GPT proceeds with caution

For much of the time since Michael Cameron became chief executive of GPT in 2009 he has been in restoration and rebuilding mode. Now he’s about to embark on some cautious expansion.

When he arrived at GPT, it was still reeling from its misadventures late in the debt and leveraged-fuelled pre-crisis era for the A-REITs and, in particular, its own disastrous joint venture with Babcock & Brown.

The initial task was to stabilise the group, exit the joint venture, recapitalise and clean up its balance sheet, which he did. He then needed to restore the credibility of what had previously been the bluest of blue-chip property groups, which he has. GPT, in a return to its past, is now a very clean and conservative entity with a focused collection of high quality properties.

Today, Cameron unveiled some shifts in strategy.  GPT will retain a diversified portfolio but it appears it plans to be somewhat more opportunistic, basing its decisions on ‘’stock’’ or asset selection rather than portfolio theory.

It plans to shift away from a conventional earnings per share-driven focus towards one of total returns, changing its incentive arrangements to reflect that shift. Perhaps of greatest significance is a very ambitious target for an expansion of its funds under management.

That shift reflects a desire for greater growth than a passive, income-driven approach to investing in property delivers. The shift may be accompanied by some acquisitions.

GPT says that, with gearing of only 21.2 per cent (against a policy of having geared of between 25 per cent and 35 per cent) and with low levels of leverage within its two wholesale property funds ,that it has about $3 billion in balance sheet capacity. This provides scope for some acquisitive activity.

The funds under management strategy is a cautiously ambitious one. At present, GPT has about $7.2 billion of external funds that it manages within the wholesale funds, which generate about 3 per cent of its earnings. It plans to increase those funds to about $17 billion over the next few years, increasing the level of its ‘’active’’ earnings to about 10 per cent.

The caution relates to the ceiling on the proportion of earnings GPT wants to see flow from the funds management strategy. It is very conscious that it has a low cost of capital because its earnings are almost entirely passive, high quality and low risk.

It believes it can increase active earnings to about 10 per cent of group earnings without materially impacting its cost of capital. In the near term, it plans to kick off the strategy by launching two new funds.

There are several reasons why the strategy might make sense.

Firstly, there is an opportunity. The compulsory nature of superannuation means there is an ever-increasing appetite for investment, with GPT calculating that the default allocation to unlisted real estate has almost doubled since 2004.

Secondly, managing funds is a lot less capital-intensive than owning or developing property and therefore generates a far higher return on capital.

In some respects, what Cameron intends doing is analogous to what the Lowys have been doing at Westfield or Steven Sewell has been doing at Federation Centres, albeit not as aggressively as they have.

Both Westfield and Federation have been bringing in co-investors for big proportions of their portfolios while continuing to earn management and investment fees on a far smaller amount of capital invested. It is a rational returns strategy and also a risk-sharing approach.

Cameron’s talking about new funds rather than existing portfolios and, due to his desire to protect his cost of capital, a more limited and conservative approach but the strategy, if well-executed, ought to generate growth and growth in GPT’s total returns.

He also wants to improve GPT’s efficiency, arguing that there is a correlation between efficiency and REIT performance. The global benchmark is a management expense ratio (MER) of 47 basis points. He is targeting an MER of 45 basis points, hoping to combine ‘’frugality’’ with a ‘’fortress’’ balance sheet and the tinges of extra growth created by the more aggressive funds management strategy.

GPT has a lower-than-sector exposure to development but now sees development not as a profit centre in its own right, but as supportive of its core operations and assets.

Cameron’s update reflects a strategy that is in keeping with most of GPT’s history, with the exception of those final few unpleasant years before the financial crisis.

It ought to be cautious and frugal and maintain the quality of its portfolio and its balance sheet. That’s not, however, inconsistent with trying to pursue low-risk additional sources of earnings and growth to the pristine but passive income flows the group now generates.