Brian Gaynor: Antiquated act in need of update

Kiwi Income Property Trusts purchase of 19.9 per cent of Capital Properties New Zealand has reignited the controversy over property trusts.

Peter Schiff, a United States stockbroker whose clients own more than 7 per cent of Kiwi and 20 per cent of Restaurant Brands, is particularly angry. He believes New Zealand is ideal for US investors, particularly with the greenback continuing to fall, but the Kiwi deal has damaged the NZX's reputation.

Kiwi Income Property Trust was listed on the sharemarket in December 1993 following the issue of units to the public at $1.03 each.

As with all property trusts, Kiwi has a number of specific characteristics including:

•It operates under the antiquated Unit Trusts Act 1960.

•The Takeovers Code does not apply to the trust.

•A separate management company runs Kiwi.

•The trust has no directors; the six individuals listed in the 2004 annual report are directors of the management company.

At the time of the IPO, the management company was jointly owned by Richard Didsbury, Ross Green and FCMI Financial Corp, a Toronto-based listed company. The annual management fee was 0.75 per cent of the average gross value of the trust plus a performance fee equal to 20 per cent of its average annual appreciation over the three preceding financial years.

This fee structure creates a potential conflict of interest because the manager has an incentive to grow the trust in asset terms whereas unit-holders are more interested in earnings and dividends.

The beauty of these management companies as far as their owners are concerned is that they have a guaranteed source of income and no capital requirements. Kiwi's management company had a share capital of only $1000 yet Colonial First State Property purchased it for $57.75 million in 2002.

The current management fee is 0.85 per cent of gross assets up to $750 million and 0.65 per cent after that. In addition, the trust reimburses the manager for a number of activities including accounting services and property and project management.

Kiwi's acquisition of a 19.9 per cent stake in Capital Properties cost $53.4 million. This immediately adds $347,000 to Colonial's management fee even though there is no management associated with this shareholding.

There are several other reasons the acquisition doesn't make sense:

•The stake was purchased at $1.15 a share compared with Capital Properties' net asset value (NAV) per share of $0.94 per share. Kiwi purchased Capital Properties shares at a 22.3 per cent premium to NAV yet, in April, it issued 49.5 million of its own units to a select number of investors at $1.01, a 12.2 per cent discount to the trust's $1.15 a unit NAV. (Under the management agreement purchasers of new units may be required to pay a fee to the manager.)

•Capital Properties shares were purchased at a 13 cents or 12.7 per cent premium to the previous market price. Why did Kiwi pay a premium for the shares when its unit-holders could have purchased them at $1.02 without having the two-fold management cost impost?

•Capital Properties' gross dividend yield is 7.83 per cent at $1.15 a share. As its average weighted cost of borrowings is 6.17 per cent and there is an additional management fee of 0.65 per cent, the annual cost of the investment is 6.82 per cent. This is an extremely low margin in view of the risks associated with the additional debt and a relatively illiquid 19.9 per cent shareholding.

Peter Schiff, whose Euro Pacific Capital clients own 52 million Kiwi shares, has about $100 million invested in New Zealand. His clients did well out of St Lukes, a property company taken over by Westfield, but he started buying Kiwi at $1 a unit in 1997 and it has gone nowhere.

He believes that a good property manager should be buying individual properties below intrinsic value. It is a sad reflection on Angus McNaughton and his management team that the best they can do is buy shares in a well-researched listed company at a 22.3 per cent premium to NAV, particularly when individual investors can purchase these shares at a lower price.

Schiff is worried that Kiwi will make a full offer for Capital Properties and issue more units at a discount to partially fund the offer.

As his website (www.Europac.net) indicates, Schiff believes the US dollar is in a major long-term bear market and he is recommending clients to shift to foreign currency-denominated investments.

New Zealand is attractive to him because of its high-dividend yields and the US tax rate on dividends has been reduced from 35 to 15 per cent. But the tax on foreign passive entities (organisations where assets are managed by an external source) remains at 35 per cent and Kiwi Income Property Trust falls into this grouping. This makes Kiwi and the other New Zealand trusts relatively unattractive to US investors although Schiff is not selling out at this stage because of capital gains tax considerations.

Schiff has tried to convince Kiwi to bring its management in-house. He believes this would remove the conflict of interest, perceived or otherwise, between the management company and the trust. It would also reduce his clients' dividend tax from 35 to 15 per cent.

The tax consideration of Schiff's clients is of little interest to the Australian owner of the management company because it paid $57.75 million for its interest and Kiwi's assets have grown by more than $200 million since then.

The only way that Schiff can replace the manager under the Unit Trusts Act 1960 is:

•By a court order on application of the trustee, any unit-holder or the Minister of Justice.

•If the trustee certifies that it is in the best interest of unit-holders.

•By agreement of a 75 per cent majority of unit-holders at a special meeting.

The third option is the most viable but is highly unlikely to succeed because parties associated with the manager own 40.7 million shares and most New Zealand institutions would support the status quo even though Kiwi's sharemarket performance is likely to be far better as a company than a trust.

The Kiwi Income Property Trust controversy highlights one of the NZX's problems, namely New Zealanders' love of real estate - yet there are only 12 listed property groups on the NZX compared with more than 90 in Australia.

One of the reasons for this is that many New Zealand promoters choose to go down the trust route, a strategy that inevitably gives the management company a much higher return that the owners of the property assets.

There is a clear need for the antiquated Unit Trusts Act 1960 to be repealed and replaced by statute that reflects best-practice corporate governance in the 21st century. This would encourage NZ investors to invest in property through listed vehicles and offer Peter Schiff's US clients attractive dividend yields and a 15 per cent tax rate.

It would be a big improvement on the present situation where investors are often held ransom to the interests of management companies.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.