By Jenny Ruth
Monday 23rd January 2006
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Sharechat: Can you explain what went wrong with your plans to develop the vacant Ascot site?
Miles Wentworth, chief executive of the manager of Calan Healthcare Properties Trust: We were very happy with the terms of the heads of agreement that had been negotiated but, due to them restructuring their interests as shareholders, effectively they were in a position that they legally had to bring to an end the heads of agreement. That was unfortunate, absolutely, but it's not the end of the world from the point of view that what we had negotiated with them we can use as a basis for negotiating with other parties which we're still working through at the moment.
SC: Does that mean Calan still owns the site?
MW: Yes. You could say we were selling it. Effectively, I think of it that we were looking to swap the land for a completed ground floor shell of a building to be built. Selling the land gives the market the view that we've exited the site. We're effectively looking to convert a non-yielding investment in land into a ground floor shell of a building which we would then lease to health-related tenants. Obviously, being located right next door to the Ascot hospital, with that being one of the trust's two icon assets, it's strategic in terms of its location for additional health-related tenants.
SC: So you're looking at alternative development arrangements for the site? Can you give me a time frame?
MW: It's certainly something we're actively working on at the moment. You never want to give a hard and fast time frame. We're working with a number of parties at the moment. We're firmly focused on getting that currently non-yielding investment into a yielding investment very promptly, basically as quick as we can.
SC:Is the plan to increase Ascot's bed capacity going ahead? Has construction started yet?
MW: Yes, it is, absolutely. It's a 15-bed extension down on the ground floor, that's 15 en-suite single rooms. The view or hope was to have started construction pre-Christmas because the hospital operator, Mercury Ascot, was able to run surgery out of its Mercury site and close the Ascot site facility. Unfortunately, due to delays at council for building and resource consent, we've had to delay the start of construction. It's not if, it's when. We're funding the shell component of the building extension with Mercury Ascot funding the fit-out component. We've contracted a 9.5% return on cost.
SC: When will construction get underway?
MW: Very shortly. When you deal with council, you never know whether it's going to be days, weeks. We're working collaboratively with Mercury Ascot to get that going as quickly as possible.
SC: Was there any downside for the trust in the delays at Epworth?
MW: Contractually, Calan was either going to receive a holding cost from tenants or liquidated damages from the contractor. Due to confidentiality around the conclusion, we can't give any detail, but it was a very small financial effect.
SC: A negative effect?
MW: Ever so slightly negative. Predominately, the delay was due to exceptional weather conditions that pushed the site excavation into winter and that delayed the finished project. It did obviously pose a few challenges for the hospital operator. You've got them trying to manage surgeons and they want to know that on this date they can bring patients to the hospital and start operating. The building has been complete for seven months now. It is an exceptionally high quality building. The tenants are very, very happy with the building. We've just completed final bits and pieces of refurbishment of the medical centre which is hard up against the hospital and linked on every floor.
SC: What's the outlook for rent reviews this year?
MW: With approximately 80% of the portfolio subject to CPI reviews and reviews to market, they're either tracking to CPI or above. If you use the New Zealand example, the CPI is 2 ½% to 3% so rental reviews should be around 2.5% to 3%. As well, we will have a full year's contribution from Epworth Central so we will have an increase year on year.
SC: What are your criteria for future developments? What is the potential for such deals becoming available?
MW: Obviously, having completed the conversion of the non-yielding assets, other than the Ascot site, we're now in an acquisitive mode, meaning both new buildings and existing buildings. The criteria for starting a new development really starts at a predominant level of pre-leasing. You have other associated construction risks which would either be priced in or contracted out to other parties. Really, it comes back to that predominant level of pre-leasing. You don't want to start a new building not having that because you could end up in a position of having a predominantly vacant and non-yielding building.
SC: You're de-risking the process?
MW: Absolutely. Historically, we had our own in-house development and acquisition team. We bought land, shaped up projects, spent a lot of money doing all the planning, the architectural plans and leasing up. Some were very, very successful. Some of them weren't so successful. Obviously, the ones that weren't so successful cost the unitholders. What we've done is restructure that into a low-risk, medium return vehicle.
SC: What are your criteria for future investments in existing properties?
MW: e're an investor in the health sector. We have a sub-sector view of categories:
1/ primary care which is GPs
2/ surgical/medical like the Ascot and Epworth hospitals
3/ aged care: obviously, there's been a lot of movement in the market in aged care
4/ mental health
5/ something we call health support services. For example, we own a laundry facility in Pt Chevalier. Spotless is our tenant and they do all the laundry processing for the public hospitals in Auckland.
SC: Didn't you exit aged care?
MW: I wouldn't say we've exited. We have sold our previous investments. We would certainly like to come back into that sector with an operator of sufficient substance. In other words, with the government being the predominant funder, they control the revenue rates of those operators. The revenue increases have lagged significantly the actual costs of running those places so they've had a margin squeeze over a significant period of time. Operators have been exiting the market entirely or there's been consolidation in the market. It's a difficult one. What you need to have is an operator of a number of sites to get administration efficiencies and buying power in terms of supplies and negotiating contracts. We will just be very selective in terms of what and how we go for. It's a very important part of the health sector and a much-needed one. We've always had a view of being in the high end of health care such as having nursing care with the facilities, the high-end care. We obviously look for good quality buildings and good tenant covenants. We look at the location and the demand profile to ensure that matches up with our investors' expectations and our internal expectations.
