Stockland chief executive Mark Steinert tells Stephen Bartholomeusz and Robert Gottliebsen:
Stephen Bartholomeusz: Hi Mark, thank you for joining us. Mark, we’ve heard from the real estate agent, John McGrath, and Commonwealth Bank’s Ian Narev warning about the impact of these historically low interest rates on the housing market and the potential for overheating. Now, you’ve got a real grassroots view of the new home market. Where do you think it’s at? And do you see any signs of emerging or latent problems?
Mark Steinert: No. We don’t see any signs of problems and we’re confident that we’re seeing a recovery and in different levels, depending on which state and which market you’re talking about, but definitely metropolitan Sydney is the strongest market, followed by Perth. The parts of regional New South Wales are a bit on the softer side. We think Victoria has stabilised and Queensland has stabilised and starting to trend up.
We think affordability has improved quite significantly after a few years of either flat prices or slight declines because of combined income growth and clearly very low interest rates. The main thing we’re seeing now is at the affordable end, a first home buyer, particularly with the state grants that are focussed on new construction both on the eastern seaboard and now Western Australia, that their repayments on the mortgage aren’t that different to rent.
SB: So, you haven’t seen any signs of cautiousness from the lenders?
MS: No, no. There was a period where certainly the lending process was very tight, I guess for want of a better word, and it remains at a high standard absolutely, but in terms of wanting to grow loan books, we don’t see any evidence that that is something that’s not being sought by banks and building societies, etc.
Robert Gottliebsen: Mark, can I put a different point of view to you – the strength of the market is not so much in the outer suburban areas but in the inner city areas, particularly in Sydney and a lesser extent in Melbourne, where we’re seeing very spirited bidding for dwellings. And I wonder whether there’s quite a big differentiation now within our cities between the outer suburban areas and the inner suburbs?
MS: I think there’s certainly absolute truth in part of that statement in that those markets are certainly the strongest and that’s where the demand supply dynamics are, you know, certainly most skewed towards moderate undersupply. Having said that, the normal process is that those markets tend to move first in all recoveries and then it ripples out.
You’ve got a couple of dynamics at play. Upgraders typically have to sell their home first before they’re going to either build a new home or buy a bigger home than the existing home. So there are the markets you described where the recovery that starts that whole process in train. The first home buyers, you know, are just as evident certainly or more evident in the outer areas relative to the inner and if they see some markets starting to show price appreciation, then their confidence could make a commitment to align growth. And the layered recovery has been about confidence. I think there’s been, post GFC an absolute lack of confidence and that’s started to change and it’s… I guess we’ve gotten far enough past the GFC where that’s becoming more evident. And it’s a little bit like you see with the share market. You go back a few years ago and people start moving and going and back into the share market and now in the last year or so you’ve seen quite a stark shift. What led this first was investors, so they were certainly the first tough market to get confidence to come back into the market and start to buy.
RG: Right now, in inner Sydney the agents are telling us that it’s white hot and investors are leading it, and it’s not quite as hot in Melbourne, but it’s still very hot. It’s all in the city and that’s where the investors are putting their money. I wonder whether we’re not seeing a real change in the market where we’re going to see really quite major price escalation in the inner city and much less in the outer areas.
MS: Yeah. Obviously we’re not active in the inner city, but certainly we are bringing Willowdale at East Leppington to market on the weekend and that’s a good example of where the preregistrations of interest were over a thousand. You know, we’re going to be marketing forty-nine lots of land on Saturday and Sunday. We have considerably more demand; dramatically more demand than we have lots available.
The Sydney market across the board in the metropolitan area is undersupplied and it has been for a number of years. It’s going to take quite a few years for that to be addressed. We’re just coming back into the metropolitan Sydney market, but in the same locations where we’re bringing projects like Leppington and Marsden Park.
You know, we’ve seen examples of other land that’s been divided where there have been campouts, where there’s been pretty strong appreciation as well. We don’t think that’s necessarily constructive. We chose to discourage that. We’re showing land on the basis of the first to register gets the first opportunity and I would highlight that there have been a lot of changes where the New South Wales government has really lined up infrastructure now, heavy rail, road connectivity to open up this land and make it convenient for people.
