Growthpoint Properties Australia

Tim Collyer is the Managing Director of Growthpoint Properties Australia, the offshoot of the South African business of the same name. It was setup in Australia just after the GFC in 2009. It owns industrial and office properties, the yield is 7%, it’s a stapled security so there’s no franking and it’s selling at a bit of a premium, a 2 or 3% premium to net NTA. It has sold at a premium of up to 30% according to Tim, I hadn’t really known that, so I suppose there’s potential for uplift in the share price to go to a higher premium and the NTA is increasing each year and more importantly, perhaps, the distribution is increasing each year by 3-4% and that’s what they’re saying they can do long term. 

It's not a bad yield stock, 7% with 3-4% growth in the yield, the distribution over time. They’ve got Woolworths distribution centres plus quite a few good tenants, 5 to 10 year tenants in offices and warehouses.  It's an interesting business, good solid yield stock for those who are looking for income. 

Here’s Tim Collyer, the Managing Director of Growthpoint Properties Australia.

Tim, perhaps we could just start with a bit of background on the company because it started as an offshoot, I think, of the South African business also called Growthpoint properties.  When you started, when your business started in 2009 it already had $650 million worth of property in it.  That was the portfolio in Australia of the South African business, was it? 

Growthpoint basically started after the GFC and our South African parent who currently owns 65% of the company, first invested into Australia, like a number of other South African companies, the yields on Australian real estate were very attractive and South Africa wasn’t affected badly by the GFC.  We restructured the group.  As you said, we had $650m of industrial property.  We restructured a listed fund that was operating.  We changed the investment mandate to include office property and retail.  We haven’t invested in retail property as yet. 

We changed the board and we internalised the management of the company, so it was externally managed and we internalised that and began operating.  Since that time we’ve built the group to about $3.3 billion of property assets through buying properties, takeovers, developments, and obviously raised equity as we’ve gone along and today we have a market capitalisation of $2 billion.   It’s been a very good investment for our major shareholder and we’ve built the business and produced consistent returns over that period.

Why haven’t you bought any retail properties?  You just don’t like it or haven’t found anything that stacks up?

It’s a good question.  It’s quite topical in the market at the moment.  I think we’re being cautious about retail post the GFC for a number of reasons.  Obviously, consumption – retail sales haven’t been growing as strongly as previous and ultimately the determinant of your rank in your shopping centres is determined by retail sales.  We’ve seen a structural shift with internet retailing which once again affects retail sales.  Growthpoint specifically has good skills in office and industrial property, but we haven’t managed retail property before.  If we were to move into that sector at some stage we would need to build a specialised team.  It’s quite difficult managing retail property, it’s more like a business and finally the yields on retail property, we believe have firmed too sharply relative to industrial and commercial and therefore the total return is not as attractive.  We keep a watching brief on the retail property market but at this point in time we don’t think the returns are sufficient for investment.

Also, I mean I don’t want to go on about retail too much but there’s a lot of uncertainty these days about the future of retail and in particular, department stores.

Yes, well the format of retail is changing, department stores are struggling, they’re trying to get their mix right.  We’ve seen a lot of competition from international retailers come in and have of course the internet retailing is becoming more prevalent, more common.  The face of retail is changing and I think our traditional shopping centres, perhaps not so much the premium major centres or destination centres, but generally retail.  It’ll take some time for these trends to sift through the market.  We’re watching it.

Mind you, your biggest tenant is a retailer, but you own the warehouses…

It is.

That’s Woolworths, with 15% of your rental income is coming from them, so you’re definitely in the retail sector, aren’t you?

Yeah, that’s right.  We do have exposure to the retail market.  Thankfully, our largest tenant is Woolworths and what goes through the warehouses that we own are basically groceries.  We don’t have any other goods.  Basically the groceries that goes to people’s supermarkets that they shop at go through our four distribution centres around the country.  They’re very large distribution centres in Queensland, Victoria, South Australia and WA.  They’re an integral part of the supply chain, so they’re great properties to hold.

I note that the lease terms of those Woolworths properties are not as long as you’ve got elsewhere, in fact I think they’re about the shortest lease terms of about 5 years.  Whereas some of your properties are up to 10-years lease.   Is there some sense that the Woolworths distribution centres are perhaps less secure long term than other properties?

Not necessarily.  We were always in dialogue with Woolworths about their properties.  A good key feature, some of these properties are very modern and they’ve been chosen by Woolworths, got sold on a lease back so Woolworths actually own them and built them in the locations that they want.  There’s possibly one property, Broadmeadows in Melbourne, that’s a 25 hectare site, they have indicated that they’ll be leaving that site in 2019.  We will look for other tenants and redevelop that site, there’s a lot of excess land.  Over our Woolworths distribution centres the buildings cover about 25-30% of the land, so there’s lots of room for expansion and we have from time to time talked to Woolworths about expanding specific properties.  We will see them as a long term tenant at Growthpoint.

That actually raises another topic, which is you’ve got quite a lot of potential, I think, for change of use for some of your properties.  Talk to us about how much potential there is, in particular in uplift in net asset value.

