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National Property Trust

by Jenny Ruth

Friday 26th October 2007

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 Jenny Ruth
National Property Trust's net profit before unrealised property valuation gains and losses rose 33.7% to $6.8 million in the year ended May. Unrealised property valuation gains of $29.5 million boosted the bottom line to $36.2 million compared with a near $11 million loss last year due to more than $16 million in property write-downs. The company is forecasting profit before unrealised valuation gains or losses will rise to $8.9 million in the current year. The company is holding a special meeting on November 9 to vote on converting its convertible preference units into ordinary units early so that the trust can qualify as a PIE (portfolio investment entity) and gain the tax benefits from the new regime which came into force on October 1.

Sharechat: How much lower will your interest rate be on bank debt after you redeem the $25 million in capital notes?

National Property Trust general manager John Crone: The interest rate we're paying on the capital notes is 9.5%. We would expect to get bank funding at the moment at around 8.5%. We're looking at an even one percentage point margin on $25 million. That equates to about $250,000 a year. The other option was to roll over for another three years. That wasn't a decision that took too long.

SC: Why didn't you decide to comply with the PIE regime at the point when it came into force? NAP had said that it would. Why the delay?

JC: That was due to uncertainty over the new regulations. We couldn't get a very clearly defined ruling as to compliance. It was only relatively recently, for example, that we've been informed that under our current structure with different forms of units we wouldn't comply. We had figured that we would be an ideal applicant. The delay primarily is that it's taken this long to get consistent responses from our advisers and from Inland Revenue.

SC: How is the Osborne St, Newmarket upgrade progressing? Will it be completed on schedule?

JC: It's slightly behind but not markedly, nothing we won't be able to pick up. Of the five tenancies, we have three leased already and we have parties interested in the others. I think it will be completed on time. The quality of tenants has been better than we anticipated. We're getting good interest from high end fashion retailers. I think we have quite a good little niche there with what was the back side of our property. There's no doubt it's going to get elevated status with the development across the road. They have resource consent to develop the old sheet metal works across the road and my understanding is that it's going to be converted into fairly intensive retail.

SC: What about the Ocean Boulevard Mall in Napier - how is leasing the rest of the space going?

JC: It's slowed in the last little while. We expected after Living & Giving and then getting Ezibuy in, that the next couple of steps would be easy. We had fairly good interest from a local retailer currently trading in Emerson St (main shopping street) wanting 350 to 400 square metres. That hasn't come through yet. The other one is a national chain that's not currently trading in Napier. They need 450 to 550 square metres. For us to accommodate them is going to require a significant shift around. If they came on board, the centre would be 100% full. They would be a coup. They would fit in well alongside Ezibuy and Living & Giving. They would take out the whole food hall area.

SC: Are there many other properties in the portfolio that need significant refurbishing?

JC: The two we're focusing on at the moment are the food court on the upper level of the Rialto which needs an upgrade and we're looking at adding value to the existing tenants who are trading. We have Baci which is effectively a bookshop that sells coffee. They've been trading really well. They support Rialto strongly. They recently won the best coffee in Newmarket award from Metro magazine. We want to get some better quality tenants alongside it. Another one that we're looking at reconfiguring is the Goddards arcade in Tauranga. It's fairly obvious that the food court isn't performing to expectations.

SC: The valuation of Eastgate since St Laurence took over the management contract has been a big see-saw. Can you explain why its value was cut so much last year and why it was supposed to be so worth so much more this year?

JC: It's probably a good example of how management can effect some changes. When we first come in, the centre had six vacant shops. The revised valuation showed that those figures from three years ago were supported by turnover rents that weren't being achieved. The value was reduced, reflecting a lower level of occupancy and lower actual rents being achieved and a historic view on capitalisation rates. You can turn all those things around. This year we've effectively filled up all those vacancies and not just with casual tenants but with good, long-term market rent tenants. In fact, we haven't lost most of those casual tenants. We've moved a few into the common areas so we're clipping the ticket twice. We've had very good rent reviews. The actual rental growth has been quite outstanding. For example, the new tenant Amazon. They're paying four times what the previous tenant was. It had been an old lease that was too tenant friendly. The reality is not only do we have the centre full, we've been able to replace tenants with better tenants. I don't think management can take all the credit for this change. The reality is that capital yields have had a big influence. The yields that a valuer used three years ago would have been 7.75% to 8%, in that area. Subsequent transactions such as AMP acquiring The Palms shopping centre just to the north of Eastgate have been considerably firmer yields. That means the current valuer had to apply a much firmer yield. They're applying 7.25% now. It's been about 60% management and about 40% market improvement.

SC: How did you select the three properties you are planning to sell as surplus to requirements?

