Federation Centres follows Westfield into the light

The Lowys are continuing to pursue their new ‘’capital light’’ model of retail property ownership. For slightly different reasons, Federation Centres, the old Centro Property group, is pursuing a similar strategy.

Westfield Group announced another joint venturing of one of its portfolios of US malls today, this time selling a 49.9 per cent interest in six regional malls in Florida to O’Connor Capital Partners. The sale, at book value, will release about $US700 million of net proceeds to Westfield.

The deal follows last month’s sale of a 45 per cent interest in a portfolio of 12 centres in the US to Canada Pension Plan Investment Board, which released about $US1.8 billion of net cash.

Those joint ventures, and a more aggressive approach to selling non-strategic retail centres, are part of a new strategy the Lowy family has adopted in the wake of the financial crisis. The biggest structural change was the spinning out of half the group’s core Australian retail portfolio in a new vehicle, Westfield Retail Trust.

By selling large interests in its portfolios to third parties, Westfield extracts big lumps of capital from its property holdings while continuing to generate management and development income from the full portfolio, getting a leveraged income return from the reduced capital employed. It can use the cash to either maintain its buyback program, leverage returns further and/or fund its development program.

While it is conceivable that the strategy is influenced by the cyclical and structural pressures on retail property – Westfield has acknowledged the pressure on speciality store rents from tough retail conditions and the encroachment of online retailers – the recycling of capital tied up in mature portfolios has a strong financial logic to it.

Federation Centre has raised more than $1 billion by selling interests in some of its best retail centres to third party investors, the Perron family in Western Australia and the industry fund property specialist, ISPT. It is also negotiating with Challenger, having already sold one property to it while retaining the management rights.

Arguably, having emerged from a horrible five-year period when the old Centro group was in the hands of banks and hedge funds and being assailed by class action litigants, the only way for the group to free up capital to invest back into assets that had been capital-constrained over that period was to sell assets to generate cash.

As Federation Centre’s Steven Sewell explained in his KGB Interview, however, the philosophy behind the deals with the Perron group and ISPT was very similar to Westfield’s.

‘’We took a decision with the equity we had invested in the properties, and the balance sheet the way it was structured, that the best way for us to materially improve the return on invested capital was to look at selling stakes in the assets, non-controlling but joint ownership stakes,’’ he said.

‘’So therefore we retain a stake, we share in the upside – the income and capital growth – but, importantly from a business point of view, we get to leverage off our national platform and provide the services to our partners.’’ Those services generate management income and development fees.

The other significant aspect of the joint ventures – particular for Federation Centres given the latent value available from reinvesting capital in developing its existing portfolio – is that the partners share the cost of development.

The obvious question, and one Sewell was posed, is that if joint ventures are such a good idea why not turn Federation Centres into a pure management company by selling all the properties to the pension funds and wealthy individuals looking for long-term stable cash flows and capital growth.

His response was that the real estate investment trust structure of Federation Centres – and other property trusts – was an attractive proposition for domestic and offshore investors chasing yield as the returns on other yield-generating investments collapsed amid record low central bank cash rates.

In fact, what Westfield and Federation Centres are doing is satisfying the needs of two very different types of investors.

There are some investors – big pension funds with defined benefit liabilities or industry and other super funds with long term liabilities – who want and are able to invest significant sums directly in property.

There are others, including retail investors and smaller institutions, which don’t have the financial capacity, or perhaps don’t have a mandate, for large-scale investment in unlisted assets.

Even some institutions with big direct property portfolios hold listed real estate investment trust securities because they don’t necessarily move in tandem with the underlying physical property markets.

In the pre-crisis environment the real estate investment trusts supercharged their returns to investors with financial leverage – debt. That turned out to be not such a good idea, particularly for Federation Centres.

In the post-crisis environment the Lowys have pioneered a different, less risky form of leverage by introducing partners to share the risk and returns from established centres while maintaining the management income from those centres and leveraging the returns on the reduced capital employed.

That’s a strategy that seems to work for them but is particularly attractive, because of its difficult and capital-short recent history, for Federation Centres.