VHP Seminar Notes: August 2023
Quote:
Originally Posted by
Snoopy
Does this explain why -in this time or rising capitalisation rates- the shrinkage of asset values at VHP of just 6.4% - was relatively modest?
Just been to a broker seminar presented by Aaron Hockly, who is the equivalent of the CEO if Vital Healthcare Property Trust (VHP), had any employees. (All the staff at VHP are employees of property manager Northwest, including the 19 or so based in Auckland and approximately double that number based in Melbourne). VHP is but one of five property investment arms managed by 'Northwest Healthcare Properties Management Limited', based in Canada. But VHP is the only one of these funds with a public listing, with the other four all majority controlled (70% stake) by the sovereign wealth fund of the Singaporean government. I managed to get a chat with Aaron after the seminar, so he was able to clear up a lot of my questions.
I was concerned that the rise in capitalisation rate that has been pre-announced to 5.06%, would be matched by an equivalent rise in discount rate. That in turn would see the present value of discounted cashflows of the future (that 17 year income stream) discounted to the extent that the value of VHP units might be significantly affected. Aaron was being coy, given the results of the company are to announced to the market on Thursday next week. But he said that the capitalization rate and the discount rate were not necessarily as closely coupled as that, as discount rates also needed to account for the quality of the lease agreements and what that meant for the surety of income going forwards.
Further to that he said that many of the 'cap and collar' CPI lease agreements, which limited CPI linked rent rises to well below the actual CPI rate of 7% that we are seeing, did have 'catch up clauses' where excess CPI rises could be carried through into future years. Failing that there were also 10 year reset clauses, where over that much longer period, rent that had fallen behind inflation could be 'made up', as that part of the rental agreement rolled over.
I asked about 'competition' from the other arms of Northwest in securing future development projects. Australia is pretty much on the doorstep of Singapore after all! Aaron said that VHP had first dibs on all New Zealand projects and aged car opportunities in both Australia and NZ. As far as Australia was concerned, Northwest arranged it so that new opportunities were offered first on a rotational basis to the five different property arms managed by Northwest. While superficially this sounds 'fair' (because you wouldn't want one property owning associated arm of Northwest bidding against another), in fact VHP did have a disadvantage because of the higher capitalisation rate hurdles that applied in Australia and New Zealand, when evaluating new opportunities. A Singaporean arm of Northwest might make a go of a project with a 4% yield on completion, where VHP needs around 6% to make an equivalent project viable.
According to Aaron, most of the acquisition opportunities for VHP have dried up. They have either already been sold to global long term asset owners, or the price that VHP might have to pay has become too high. That means that from now on, Vital will be undertaking new developments, which, initially at least, will involve more construction contract risk that has been typical of VHP in recent years. An investor asked if these new developments had further opportunities for yield improvement by 'building out' more lease-able space on current sites. Aaron's answer was a fairly definitive 'no', although he did add that where VHP had been able to purchase adjacent land to existing developments, that remained a possibility. I asked about public private partnerships in development of the 'health precincts' that VHP now favours. He said VHP had not gone the PPP way, although he did note the new birthing unit being built in Christchurch on the old Police site was the be fully tenanted by 'Health New Zealand'.
The biggest threat to VHP in the near term is rising interest rates, because costs are rising faster than any rent increases can cover. To that end, Vital had put some of their less desirable properties up for sale. Even in these tough times they had been able to sell assets at a 9% discount to book value, verses something like a 27% discount that it was possible to buy VHP shares at on market. Properties put up for sale had doubts about end of contract lease renewals. One instance being where a hospital had acquired land to develop a new facility that looked like it might 'replace' a building where an existing lease had just a few years until expiry.
The long term strategy for VHP management is to keep AFFO (Adjusted funds from operations) growing at a rate of 2-3% per year. That does not sound a lot in the current interest rate climate. But long term Aaron is convinced this policy will provide a satisfactory return for unit holders. Reassuringly, VHP is able to over-rule potential new project purchases that might benefit Northwest (because if the size of the property portfolio under management at VHP increases, then Northwest fees increase, tied to the value of assets being managed) but not VHP (because the yield available on some new rental contracts make them not viable for VHP, the property owner). Aaron said the NZ domiciled directors are there to ensure the NZ unit-holders interests are looked after in this regard.
It is unusual for an NZ based property company to have most of their assets in Australia. This obviously limits the NZ imputation credits that are able to be attached to dividends paid to NZ unit-holders. But Aaron seems adamant that the arrangement works well, because no 'extra' tax is deducted from the Australian income at source if it is brought back to NZ. This sounds a bit odd to me. Even though no extra tax is deducted when the money leaves Australia, that doesn't remove the liability to pay income tax on that money to the NZ government once it hits the bank account of an NZ domiciled entity. In practice I suspect any retained profits in Australia stay in Australia, to fund Australian developments. Aaron also made an off the cuff remark about some of the Australian assets being subject to NZ's FIF tax regime. I was shocked by that because generally Australian assets that produce taxable income in Australia are exempt from FIF. So maybe some of these 'Australian' assets are held my offshore companies in Singapore or Bermuda or something? Whatever, I guess VHP have done all the calculations to make sure the tax paid is optimized for VHP!
SNOOPY
discl: do not hold, but considering it.