Rights issue does have an upside

BY GREG NINNESS

AMP NZ Office Trust's (ANZO) announcement that it will raise $201 million from its investors may have been born from the clouds of recession, but at least there is a silver lining.

Because while it will adversely affect the value of investors existing holdings, the renounceable rights issue also allows those with some spare cash to reinvest on extremely favourable terms.

ANZO's unit price has been in steady decline from its peak in early 2007 and over the last year has fallen by around a third, from $1.20 this time last year to under 80c last week.

Few investors would have been surprised when a revaluation of the trust's portfolio at March 31 resulted in a decline in asset value of 10.63%. This was pretty much in line with revaluations at other major property- based vehicles and such declines have been widely anticipated.

But while the decline in the portfolio value was expected, the need to raise further capital was not. After all, it wasn't as if the trust was highly geared.

Even after the downward revaluation, ANZO's debt was only 33.2% of assets and was expected to rise to 35.5% by June 30 on the back of planned capital expenditure, which would have been comfortably below the 40% limit in its banking covenants.

Of the $201m being raised, $195m will be applied to reducing debt, which will reduce the gearing level to 19.3%.

Given the high quality of ANZO's assets, that seems exceptionally low.

So is ANZO's management being overly cautious in going to investors now for such a large amount of money?

ANZO chief executive Robert Lang thinks not.

He points out that while a projected gearing level of 35.5% may seem prudent, it would not take much in the way of further falls in asset values to push that figure towards the 40% limit of its banking covenants.

If that happened, ANZO could suddenly face an urgent need to raise new capital or sell assets to bring down its debt.

In such a situation selling assets would likely be regarded as a distressed sale, which would adversely affect the price. And with capital in short supply, investors would be driving a hard bargain to stump up with new funds.

Although it is not certain that commercial property values will continue to decline, Lang said there was enough uncertainty in the market at the moment to make it a possibility.

"It may not happen, but as a low risk, high quality investment vehicle, do you want to make that bet? We feel the trust is not the kind of vehicle that makes those kinds of bets on behalf of unit holders," he said.

So the strategy is to raise the money now before it needs to, rather than wait until it may have no choice.

And it is raising sufficient money to enable it to cope with whatever the economy is likely to throw at it, rather than having to keep going back to the market for a series of smaller amounts if the property sector continues down the slippery slope.

But how likely is that?

ANZO's portfolio is in pretty good shape. Occupancy is at 97.5% and the weighted average lease term is 4.9 years. But its property at 21 Queen St in Auckland, beside the downtown shopping mall, could provide an indication of where the pressure points are.

The building, previously occupied by Air New Zealand, is in a prime location but had become tired.

ANZO has gutted it and is completely refurbishing it to A-grade standard.

It will be the type of prime office space that is supposed to be most resistant to the recession.

"Construction is on schedule [with completion due October 1], cost is to budget, but from a leasing perspective it's been disappointing," Lang said.

Although ANZO has been seeking commitments from potential tenants since last year, there is a strong possibility there will still be space to lease when it opens its doors in October.

The key to future demand is employment levels.

"We watch unemployment very closely and if it continues to travel upward, then occupier demand will weaken," Lang said.

So the risks facing owners of even A-grade stock are very real.

The good news for investors is that the rights issue will allow those investors who take it up to buy into a vehicle that is well placed to weather those storms, at very attractive yields.

If someone had bought into ANZO at $1.20 a unit, their gross yield for the year to June 2008 would have been 6.99%.

If the same investor took up the rights issue (nine units for every 20 held, at 65c each) the gross yield at ANZO's projected distribution rate for the year to June 2010 would average out at 8.99%.

But those with an eye for the main chance would have bought more units last week.

The record date for the rights issue was Friday, so units bought last week carried their full entitlement.

Anyone who bought units last week when they were available at 78c, and took up their full rights entitlement, would receive an average yield of 9.54% in the year to June 2010.

And ANZO provides the tax advantages of a PIE regime, so the equivalent gross returns for many investors would be even higher.

- © Fairfax NZ News