Dynamic duo faces paradise funding problem

Friday 8th February 2002

Those familiar with Auckland's Mt Wellington Highway, a concrete scar across one of the city's ugliest neighbourhoods, will probably find it hard to imagine the area as a potential urban utopia.

Nonetheless that's how Richard Didsbury and Ross Green, Auckland's high-profile development duo, envision a 21ha block down at the highway's end.

The land has been poetically dubbed Sylvia Park and the Green/Didsbury vision is no less high-flown.

Their proposed "mini-city," with 60,000sq m of retail space and a similar area of office and housing space will, they say, be "an urban village for the 21st century" where people "can live and work, shop and learn ... where they are entertained, involved in community activities, where they socialise and celebrate."

The proposal has gone the rounds of Resource Management Act argy-bargy.

It found favour with Auckland City Council, which granted planning consent two years ago, but somewhat inevitably, the decision was appealed and disappeared into the slow-grinding machinery of Environment Court last August.

Green and Didsbury won and the court confirmed rezoning permission early in December. Now all the dynamic duo has to do is come up with $500 million and Mt Wellington's mini-city will be on its way.

And there's the rub.

The land sits on the books of Kiwi Income Property Trust, a development outfit that started modestly nine years ago and has grown into a monolith with a market capitalisation of nearly $600 million.

Along the way, however, the trust's managers have not always got along smoothly with the institutional investors who take up most of the unit register.

Simply put, the problem is that many of the instoes feel the returns they're getting on their investment haven't kept pace with the ever-higher fees KIPT's managers have received as the trust's assets have grown.

The manager is Kiwi Income Properties Ltd, owned half by Green, Didsbury and Friedberg Group and half by Australia's Lend Lease. Following a rewrite of the trust deed last year the fees are calculated as 0.85% of the gross assets up to a value of $750 million and $0.65% of the assets thereafter.

Last year the manager's efforts earned it $5.9 million, up from $5.4 million in 2000.

The issue has been brought to something of a head by the Sylvia Park financing issue. To make life even more interesting, an option held by Lend Lease to buy Green and Didsbury's half of the management company expires on March 31 next year.

The possibilities have been a favourite subject of speculation around the property industry. Clearly KIPT's management contract is a great little earner as things stand and 0.65% of an additional $500 million of assets will bring in an extra $3.25 million a year.

One possibility is that Green and Didsbury will buy Lend Lease out and try to finance Sylvia Park on KIPT's balance sheet but that option isn't one that will find favour with the instoes, who put their hands in their pockets a few years ago to support a string of rights issues and have made it clear they're unwilling to do so again.

The trust's deed caps its ratio of debt to gross assets at 35%, although a short-term rise to 40% is allowed under certain circumstances. It now stands at 29.1%.

Funding Sylvia Park will lift assets to just short of $1.4 billion. To keep the ratio intact the maximum additional debt that could be raised would be around $230 million, so KIPT would have to go to its unitholders for a further $270 million.

While Lend Lease's investment bankers have been crunching the numbers KIPT's advisers have identified three financing options.

First, KIPT could simply sell the development to another industry player - which would then reap the management fee.

Second, it could preserve the debt ratio by issuing hybrid debt/equity securities such as capital notes. But to do so it would have to change from a trust to a corporate structure, a cumbersome process.

Third, it could float off Sylvia Park as a separate vehicle, as it did with Kiwi Development Trust, the developer of Auckland's Royal & SunAlliance Centre. The trouble here is that, while KIPT did nicely from the development, KDT unitholders had an experience they won't forget for a while.

As anybody can, KIPT mistimed the market and started building its 38-storey giant just as demand for central business district property turned down.

It let lapse a September 2000 option to buy out the KDT holders for $202 million cash because the building was only 78% leased. It came back the following January, at 87% occupancy, with a $194 million offer of a straight unit swap.

The resulting unit issue once again bumped up its assets, and the management company's fee.

As Green, Didsbury and Lend Lease work through their options, the good news for KIPT's board is that sharemarket trading in recent months has sharply narrowed the gap between the units' price and their net asset backing.

At the time the last annual report was released asset backing was $1.07 and the units were trading at 86c, a discount of nearly 20%. They're now changing hands at around 100c.

Whether the discount closes further or blows out again will depend largely on the financing structure of the trust's next big development, Sylvia Park.

The institutions will be watching closely. So will KIPT's competitors.

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