I mean East Leppington has got a major train station one and a half kilometres away, a direct line into the city at fifteen minute intervals, forty-five minutes on the train, and eight hundred car parks around the station. That brings real amenity. We’ve got private schools coming in, public schools, shopping centres, and there’s a very significant employment base over in Parramatta, Liverpool and Campbelltown. That is actually a big part of the economic engine of Sydney. So, I wouldn’t agree that it’s all just in the inner city and there’s nothing going on outside of that.
RG: But as you describe, people camping out and things like that, that’s boom time stuff. That’s a bit of a panic. And so, what you’re telling me is that in eastern Sydney the intensity of demand that you’re seeing in the inner city is starting to go into the outer suburbs as well.
MS: Yeah. But I would highlight that there is a determined protest around land release. You know, the New South Wales government has… you know, the Minister has put a very clear program around land release to address that. That’s why I started out by saying the markets are definitely improving, but I don’t see we’re going to get into a situation where we have some sort of severe bubble that gets created. But yes it’s a solid market and it’s getting stronger.
SB: Mark, within the Stockland result we saw a big fall in the recent development earnings and a $355 million dollar writedown in the value of your land bank. Now, is that a reflection of the conditions that you have been experiencing and the outlook or does it relate to wholly of what you inherited?
MS: A lot of it related to land that was bought in the early 2000s in certain quite often nonmetropolitan locations, lifestyle orientated end buyers in mind who, you know, that’s a shallow demand base and with post GFC we saw the demand for lifestyle land actually impacted quite considerably as well which compounded that issue. So, it’s more to do with where that land has been located and that the lack of demand in some of those submarkets which is why we dealt with the land in the way that we’ve written it down, so that others who are active in those markets, local developers, are able to buy that land from us and achieve a decent return from that and drafted them and it make sense to start operations in some of those locations, we thought were better to focus in the core growth corridors which has been our strategy for the last three or four years and that’s where demand is steepest, that’s where the population growth is and that’s where there’s more consistent demand for the end product.
SB: So, what are the implications of that for your earnings from that residential development division going forward?
MS: Having cleared the decks it sets the stage for a solid improvement in profitability which we believe will be sustainable into the future. That was all part of the rationale for taking those write downs in the first place and changing our policies around things like interest treatment, so that our margins would be a lot more predictable into the future, stable through time and by focusing on the core activities around the growth corridors that I described before, that really gives us the ability to give a lot more confidence in relation to the improvement in profits from that part of the business.
SB: I wanted to ask you about that treatment of capitalised interest because you did change it – I’m aware of that – and to bring it forward some future interest to smooth out the earnings. Despite the high levels of your capitalised interest in your cost of goods sold, the capitalised interest balance in the business remained pretty much stable and relative to the value of the remaining inventory, actually rose. How does one reconcile that?
MS: It’s starting to come down and that will accelerate now as we move forward and what would really accelerate it would be completing the disposal of the 14 sites that we’ve identified for sale. In fact the cost expense will be higher than capitalised interest, so that organic decline that I’ve described starts to come through and as we trade through there’s another parcel of land that we’ve identified as it’s impaired, but we’re going to trade it out for cash generation. We can unlock an incremental $300 million dollars over the next five years by trading through that impaired land and that obviously has the heavy component of capitalised interest in the cost of goods sold, so you’ll see that decline quite dramatically over the years to come.
RG: Mark, you’re basically telling us that past management made a mistake in buying land in those lifestyle areas. I wonder if it is the second mistake that requires attention in that what you have is a business that is on the one hand a land development, housing residential business and then you have a property investment business and wouldn’t it be far better to have those two businesses in totally different structures, so that the people who investing in a property in the retirement areas or particularly in the property areas would accept much lower returns because there’s much less risk in them and of course the the housing areas would be rated differently. By putting it in together you get the worst of all worlds.
MS: I mean we look very carefully as part of the strategic review about whether we could unlock value for our investor base by doing exactly what you’ve just described and it was very clear that under all the scenarios that that would actually destroy or remove a lot of value for our investor base. The historic position at the company (and, you know, it’s got a 62-year history) has been that by combining those two activities in the right portion, and we define that as part of the review as well where we didn’t want too much development activity, try and maintain it in the 20-30 per cent allocation and the core to focus on investment assets which you’ve described. But that combination, when it’s done, in a consistent way and where there is very realistic assumptions which we believe we’re now overlaying and that was also part of what we changed earlier in the year.
