the average yield on rival Westfield's 11 New Zealand shopping centres is 8.11 per cent. The three Westfield centres nearest Sylvia Park are Pakuranga, yielding 9.01 per cent, Newmarket 7.68 per cent and Manukau 8.64 per cent.

This begs the important question; why is the Sylvia Park development acceptable when it is only 13 per cent leased (in dollar terms), has a projected return of 7 per cent and represents 47 per cent of the trust's assets, whereas the Vero project was considered to be too risky even though it was 36 per cent pre-leased, had a projected return of 9.5 per cent and represented 38 per cent of total assets?

One of the main problems with the Sylvia Park development is that Wareing and McNaughton have poorly managed investors' expectations. They gave the impression at January's meeting that the project would give a return of 9.5 per cent although they deny having had this intention.

McNaughton has also indicated that it was important for Kiwi to find a partner to share the risks.

Kiwi Income Property Trust can proceed with the project because unit holders have almost no powers under the unit trust structure. But McNaughton's performance as dealmaker, in terms of a joint-venture partner and tenants, has fallen well short of expectations. Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management.


The project

* The Sylvia Park development, which is expected to cost $538 million, is divided into two main stages, retail and office.
* The retail stage will cost $363 million and the office development $175 million.
* Construction has begun on the retail area, which will comprise nearly 200 retail tenants and 3000 car parks, and will be completed in mid-2007.
* The office project, which will comprise five buildings with six to eight floors each, will start in 2007 and is due to be completed in 2010.