Yes.  Well, with that concept, our strategy has been to look at our portfolio and identify properties which have an upside from a change of use, and we’ve been executing on that strategy.  Last year we sold an actual Woolworths distribution centre in Mulgrave, Victoria.  Once again, a large site with an industrial warehouse on it, leased for another four and a half years to Woolworths, but potential for residential or commercial use down the track.  We sold that at a 38% premium to book value and that came through in our results where overall we had a $24 million dollar profit on sales of property.  So, what we do is we sell that property at a low yield and then reinvest it into higher yields driving earnings.  We have another property identified that we are looking at selling and that is at Sydney Olympic Park, there’s two office assets there where the Sydney Olympic Park 2030 strategy allows for apartment development over the site.  We are investigating the sale of that property and obviously it has an income there from the office tenants for the period.  So, a short term income and then potential development into apartments.  They’re sort of two examples.

You got a decent lift in net asset value during the latest period despite some capitalisation rate compression.  How did you achieve that?  Tell us the components of that increase in net asset value? 

Sure.  The net assets went from $2.88 to $3.08.  Property investments made up about 16 cents of that increase.  Asset sales above book value, a smaller component.  As I said before, we made $24 million dollars, so that was about 4 cents.  Then miscellaneous things.  The bulk of it was made up from property valuations.  The average property yield on our portfolio decreased 17 basis points to about 6.4%.  Part of the actual gain in valuation was not due to the yield coming down but also the market rent assumption that the valuers use was increased.  That drove part of the value gain as well.  Probably about two-thirds cap rate compression or yield compression and about a third in market income growth.

I suppose the big question for investors is, to what extent the rental growth will be able to offset the increase in interest rates over the next little while, however long that takes?

Yeah, it’s a topical question, Alan, and we’ve seen bond rates move up.  Mind you, bond rates were only sort of where they were back in December, 2016, so that’s come down then gone back up again.  Undoubtedly, they will go up.  I think with commercial real estate in Australia the total return or 10-year IRR that we get on our properties by valuation is about 7.3%.  The bond rate at December when properties were valued, is about 2.8%.  We’ve got a good risk premium spread there, it’s still quite attractive so that will support values.  Also, economic growth is forecast by the RBA to be 3% over the next few years. 

We’re not overbuilding in our markets.  There’s strong demand and strong population growth and we’re seeing vacancy rates come down through the country.  So, that’s positive for rent growth despite bond rates going up.  They’re going to go up because economic growth is much better, so we expect rent to go up.   The other thing of course is there’s huge demand for Australian commercial real estate.  In 2017 there was $34 billion of transactions completed and that’s the fourth year in a row over $30 billion of sales.  We have strong domestic super funds, unlisted funds, listed funds, but particularly offshore demand to buy Australian property.  We haven’t seen and we don’t expect that that demand will fall off as bond rates increase over the next 12 months.

I note that your shares are selling at a premium to net asset value at the moment and I wonder – I haven’t had a chance to look at the history for that, but is that typical for you, the sort of premium you’re getting at the moment?

Actually, the premium’s smaller, Alan.  Our trading price is about $3.16 and our NTA is $3.08, so it’s a couple of per cent higher.  We have over periods of time traded up to premiums of 30% above our NTA and we sort of first broke through the NTA barrier back in about 2012.  In the recent history, the pricing is quite good relative to NTA. 

How did you get a 30% premium to NTA?  That’s amazing!  I mean, investors will be kind of keen to know about that.

Yeah, I think obviously yields were coming down in the listed market.  Our distribution was going up.  Demand for the stock was quite high at that point in time.

There’s no reason why the distribution will come down now, what’s your future guidance for distribution over the next 12 months?

Our distribution guidance for this financial year, is 22.2 cents.  Our stock is yielding 7%.  Over a long period of time, we target growth in the distribution of 3-4% and over the past 5 years for example, we have achieved distribution growth of about 3.9%.  Very attractive yield at 7% with growth.  If you get 7% return and some growth, it’s quite an attractive return for a very solid investment, Alan.

Of course, not being a stapled security, it’s not franked of course?

No, it’s a pass through and the investor pays tax in their own hands.

So really, for someone like you, 7% is kind of what you have to produce, isn’t it?

That’s right, it’s attractive and there is a component of tax deferral within the distribution, typically about half the distribution.  That gets deferred obviously and gets taken into account when you sell the shares in any capital gain or loss.  But just going back to your question about how sustainable is the distribution?  I think when you look at our portfolio and the quality of our tenants, we have Woolworths, we have the Commonwealth Government, we have Linfox, Samsung, Lion, ANZ Bank… We have really good quality tenants and we have a medium term to long term average lease to those tenants.  They’re very modern properties, modern offices, modern industrial. 

Of course, in protecting that distribution we have a lot of hedging and long term debt in place.  If interest rates go up we have a high level of hedging and we have facilities in place for a reasonably long time.  Also, we have generally low operating expenses, normally about 0.4% of gross assets.  We have a rising income from our tenants, the average rent review throughout the portfolio is 3.3% per annum, so we have this rising long term income stream from quality tenants and generally fixed costs at a ratio and long term debt that’s hedged.  A very transparent distribution profile. 

Well, very good.  Thanks very much for talking to us, Tim.

Thank you, Alan, all the best.

That was Tim Collyer, the CEO of Growthpoint properties.