Brent Sheather: Selfish managers have lost investor trust

With most listed property companies management are rewarded as the size of the property company grows. Photo / File photo

It is well known that New Zealand retail investors have a preoccupation with property.

However, it seems anomalous that non-expert investors would buy individual commercial or residential properties directly rather than investing via one of our NZX-listed property trusts.

On paper the advantages of the latter look unbeatable - you get risk reduction via diversification by building, by tenant and throughout New Zealand.

In addition there is no management required.

Another often overlooked advantage of the listed property scene is that you can be more confident about the price you pay because the listed market price represents the consensus view of expert analysts.

All things being equal, if you are not a property expert there is less chance of overpaying when you buy a listed property company than if you were referred to a property by a real estate agent.

Today the cash dividend after fees on residential is only about 4 per cent whereas thanks to the portfolio investment entity (PIE) regime it is 9-10 per cent for listed property.

On this basis listed property should outperform residential by the difference in yields - 5-6 per cent a year.

So why, when faced with all these advantages, do so many retail investors opt for owning their own investment property and doing the management themselves?

The simple answer appears to be a lack of trust. Sadly that cynical view has been proven to be right much too often for listed property investors both in New Zealand and Australia.

Listed property managers and the NZX have squandered the opportunity to endear listed property trusts to retail investors because of some manager's poor track record. Some property managers have in the past made key decisions without fully considering the interests of their shareholders.

The key weakness of most listed property companies is that management are rewarded as the size of the property company grows, whereas mum and dad are interested in growth in rental income and capital.

One of the most obvious instances of the bias that external management brings is the tendency for property companies to invest in new properties at net asset value (NAV) when they often have the alternative of buying back their own shares at a discount to NAV.

In the United States, where property companies are invariably managed internally, stock buybacks are far more common.

I was surprised that the recent large cash issue by Vital Healthcare Property Trust got the okay from shareholders, financial planners and stockbrokers that manage their funds as it wasn't clear, to me anyway, that the purchase of all these new medical buildings in Australia was a compelling deal for shareholders.

The fund manager will benefit as the management fee will increase by almost $3 million on an ongoing basis with a $2 million one-off payment, but neither earnings per share nor net asset value will be enhanced by the deal. Let's take a closer look at this transaction.

In the prospectus, the chairman wrote: "The board believes the transaction represents a unique opportunity to improve unitholders' returns."

I don't think so, at least not so far.

More likely retail Vital shareholders will be in a state of shock - firstly because their shares have fallen in value so much and secondly because of the amount of money they are being asked to part with.

Vital shares were trading at about $1.24 before the announcement, but the same shareholder now owns a share quoted at $1.06 and a right worth 0.2c, which is a grand total of $1.062, a fall of about 14 per cent and not at all like an "improvement in unitholder returns".

But it gets worse - trading in Vital shares is usually pretty thin - 30,000 or 40,000 shares a day. However, there has been huge rights trading volume; over the period of rights trading about 32.4 million have traded, suggesting existing holders are selling and institutional investors are buying in at what is close to the rights price.

The rights traded down as low as 0.1c, which meant the new shareholders were buying in at a total of 0.1c plus $1.05 = $1.051 versus the property's net asset value, adjusted for the rights issue of $1.15.

So, ignoring the economics of the transaction, there seems to be a huge net transfer of wealth from existing investors to new investors as the price has been pushed down by the weight of the rights issue and existing investors by and large are not taking up the issue, which allows institutional investors to buy in at the low price.

The size of the issue and the extent of rights trading suggests a complete lack of consultation with existing shareholders and value destruction has been the net result.

Then there is the matter of costs - Vital shareholders are going to pay $20 million in fees and stamp duty to acquire $212 million of property. That's a huge fee of 10 per cent.

Put another way, if this $20 million was paid out to existing unit holders they would get a dividend of 13.1 per cent.

This deal doesn't sound anything like a "unique opportunity" and one wonders what planet the directors are on.

Professional investors in Vital Healthcare won't put their hands in their pockets automatically. They will give some thought to determine just how vital Vital should be in their portfolios.

In deciding whether to take up this issue they will have regard to how big Vital is as part of the New Zealand listed property sector and make sure that their portfolio doesn't exceed this percentage by too much.

If we look at the market capitalisation of Vital post the issue it will be about $300 million. The total capitalisation of the NZ listed property sector is about $3.6 billion, suggesting a neutral weighting in client portfolios is 8 per cent after the issue.

Anecdotal evidence suggests that many retail Vital shareholders have much higher weightings than this and taking up the cash issue will just increase the risk of their portfolios as against the benchmark.

Whether retail investors and their advisers will actually follow this disciplined approach is questionable as Vital will pay 0.5 per cent in commission to advisers who submit client rights issue application forms bearing their broker stamp. This payment could influence adviser decisions and is another example of why commissions should be banned.

This transaction hasn't turned out particularly well for anyone so far with investors owning 40 million rights opting not to accept them and leaving the underwriters needing to put their hands in their pockets for more than $40 million.

Disclosure: Brent Sheather has shares in Vital Healthcare Property Trust.

Brent Sheather is an Auckland financial adviser and his full adviser/disclosure statement is available on request and free of charge.