Born-again property trust right back in favour

Calan Healthcare Properties Trust is a classic example of how an investment entity that has let its investors down can win its way back to favour.

In 2002 and 2003, investors' disquiet mounted over their poor returns from what should have been a safe, solid income-earning trust but which was looking more like a high-risk development vehicle.

In June 2002, $29.9 million of its $210.9 million in assets was non-income-earning. And that was after selling $23.4 million worth of non-income earning or non-strategic assets that year.

While unitholders were suffering, the manager seemed to be raking in huge amounts of fees. In 2001, the trust's costs excluding interest were 22.9 per cent of revenue.

The manager received $6.5 million in straight management fees between 1997 and 2002, and was also paid another $15 million for in-house work on due diligence on potential acquisitions and developments.

That year, the annual report noted that the trust's manager had decided to go ahead with spending an estimated $56.1 million on developing the Epworth Eastern Hospital in Melbourne.

Showing the market's lack of confidence in Calan's manager, the units were trading at a deep discount to net-asset backing, a situation which was exacerbated when Calan dropped out of the Top 50 index.

A year later, when the trust's net profit fell 19.3 per cent to $7.4 million, investors were decidedly cross and subjected the management company to a rowdy annual meeting.

At that point, the manager decided to embark on a major restructuring. Under its new chief executive, Miles Wentworth, who took over from July 2003, it moved to contracting out its property and development functions to a non-related third party.

The unit trust structure, which doesn't allow investors any governance rights and puts the manager firmly in the driving seat, came under fire back then. But the management company decided after a review that instead of changing the structure, it should concentrate on improving returns to unitholders and that the manager's and investors' interests should be in alignment.

In other words, the manager opted for substance over style.

It also worked on beefing up communication with unitholders, with Wentworth sending out updates every few months in addition to the usual half-yearly and annual reports.

The major problem that needed addressing was to get the non-income-earning assets off its books. Throughout 2004, the manager announced several asset sales.

By April this year, Calan said it had sold the last of these assets, realising more than $25 million over the two years.

It still has one significant development site on its books, 3000sq m adjacent the trust's Ascot Hospital in Auckland, which is valued in its books at $2.8 million.

Wentworth says the trust won't be selling that site. "That's a strategic asset for us. Certainly, our strong focus and desire is to convert that into a yielding asset, but it represents about 1.3 per cent of the whole portfolio."

Selling that land would boost the trust's income by only a couple of thousand dollars a year, which isn't material, and the other asset sales mean converting it to an income-earner isn't nearly as pressing.

Across the income-yielding portfolio, occupancy at the end of June was 99.1 per cent with a weighted average lease term of 11.65 years, significantly higher than the average lease terms of other property vehicles.

The completion of the Epworth Hospital, which opened to patients in early June, is also a major milestone. While the opening was significantly delayed from the original schedule of October 2004, Calan's income from the project effectively started from last October. It has received liquidated damages in cash from the development contractor and other payments from the tenants.

The rental was set at 9.5 per cent of the development costs, which were about A$41 million ($44 million).

Wentworth says that's less than previously estimated because of a competitive tender process controlling costs and the benefits of the dollar rising against its Australian counterpart.

As the development cost was less, the starting rental from Epworth is A$3.72 million, down from the estimated A$4 million two years ago.

That will rise by the consumer price index inflation figure each year and will be reviewed to market every five years.

The benefits were obvious in the latest results: Calan's net profit rose 16 per cent to $10.5 million in the year ended June.

The trust had been subsidising the annual distribution at 8c a unit throughout the two years of Epworth's construction. That subsidy is now ended but the trust was still able to raise its distribution to 8.5c a unit for the year and forecasts 9.2c a unit this year.

While Calan resolved two years ago that it wouldn't get involved in new developments where it carries the costs of acquiring land and creating the project, Wentworth says it "absolutely" will consider another project like Epworth.

"We will construct on the basis of pre-commitment. To me, a development has the word risk written all over it. Obviously, we're not a builder, but we will manage the construction process."

He says Calan is still contracting out its property and development functions to the Odin Group in Australia.

Now that the asset sales have been completed, the manager is working on several opportunities, but Wentworth doesn't want to talk about these until he has something concrete to announce.

"It's got to be appropriate expansion, not growth for growth's sake."

One of the criticisms of property trusts is that, because their fees are based on assets under management, managers have an incentive to grow assets in ways that may not benefit unitholders. Wentworth says any investments will have to be "right for your investors".

The trust certainly has plenty of balance sheet capacity to fund acquisitions or developments. Total assets at the end of June were $218 million and bank debt was only $49.5 million.

The vexed issue of fees is unlikely to be a major issue at this year's annual meeting. Total costs before interest of running the trust was down to 12.9 per cent of revenue at $2.06 million in the latest year from 16.5 per cent or $2.28 million last year.

A major reason for that is that property acquisition and investment evaluation costs expensed against income have fallen to just $9000 in the latest year from $299,000 last year.

Unitholders are also likely to be reasonably happy about how their units are trading, although at $2.12, they are still at a small discount to their $1.19 net asset backing, That's up from the low of about 74c in 2001.

* Calan Healthcare Properties Trust

Headquarters: Level 16, 209 Queen St, Auckland.

Profile: Calan owns several hospitals and other health-related properties, with 49 per cent by value in Auckland, 37 per cent in Melbourne, 9 per cent in Hawkes Bay and 6 per cent in Whangarei. Its 12 properties have 72 tenants.

Market capitalisation: $154.4 million.

Recent results: The trust reported a 15 per cent rise to $10.5 million for the year ended June.

Management: Miles Wentworth, chief executive; Vicki Harrison, company secretary and chief financial officer.

Major unitholders: Institutions own about 21 per cent of Calan, with ING holding just under 10 per cent.