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Kiwi Income Property Trust, Angus McNaughton

By Jenny Ruth

Tuesday 21st June 2005

Text too small?
 Jenny Ruth
Kiwi Income Property Trust will spend $363 million on getting its Sylvia Park shopping centre project at Mt Wellington in Auckland, which will be by far New Zealand's largest shopping centre, to the end of its first stage. To part fund the development, the trust is trying to raise up to $142 million through an issue of five-year mandatory convertible notes (MCNs) which will pay the higher of 8% or the five-year swap rate plus a 1.3 point margin a year. Existing unitholders have been offered rights to take up $33 million of the MCNs.


Sharechat: Why is so little of the MCN issue being offered to existing unitholders?

Chief executive of the trust's manager, Angus McNaughton: With our advisers, we've spent a lot of time looking at the level of demand and the level of new demand for these issues, what's the interest rate, what other offers there are in the market at the same time. With our advisers, we've come up with a number. We will ultimately only know whether it's right or wrong (when the issue closes). The entitlement offer of $33 million is open to existing unitholders. They also have the right to apply for additional MCNs. Our intention is that if some existing unitholders don't pick up their rights or entitlements, we will give (other) existing unitholders the first option to them and so give them priority.


SC: Why didn't you get the entitlement part of the offer underwritten?

AM: To keep the issue costs down. The big chunk of it we have underwritten. We believe there's going to be strong demand for the entitlement issue so there's less need to underwrite it.


SC: The unit price fell substantially on heavy volumes once the MCN prospectus was issued. Doesn't that suggest unitholders aren't happy?

AM: There were quite a few events that happened at the same time. One is the MSCI index: the day we announced Sylvia Park to the market, we went into the MSCI index. There's obviously been quite a lot of juggling by the fund managers who needed to have an index weighting. We spiked to a 12 month high. A lot of that was around the MSCI weighting. There are probably some investors who have swapped between our ordinary units and the MCNs. Some are taking them up as an additional exposure to Kiwi. Others are saying that they prefer the MCNs and the capital appreciation opportunities. When the prospectus was lodged on the 7th (June), we went ex-dividend, the 4 cent dividend, as well.


SC: But there are unhappy unitholders out there, aren't there?

AM: Yes. There's some inaccurate reporting. A good example is ING. They're our major shareholder with nearly 10% of our stock. Shane Solly is really keen to get regular updates on leasing. He knows about the project and he's a supporter of the project. He wants regular disclosure on leasing progress. We've got a number that are very happy as well. It's all about trying to get the balance right. We've been approached by a number of investors. They know how tightly held retail assets are. You just can't acquire a retail asset like Sylvia Park in the New Zealand market. You probably can't acquire it in the Australasian context either.


SC: What happens as far as conversion goes if the unit price falls below $1?

AM: You get more units. You will get $1.02 of value for every $1 initially invested. You will effectively always get your money back plus a 2% discount.


SC: Development will go from only 8% of the portfolio to more than 20% with Silvia Park. Doesn't that make Kiwi inherently a far riskier proposition for investors?

AM: We've got a $1.2 billion portfolio now of assets located throughout New Zealand. We've got record occupancy of 99.5% and we've got 600 tenants in the portfolio now which I think provides us with a very solid investment base. We believe a level of development activity is really important to the trust because it improves the quality of the income streams by securing key national and international tenants on long-term leases. It adds value and increases returns. The Northlands shopping centre's probably a good example of that. The development initially was quite hard to stack up. It's performed very strongly and we've beaten all our prospectus forecasts. Particularly in retail, it's important that you have a level of development activity. You've got to stay relevant, you've got to keep your assets current. Over the last period of time we've bought the land, we've achieved the re-zoning of it, we've got the resource consents, we've locked down the major anchor tenants. Around leasing: specialty tenants won't pre-commit. They say, get those anchor tenants locked down and then come back and talk to us. If you secure the good strong anchor tenants then the specialties are obviously keen to go into a development. Early leasing results have been very encouraging. The other thing is construction costs. There are guaranteed maximum price contracts and some lump-sum fixed contracts. There are a number of separate contracts on the site. The key focus on the development now, and we've got a lot of them locked down now, is the specialty leasing. We've got five leasing agents. It's quite a different development to an office development. With an office development, you are really reliant ... the market's not growing significantly so you're reliant on getting an existing tenant an upgrading their facilities. In the retail sector, you've got retailers that are looking for growth. It's (development) around 21%. We're also staging the development as well. The retail development is in four stages which further spreads the risk of the project. As each stage opens, we're required to re-classify it as investment property. We will build up to 21% but that will drop away reasonably significantly. There is more development risk, obviously, in the portfolio, but I think we've got a very strict process to handle that risk.


