Thursday 3rd January 2019
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Vital Healthcare Property Trust’s manager continues to maintain the fiction that Vital and its investors have any agency in determining its future. Effectively, they don’t.
This lack of agency, the governance structure, and the fact that Vital is largely at the mercy of its manager, is at the root of investors’ complaints.
Take last month’s annual general meeting. It wasn’t, in fact, Vital’s AGM, even though it was billed as that, but actually the AGM of its manager, NorthWest Healthcare Properties Management.
The director who was elected at that meeting, Graham Stuart, wasn’t elected to Vital’s board because Vital has no board. Stuart was elected to the manager’s board.
Similarly, the chair, Clair Higgins, isn’t Vital’s chair but the chair of the NorthWest management company, which is owned by the Toronto-listed NorthWest Healthcare Properties Real Estate Investment Trust.
At the AGM, Higgins discussed NorthWest’s decision to buy a 13.4 percent stake in ASX-listed Healthscope, borrowing A$81 million from the already highly geared Vital to do so.
“Vital and the NorthWest REIT agreed to pursue this opportunity equally,” Higgins told the meeting.
But Vital didn’t agree to anything because it can’t agree to anything.
Vital has no directors or executives and, although it does have a trustee, Trustees Executors, nobody is pretending it has any role in investment decisions.
Vital can only do what NorthWest causes it to do and only Vital’s trust deed limits what NorthWest can make it do.
A more accurate statement from Higgins would have been that the NorthWest REIT agreed with itself that it and Vital should invest in Healthscope.
And likewise NorthWest agreed with itself to load up Vital's balance sheet with debt, with Vital’s gearing under its bank covenant at 38.7 percent at June 30, a level NorthWest describes as “conservative”. Long term borrowings rose from $668.7 million at June 30 to $695.9 million at Sept. 30, taking Vital closer to its maximum 50 percent gearing limit, although how much closer isn't clear without an updated balance sheet.
The AGM was told NorthWest had committed Vital to $109.4 million in “brownfields” developments of properties it already owns and that $5.5 million of that had been spent to date.
Unitholders also heard that NorthWest has had Vital take out an additional A$275 million credit facility.
In other words, Vital’s gearing is set to rise and the only limit is the 50 percent gearing set by its bank covenant.
NorthWest has a built-in incentive to gear Vital to the hilt because its management fees, both the base fee and the "incentive" fee, are based on a percentage of gross, not net, assets, so the more Vital borrows, the higher NorthWest’s fees can be.
The only other trust still listed on NZX, Goodman Property Trust, had a loan-to-value ratio of 17.5 percent at Sept 30, or 25.8 percent after contracted sales and committed gearing.
Most of the other trusts have long since been converted to companies with their management internalised, largely because of pressure from investors and as the owners of management contracts wanted to avoid reputational damage of the kind NorthWest is currently experiencing.
But the misalignment between the interests of Vital’s manager and investors is so much greater than it was for companies such as Precinct Properties, which used to be AMP NZ Office Trust, and Kiwi Property, which used to be Kiwi Income Property Trust, with their management contracts respectively owned by AMP and Commonwealth Bank of Australia.
A quick comparison between Goodman and Vital demonstrates the extent of the misalignment.
Goodman’s base fee is still based on gross assets but is set at 0.5 percent for the first $500 million and 0.4 percent thereafter, compared with Vital’s flat 0.75 percent fee.
Goodman’s manager can only collect incentive fees if the trust’s NZX-traded units outperform the benchmark index of similar entities, and any under-performance is cumulative – the units can’t just outperform one year to allow the manager to collect a fee if they under-performed the previous year. And there’s a cap of 5 percent of any out-performance.
NorthWest's incentive is that it gets 10 percent of any gain in Vital’s fair value, a return capped at 1 percent of Vital’s gross value (the total base and incentive fee NorthWest can extract in any one year is 1.75 percent of total assets). So crank up those assets, NorthWest!
As an incentive, it’s certainly working, but to the detriment of Vital’s investors.
Gross assets have risen from $533.4 million in June 2011 to $1.78 billion in June 2018.
NorthWest’s fees as a percentage of rental income soared from just 8 percent in the year ended June 2013 to 31 percent in the latest year.
Unitholders’ share of the spoils, or net distributable income, fell 27.6 percent in the latest year while total fees paid to NorthWest rose 22.5 percent to $28.1 million. NorthWest did also collect an additional $3.2 million in sundry other fees such as letting fees, although that was down from $5 million the previous year.
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