All property is theft. Or you can buy or lease it. CFO weighs up the different forms of legal title. CFO 01 July 2004.
The choice of whether to own property or not is a no-brainer for many publicly listed companies in Australia. When retail group Foodland Associated Limited (FAL) reviewed its property assets, the decision was simple: sell.
James Brown, general manager finance at Foodland, explains: “We got a return below our weighted cost of capital. It is really a matter of ensuring we have assets where we create the best return for our shareholders, and having our money tied up in property was not going to give us that return.”
More than $180 million of industrial and retail assets were spun off into an unlisted property trust branded the FAL Property Trust. The company is following a similar policy with its New Zealand-based property assets.
Brown and his colleagues examined many ideas, including injecting the assets into an existing trust, creating a listed vehicle and the unlisted route it eventually followed.
“We wanted to maintain some kind of corporate identity,” he says. “We also wanted a vehicle almost like the Bunnings Property Trust, which specialised in the Bunnings assets. We wanted a property trust to specialise in our retail assets.”
The preference was to create a listed trust – by definition a more liquid and volatile product than an unlisted vehicle. However, differing tax regimes meant that the food retailer’s Australian assets could not sit tax-effectively with the New Zealand assets in a single vehicle. And the company would have needed much more than $183 million of Australian assets to create a listed vehicle. On the balance sheet, the transaction shows up in a sharp drop in property income from FAL’s divisions, with a similar drop in depreciation and interest charges.
Brown says: “My advice to CFOs is to place your capital where you get your best return. We are a retail supermarket chain/wholesaler. And we believe that our capital is better employed in what will actively give us a return to our shareholders. I don’t subscribe to the theory that you need to hold property as a defensive mechanism.”
Makita is a global company that believes in buying rather than leasing. Its Australian general manager, finance and administration, Stephen Butt, says the company went through a detailed analysis of the options before buying a warehouse/office from Australand at Eastern Creek, Sydney, as part of a consolidation of properties. The deal was funded by a loan from the parent company.
Butt says: “We believe the advantages of ownership outweigh the negatives.” Leasing had the advantage of being competitively priced, flexible with changing needs and tax-deductible, as well as allowing capital to be deployed in the core business. The advantages of purchasing include the opportunity for capital gains, no exposure to rental rate increases, the buildings could be purpose-built and the company has complete control over the land and buildings.
There are four elements to the decision to lease or buy industrial property: size, the flexibility of property, the owner’s philosophy and whether the company is privately or publicly owned. Industrial assets, mainly generic warehouse-type buildings, are following the trend established in the commercial market in taking property off the balance sheet.
John Wakefield, managing director of CPM Research, says that 60Ã70% of industrial property deals in the $50Ã100 million area are trusts. “There is a trend to getting the [industrial] property asset off the balance sheet,” he says. In 2003 there were $8.2 billion of industrial deals – up 10% on 2002 – and 2004 is expected to show similar growth.
Michael Fox, general manager, property, at Toll Holdings, rates the company among the top industrial property occupiers in Australia. With more than 1.5 million square metres of space, an annual property bill of more than $100 million and $100 million worth of development land in hand, it is his job to ensure that Toll’s business units are in the best possible locations, at the best prices and in the best facilities.
As a rule, Toll prefers to lease rather than own, but it owns large tracts of industrial land for development, which it eventually spins off-balance-sheet to institutions. Fox says the creation of an off-balance-sheet vehicle for Toll assets is on his radar.
Recent deals include selling three industrial buildings in Victoria to Challenger for $20 million. Another three were sold to a private investor.
The choice between owning or leasing often comes down to availability of land in the best locations – and buying land in these locations is difficult. Fox says Sydney’s industrial land is almost exclusively in the hands of developers, although recently he was able to pick up a nine-hectare site near Bankstown Airport. In Brisbane, most land ownership is split between Port of Brisbane Corporate and the airport, meaning that leasing developments are the only option.
Jennelle Wilson, national research director at the valuation consultancy Landmark White, says that although the economic environment is the driver of occupier demand within the industrial market, the price of industrial assets is influenced by the availability of zoned and serviced land supply, construction costs and the underlying property investment environment. She says that during the past five years tenants have been firmly in control in rental negotiations.
Wilson says the recent strong growth of the economy has supported the warehouse sector. “With both business and retail trade high, warehousing requirements, led by the transport and logistics sector, have shown steady demand. This has also been influenced by these tenants requiring upgrades to premises to increase the efficiency of use and implementation of electronic tracking technology,” she says. According to Wilson, for properties worth less than $5 million, companies tend to be owner-occupiers, a decision based on the low interest rates.
The manufacturing sector’s demand for space comes from occupiers’ needs to upgrade premises as equipment becomes obsolete. Knight Frank’s national director business and industrial space, Ray Gent, says that owned industrial property works for many global manufacturers, which may need specialised buildings and plant. For example, cosmetics company Estee Lauder owns manufacturing plants because of the flexibility they offer in servicing peaks and troughs in demand.
Gent says that, when it comes to generic warehousing, leasing offers flexibility as inventories rise and fall.
Most industrial off-balance-sheet deals are on the distribution side because companies want to protect their manufacturing base. “If you look at major manufacturers, they tend to have surplus land and very specific buildings that sometimes have no readaptable use,” says Gent. “If I look about at what the [Knight Frank] team’s doing around the country, there would be very few manufacturers they would be talking to about leasing. Generally, manufacturers would still want to own when the climate’s right.
“From a warehousing perspective, it hasn’t been any better. You’ve got institutions cashed up looking for large land tracts in this state [New South Wales] and in Victoria. When they’ve got those, they need income. And the only way they can get income is to build buildings and lease those to occupiers.”
This means it is a buyer’s market. The balance is in favor of the corporate.