SC: Why didn't you create a separate vehicle to develop Sylvia Park as you did with Kiwi Development Trust?


AM: A retail development is quite different to an office development. We're not looking to create new benchmarks in terms of sales and rentals in this project. Our focus isn't on day one development profits, it's on the longer term growth and performance of Sylvia Park. Certainly in the partner discussions we've had, that wasn't the appropriate vehicle to put a partner into. Kiwi's focused on the long term performance. If we were focused on the day one development profit, then there are a lot of things we would do differently on this project, but (if we did) we don't believe it would be as profitable going forward. We still need the flexibility to bring a partner into the development.


SC: Why do you regard the 7% initial yield on Sylvia Park as acceptable?

AM: There's a couple of things. It's like buying a house that's under-rented. You've got to look at what is the growth going to be over time. You can't just look at it on the day you buy it. CBRE have forecast 10% per annum over a 10-year investment period. That's a combination of income and capital growth. What we could strip out: we've got a lot of major and mini-major tenants. We could improve the yield from day one if we took them out and replaced them with specialties. If we did that, the yield would be higher, but what we're trying to do is secure key traffic drivers in the centre. If you get that right, the specialty stores' sales will be higher and you will get better rental growth. We've made it (the centre's roof) structurally capable of putting another layer of retail on top. That's come at considerable cost but will be of benefit in the future. Other elements are the internal ring road for convenience, extensive landscaping and other architectural and structural elements, there's going to be the train station and a bus interchange as well. It's possible to deliver a higher initial yield by reducing costs and quality. It's a really unique site. I don't think the trust will ever have the opportunity again of investing in something like Sylvia Park. You simply can't acquire a 50 acre site in central Auckland. You also have to get resource consents. I wouldn't like to go through that process again.


SC: What do you anticipate the yield on Sylvia Park will rise to over the next 5 years? How much by rent reviews and how much by new add on developments?

AM: These happen annually. Most of the specialty stores are on what's called a market review, CPI plus 2% annual increase or up to 5% annual increases, and after year three you get the market review. You've got the ability, if the stores are trading well, to get another increase. Around 85% of the specialty stores are on annual CPI plus 2%. I can't answer your question specifically, but CBRE have an internal rate of return of 10% per annum over that 10-year period. It's both rental and capital growth. We haven't factored in any add-on developments. All the growth is through rent reviews and leasing.


SC: What was the cost of the land at Sylvia Park? And what have you got it in your books at? What would be its market value today?

AM: $143 million as at 30 June, 2005. The asset's held at cost - it's really land and infrastructure works. An independent valuation at 31 March, 2005 supported the investment at that time.


SC: After the stage one development how much more is planned to be spent on Sylvia Park?

AM: There's potential for office buildings, there's potential for five office buildings on the site. We have absolutely no commitment to that expenditure, but at this stage it could be up to $75 million over time as we secure tenants.


SC: That doesn't include education facilities?

AM: Education could be in one of those buildings. There is a very small residential strip, a buffer between the current residential and the retail. We could sell a parcel of land. We haven't finalised that.


SC: With the benefit of hindsight what would you have done differently with respect to shareholder relations?

AM: Historically, our communications has been around annual and interim reports. We think we need to provide probably more regular updates, particularly around Sylvia Park, but also around the trust activities. Going forward, that would probably be the key. Two years ago we did a roadshow across New Zealand. We did Invercargill, Christchurch, Tauranga, Dunedin, basically all the major centres, and we had quite significant turnouts. That's something we might look at doing again in the future.


SC: Why is so little of the portfolio in industrial property?

AM: The market's extremely competitive. While we will continue to look at opportunities in that sector, the size of the assets is generally quite small. A lot of family interests and smaller investors have invested in that sector. Some of the yields are down to 6%. It's a sector where barriers to entry are quite low as opposed to retail where the barriers to entry are quite high. We will continue to evaluate opportunities, but it's just a very competitive market at the moment.


SC: Given the point of the economic cycle that we're at, isn't this a bad time to be starting Sylvia Park?

AM: No, is the simple answer. Retailers have got a long-term focus when they're considering new opportunities. There are so few opportunities in New Zealand where they can expand their business. Retailing has been one of the strongest performing sectors over the long term and also through a number of economic cycles.


SC:Why did you decide against having a JV partner in developing Sylvia Park?

AM: There's still an opportunity for the trust to have a partner for the project. Late last year, we went through an expressions of interest process. We had a short list and selected one party. We ran through a due dilligence process that started in late February. We weren't able to conclude a deal at the time. The nature of the party we were dealing with, their business changed and the deal wasn't acceptable. Securing a partner for Sylvia Park remains a very real option and we've got a number of parties that are still interested that we're still talking to.

Bond Offer: Infratil Ltd, 7.2 year & 10.2 year unsecured unsubordinated bond


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