a piece of good news

6:54 AM, 17 Jul 2008 Robert Gottliebsen
The true value of Centro's sale

Amid the avalanche of bad news and scare stories that has hit our desks this week there was one piece of good news that was easy to overlook – the ability of Centro to sell 29 shopping centres in the US for $728 million, just 10 per cent below book value.

I must underline that the Centro deal will not be consummated until September/October, but on the basis that we have basic agreement I think it is a pointer for the wider property trust movement, as well as for Centro.

But let’s start with Centro. Why did the private US investor who bought the Centro centres pay what looks to be a high price? If you are in the US and are cashed up, where do you put your money outside a secure bank? You would be suspicious of many of the corporate structures that look attractive. But Centro’s US shopping centres are physical assets which are based around food, and therefore represent some of the safest assets in the country during a downturn. And if the lenders to Centro (be they in the US or Australia) have half a brain they will make sure these sale deals can be funded with loans, because they can then exchange poor security for a direct property investment security.

A portion of the $728 million Centro sale proceeds will trickle down to Centro Properties via the complex web of Centro vehicles. This will be handy for Centro Properties’ banks and it will make them feel better. But it's not the main game. The sale underlined to Centro Properties' banks that big repayments depend on the value of the Centro Properties’ shopping centre management contracts. The US private investor not only paid only 10 per cent below book value, but was prepared to sign up for Centro management for 12 months.

While 12 months is not a long period, it is reasonable given the overall position of the Centro group and the fact that the investor will want to see how they perform. It is vital in future sales of Australian shopping centres that Centro hold on to its management contacts because that’s where the value will be generated for both banks and shareholders.

The US sale price is also good news for Centro Retail investors, who have a large exposure to the US, and those Centro syndicates that have American exposure. The Centro deal was negotiated before the latest volley of American problems, but assuming the deal goes through it will cushion any reductions in Centro’s US valuations to relatively modest levels. Centro is like so many of our listed property trusts – they have wonderful assets imprisoned in structures that are a total mess given the current environment.

So investors will pay what appear to be high prices for a direct property investment because they don’t want to be exposed to the corporate and trust morass.

In the US we also saw the private equity operators pay what seemed to be a high price for the ABC Learning child care centres. Like the Centro shopping centres, the ABC child care assets provide insulation against a downturn because people will have to work longer hours and need more childcare.

Centro was caught out by its own structural morass and excessive gearing. Other listed trusts have a related problem. During the boom, listed trusts like GPT, Mirvac and Stockland got caught in a terrible trap – they found that superannuation funds were investing in vehicles that selected the best performing property trusts.

These so called 'performance' funds were not interested in conventional property investment because the returns were too low. So we found that the trusts had to take bigger risks to attract money and property development operations were stapled to conventional property investments. The stapled trusts showed incredible returns in the bull market. These returns were then rated as though they were conventional property investments. Now the market fears that these property development businesses are headed for big losses and even if the market is wrong there is fear of the unknown.

As Stephen Bartholomeusz has explained, the market values the European operation of GPT at nil and that’s probably right (Less is more for LPTs, July 14). But having blown up to $2.5 billion in Europe, the market is concerned that there are other nasties to come.

Stockland and Mirvac have large exposures to developmental land, particularly in NSW. Some in the Reserve Bank believe that part of the problem of Sydney is that these funds paid far too much for the land and the 'Sydney problem' will be helped if this land comes onto the market at a fraction of the price the trusts paid. As I have explained (Property will tumble, July 15) that’s not why the Reserve Bank plans to keep interest rates high for the next two or three years. The Reserve Bank is concerned about big housing developments coming at a time when infrastructure and resources project investment is stretching the Australian building industry. But if Mirvac, Stockland and others are forced to sell at low prices then so be it – albeit a disaster for unit holders. The stock market fears that’s what may happen.

When it comes to Westfield, the group has a large and increasing exposure to large shopping centres. The group has wisely stopped distributing development profits. But the valuation of some of the centres may come under pressure because of higher cap rates and the fact that a lot of the retailers in these centres rely on discretionary spending, which will be hit in a downturn.

With the major trusts under pressure the selling has extended to all listed property trusts. And the simple fact is that if property values fall, as is likely, then the effect on unit holder’s equity is multiplied by the gearing. The key is to find simple listed trusts that are well funded and can ride through the tough times because, assuming the crisis settles, these trusts will be able to attract the sort of investors who bought the US centres from Centro.