JC: Mostly because these were ones that we had finished adding value to. To my mind, the time you sell a property is when it has a few years to run under the lease and when it has no major outstanding capital works and a pretty good tenant profile. All those three qualify.

SC: Do you expect to be able to sell the three properties earmarked for sale at or above current valuations?

JC: Certainly. In fact, I doubt if I would recommend accepting offers at valuation. I consider our valuations are relatively conservative still. I would be surprised if we only sold those three at valuation. That's why we're taking them to market - we're expecting to achieve a premium. If we were only going to achieve book value, I would be very disappointed.

SC: Why did the trust decide to sell the Dunedin multiplex? It looks like a good property?

JC: It is quite a good one. If I took my logic with the other three, we weren't going to be adding any value to this property in the next few years. It's got six years to run on the lease - a bit over six when we sold it. We were confident we would achieve the valuation and then some. I was rather pleased we were well over $1 million above valuation.

SC: Why did the trust buy the Watties' building in Hastings?

JC: It has a good tenant, a 10 year lease to run and also it helped restore better balance to our portfolio. We would argue that then were had a little too much exposure to retail. Getting a $20 million acquisition of industrial (property) was certainly advantageous to us on all those fronts: a good tenant, a good lease term and better diversification.

SC: Isn't the purchase of the Watties' building the reason why the trust's debt blew out and why the trust had to turn around and sell properties?

JC: No. The debt blew out pre the Watties acquisition. This was by virtue of the drop in valuations of the portfolio in early 2006 after St Laurence revisited the valuations and the disclosure we were in breach of banking covenants. Under the trust deed, we're only allowed to have debt equal or less than 45%. By virtue of the reductions in value, we got to around 47%. The trust deed allowed a period of time to rectify that. That was when we issued the convertible preference units that rectified that and allowed us to repay the capital notes later on this year.

SC: If the properties earmarked for sale are sold, will that mean the trust's balance sheet is back in an ideal position?

JC: I will be improved. I'm not sure what ideal is. It will certainly be better. I guess we tend to be compared with other listed property entities. It's our observation that Goodman, AMP Office and Kiwi Income tend to sit around 28/29% bank debt to LVR. That means when interest rates are higher we're disadvantaged. This (selling the properties) would get us down to around 35%.

SC: Is 28/29% ideal?

JC: I don't think I would want to go lower than that, to be honest. Having said that, your sense of ideal shifts. It depends on the prevailing interest rates. Eight years ago (when interest rates were lower), the ideal bank debt would have been 45%.

SC: If you look at the trust's distribution levels before St Laurence became manager and since, it looks like unitholders were better off under the previous regime. Is that correct? What value has St Laurence added?

JC: I think that's fair criticism. However, my recollection is that some years ago National Property Trust was increasing bank debt in order to maintain distributions. (The trust earned $6.16 million in 2005 but paid out $10.12 million to unitholders.) Our board decided some time ago that we should only be paying distributions at a level that our earnings can support. That doesn't include gains on sales. The gain on the sale of Multiplex isn't being treated as distributable income. We certainly don't think it's wise to be increasing bank debt to top up shareholder distributions. The second half of that question is have we added value: I think we are. I tend to focus on our trading margin. For the 2007 financial year, we almost doubled our trading surplus. A lot of this is due to St Laurence using its wider purchasing power to reduce costs.

SC: In July 2006, the trust forecast distributions would range between 5.5 cents per unit and 6.5 cents for the next three years but now it's saying next year's distribution will only be 5 cents. Why is the trust failing to meet forecasts?

JC: Bear in mind that distribution range of 5.5 to 6.5 cents was made some time ago. Since then, we've had four increases in the OCR, an increase of 1 percentage point. That's an impact of about $1 million on our bottom line. It's very difficult for any trading entity to absorb those sort of costs. There's no way we could have predicted an OCR increase of that magnitude. Our trading margins have been improving right through that whole time but $1 million is a fair bit of extra rent you have to collect.

SC: Why do you think the units trade at such a deep discount to net tangible assets?

JC: I think it's a lack of appreciation of the value of the underlying assets and perhaps too much focus on dividend yield. I certainly view those property assets as being fairly conservatively valued. If sold they would probably meet or exceed book value, particularly if you sold them at the right time. You would expect it to trade at some discount but not the deep discount that's evident. Perhaps there's a lack of appreciation of the prospective benefits from PIE and undoubtedly there's some disappointment at the reduction in distributions. After we sell those three properties I would like to think investors would think the portfolio is worth its book value. Also, we need to be on the front foot by reducing our bank debt and reducing our exposure to interest rates. I'm sure improved profitability will help decrease that deep discount.

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


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