COMMENT:

The old adage, turkeys don't vote for Christmas, comes to mind as Vital Healthcare Property Trust investors contemplate voting on proposed changes to the manager's fee structure.

The manager, Canada-based NorthWest Healthcare Property Real Estate Investment Trust, has promised to call a meeting to vote on the changes before the end of October.

NorthWest has calculated that applying the new structure to 2018 results would have reduced its base plus activity fees by $1-1.5 million and its incentive fees by another $1-1.5 million.

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Manager's fees, incentives, strategic acquisition and other costs totalled $31.3 million in the year ended June 2018, up from $22.1 million the previous year.

All told, NorthWest had collected gross fees and expenses of almost $100 million since paying $11.5 million for the management contract in 2011, a major reason why investors began to rebel against what they considered blatant profiteering.

That rebellion, graphically on display at December's annual shareholders' meeting, helps to explain why NorthWest felt it had to offer at least some concessions on fees.

NorthWest proposes to adopt a tiered fee structure that will see the percentage of base fees reduce as gross assets increase, incentive fees will be based on net, not gross, assets and it is also adding a raft of new fees not mentioned in Vital's governing trust deed.

These include acquisition, disposition, leasing, rent review and rent renewal fees.

As former Craigs Investment Partners analyst Joshua Dale said when the proposed new structure was released in April, previously such fees "were generally charged on a reimbursement basis with little visibility or disclosure provided."

But, like the old fee structure, both the base and incentive fees that Canada-based NorthWest Healthcare Property REIT will collect in future will still be based on the value of Vital's buildings.

Vital's assets rose substantially over the period of NorthWest's ownership. Gross assets at June 30, 2018 were $1.79 billion for its 42 existing properties, up from $533.4 million at June 30, 2011, when it had 25 properties.

The new fee structure may be an improvement but is still far from ideal. However, NorthWest is taking very much a "take it or leave it" stance, saying that if unitholders don't accept the proposals without changes, it will revert to the old very lucrative structure.

NorthWest expressly said such a reversion will occur following "commencement of a co-ordinated campaign by unitholders to re-open the fees and governance review" or "the commencement of material regulatory intervention."

That last was a poke at both NorthWest's trustee, Trustees Executors, and the Financial Markets Authority (FMA).

While the FMA has been guarded in its response to BusinessDesk's questions about the Vital situation, it has made it obvious that it has been breathing down the necks of Trustees Executors to try to ensure they do the right thing by Vital's investors.

A combination of that pressure, advocacy from recently appointed independent director of the NorthWest management company, Graham Stuart, and the investor rebellion led by three institutional investors - ANZ Investment Funds, Mint Asset Management and ACC - which own 10 per cent of Vital's units between them, succeeded in preventing NorthWest from having Vital participate in a major asset purchase that would have been well below Vital's cost of capital of about 6 per cent.

NorthWest is buying 11 Australian hospitals from fellow Canadian, Brookfield Asset Management, for A$1.258 billion, representing a weighted average capitalisation rate of 5 per cent – Vital's purchase price would have represented an even lower rate after costs – and it had intended Vital would participate.

But the numbers could never add up to being in the interests of Vital's unitholders: the price was just too rich.

Vital's investors should also keep in mind how NorthWest became Vital's manager. The seller of the management contract in 2011 was ANZ Bank and it first offered to sell the contract to Vital's investors for $14 million. But investors, ironically then led by ACC, thought the price was too steep.

Vital's independent directors managed to beat the price down to just $8 million but riled up investors still thought that was too much so, when NorthWest came along offering $11.5 million, ANZ washed its hands of them.

But despite all those reasons to be cautious, Vital's investors would do well to consider whether NorthWest's fees ought to be based on asset values.

Craigs' Dale published a paper in October last year that concluded that of the $448 million of revaluation gains by Vital's properties since 2010, 97 per cent, or $435 million, was directly attributable to rising property values, particularly rising values of medical properties that Vital specialises in.

In other words, NorthWest did next to nothing to earn its incentive fees based on these gains.

Dale estimated that the manager generated $47 million in development margins for the trust over that period but that rental returns fell $14 million and other factors reduced returns by another $19 million.

As Dale explains, two of Vital's hospitals, Ascot in Remuera and Allamanda, now renamed Southport, on Australia's Gold Coast, were almost entirely responsible for the rental decline.

The Ascot hospital had been "over-rented" or rented at rates higher than supported by the prevailing market and a rent review resulted in a 30 percent drop in rent. Southport's previous tenant had moved out and the lease signed by the new tenant was 60 per cent lower.

Dale was more positive on the outlook for growth in Vital's rental income and the value NorthWest is adding by continued redevelopment of Vital's properties.

Essentially, Vital's investors are going to have to choose between taking the crumbs NorthWest is offering or to gamble on trying to achieve larger concessions.