We reduced the future growth rate as well as changing the interest policy, so we didn’t only normalise the margins but we also provided a more conservative forward looking view about how we plan the business where we get the corporation side of the business back into profit and retain earnings to allow us to also manage any volatility in future years or try to manage that in a consistent way to the cycle that’s actually seen the group trade at a very large premium. And it’s not trading at that premium right now, but obviously we’re re-earning trust and we’re resetting as we’ve talked about. But I covered the company for ten years. You analyse the twenty-year history before the ten years that I took it over, I was fortunate enough to spend a lot of time with Ervin Graf and Peter Daly and John Pettigrew and then obviously Matthew in the early parts of his tenure and, you know, I can assure you for the vast majority of time that I served the company its structure and its business model is something that investors held in very high regard and that’s our intention; to get back to that position over time.
RG: Mark, both the results and the strategy presentation you made earlier in the year had the 'new broom' effect to them. When you got there, was Stockland what you expected it to be?
MS: The impairments were larger than I anticipated. That was what we felt was prudent to do. You can see I’ve made considerable changes. In management, only 75 per cent of the management team has changed and we are making a lot of changes. We’ve consolidated many activities to create critical mass and efficiency and take costs out. We’ve committed to bringing the full-year effect of those changes in 2013 through in FY14 and that reflects a 10 per cent net reduction in costs. We’ve consolidated the finance function. We’ve consolidated human resources. We’ve consolidated branding and marketing. We’ve consolidated all communication. We’ve consolidated research and strategy. We’ve consolidated project management so that it’s over the entire business, so we can now value-engineer the residential side of the business as well as the retirement living business. We’re progressively improving processes and systematising where appropriate.
We’re really focussed on making sure that we have a very strong, reliable business model that’s able to deliver consistent earnings per security and total security-holder returns that are above that tier group. That is our core business objective, together with the company’s purpose – through our sustainability initiatives to help improve the community and create a better way to live – that’s where the synergies between the residential communities, the shopping centre business, retirement living start to come into play. If you look at the majority of the shopping centre developments we’ve got in the $1.5 billion dollar highly accretive development program, the majority of those either were part of a residential community that Stockland built at some point in history or, because we were active in the submarket, we were able to acquire those shopping centres in a reasonable manner.
RG: Mark, I wonder if I could take you in a broader sphere, partly affecting your own company, but mainly the development industry in total. While the banks are happy to lend to people who want to buy houses, I get the impression that, for a lot of developers, it’s very hard to get the money. That applies to apartments; it probably applies to outer suburban areas as well. Is that your impression?
MS: You know, levered development is, as you highlighted earlier, very risky. In that regard, banks put prudent requirements around lending and make individual assessments about the direct exposures. You know, in prudent practising is very prudent practice. What you want are well capitalised operators that are able to ensure the quality of what’s delivered is there and, for the end buyer, that they’re able to rely on what’s delivered and know that there’s a very high-quality organisation standing behind that product. When I talked about the history of Stockland, that was a key part of it. There’s a lot of trust in the Stockland brand. We’ve got $12 billion of outfits, we’ve got an A-minus credit rating, we’ve got one of the lowest levels of leverage in the industry. We’re here for the long term.
RG: Now, I’m recognising your position and as a lowly exercise, I’m really taking you outside side your own company and there is a real risk here that you’ve got the banks with low interest rates and plenty of money, but for consumers to buy houses it’s much tougher to get the supply. Not just houses, I’m talking apartments. In those situations, you can get into a very nasty position because you can find the consumer is being pumped with money, but the supply is not there because it’s much harder to get, albeit for prudent reasons. Can you see that as a real danger, not for yourself but for the wider development industry?
MS: Not really. We see plenty of evidence of people building good product in the right locations and we see plenty of evidence of people building product where, to be honest, if they made a profit, I’d be quite surprised. I don’t see any evidence of some type of dire constraint in terms of capital. It may not be coming from the banks, it may be coming from the ultra-high net worth individuals and the superannuation savings, because it’s pretty clear that at this point in the country’s history, the accumulated wealth of Australians has never been higher. We see a lot of activity from the private sector as well as from institutions like ourselves.
SB: Mark, I’m afraid we’re going to have to end it there, but we do appreciate your talking to us, so thank you.