SC: Do you have a minimum yield requirement?
MW: Not in terms of a set figure. At the end of the day, it needs to be earnings accretive. One always needs to consider the average weighted cost of capital.
SC: How much scope is there in Australia and New Zealand for additional private hospitals?
MW: In New Zealand, we don't envisage another Ascot-sized investment. We're in the largest market, being Auckland, and that will be the only one of that size. There are other surgical facilities around New Zealand in significant centres or population bases. We're always very keen to dialogue with those parties if they see a lease-back would be of interest due to a range of different reasons for their own business plans. Small day surgeries are possible in New Zealand. In the Australian market, there's certainly a lot more activity and demand. There's been a huge investment by the public sector into new infrastructure. There are huge building projects going on. That provides additional hubs which the private sector likes being effectively co-located. The majority of surgeons do a mix of time in both. There would be more opportunity in the Australian market. Broadly speaking, it's about six times larger than New Zealand.
SC: Isn't primary care a bit small for Calan to be involved in?
MW: If you're talking a two or three GP practice, it is. But an integrated medical centre where you have, say, 10 to 20 GPs, radiology, pharmacy, podiatry, dentists and pathology, that has huge efficiencies. We own one of those in St Helliers Bay in Auckland.
SC: What would you look for in mental health?
MW: The one provider of any size is obviously the government. Going back about eight years, we actually had a contract with the government for a sales and lease-back of a significant mental health facility in Auckland. We would be very keen to effectively diversify into that sub-sector as well. That obviously depends on the view of the government of the day.
SC: Wouldn't you want to avoid being involved in politics?
MW: We have a number of properties in the portfolio leased to the public sector. They're basically on long-term lease to the public sector. Once the deal's done and they're in there, you don't get any political interference. We've got very good relationships with the Hawkes Bay District Health Board and with the Waitemata Health Board.
SC: Do you have a view on the Wakefield/Royston merger? Are there any implications for the trust?
MW: From my perspective, I think it's a good move. Hospitals themselves are capital intensive. You need to be able to have economies of scale. That transaction will deliver an enhanced scale and synergies across the two sites. For the public, I think it's a very good outcome. The implications for the trust depend on the view of the directors of both Wakefield and Royston and their respective shareholders. There may in future be opportunities, but there may not.
SC: What's the ideal debt position for the trust? (35% of total assets?)
MW: Across listed entities in New Zealand you have a range of debt levels. 35% is conservative in this market. Overlay that our leasing profile. We've got the longest average weighted lease term by a country mile (11.65 years at June 30, 2005). Therefore the risk profile around our income stream is very low which means you should be able to consider a higher level of debt without changing the market's view of your risk premium. If we were up at 35% and we were continuing to grow, then reviewing that 35% cap would certainly be something worth considering. We can't (exceed it) currently because it's in the trust deed but we could get unitholder approval to do that. That would be one option for us if we were hard up against that 35%. Effectively we've got three options, increase your debt level, you could go to the market or institutions and do a placement or you could got to investors with a rights issue, but the lowest cost of funding is debt.
SC: Would you look at some for of capital return to unitholders if further investments/developments don't eventuate?
MW: I can't say we've considered that. We are in acquisitive mode. I would see that 23% gearing that we have currently as a temporary position. Over a longer time frame, if nothing in terms of growth comes, it would be something we would need to consider as an effective use of capital.
SC: Is it likely that the trust's total running costs will rise again significantly?
MW: I don't believe so, the way we're structured now.
SC: Has re-joining the Top 50 Index brought the benefits you had hoped for?
MW: It always brings with it more focus from the market. Certainly, some institutions need to weight their investment according to the NZX Top 40 Index. We've seen some new institutions come onto the register, which is good. We've seen a fairly strong appreciation in the unit price over the last six months. That's probably a combination of three things: one would be re-joining the NZX Top 50, the appreciation in the market with the Capital situation. AMP is likely to de-list that so we've seen some people exit and reinvest in other property stocks. With the increase in equities generally, investors have come back and looked for defensive stocks, ones with good yields. The NZX Top 50 has been good for us, but it's only one component.
SC: How will an economic slowdown in New Zealand affect the trust?
MW: Not significantly. When you look at the health sector, you've got an ageing population and you've got a growing population. Within New Zealand, with these two drivers, demand for health services will continue to grow at unprecedented levels. Within that comes new technology, new solutions to health issues. With that demand, we will require new up to date facilities. With us being an experienced health facility provider, we should be a recipient of that growth in demand. Different industries get affected differently (by a slowdown). Some are directly correlated to GDP growth but health isn't. It's more a defensive stock. You will see some variability but if you do have peaks and troughs, health's are very small peaks and troughs.
SC: Is there anything you would like to add?
MW: really pleased with how the stock has been repositioned. The market has certainly endorsed that. Marketing ourselves as a low risk, medium return vehicle and communicating that to the market consistently is continuing to be well responded to.
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