AMP’s property suitors need to prove they have a plan

Dexus Industria owns a stake in Jandakot Airport in Perth. Picture: Supplied.

The battle between two major property developers to control all or part of AMP Capital’s $23bn prime real estate assets comes at a time when the industry is set to undergo fundamental change.

Both combatants, Mirvac and Dexus, have an array of motivations, including the returns they earn from property management. But a new one will be to enhance their ability to adapt to the new environment.

The 1300 institutions including larger self-managed funds that have investments with AMP Capital need to be aware of this change and therefore how each developer is planning for the future.

As readers will know, Dexus is looking to manage the entire AMP Capital property portfolio, while Mirvac wants only the office assets.

Both Mirvac and Dexus have been fine property developers and fund managers in an era when building properties for institutions has provided great awards and, if structured properly, limited risk. Developers do the hard work required in gaining complex regulatory approval for a particular development. It is a time-consuming task that requires skill.

Under the old model, once the process was completed developments had the potential to be a “gravy train”. Fixed-price building contracts were signed so the developer took very limited building cost risk. The development was then sold to the institutional owner (sometimes the developer’s own funds under management pool) at an agreed yield. Sometimes the property-owning fund actually became the developer, a task made easier by the limited risk. There were many variations to these deals but at the base of the developments was the fact that it was the large builders, and particularly their subcontractors, who were in fact taking the biggest risk via fixed-priced contracts.

All of the building groups added a margin, but those margins were nowhere near enough to cover the huge rise in costs that we have seen in the past two years. Huge losses have been incurred and most surviving builders and subcontractors have learned their lesson.

In the future, they will want the developer and-or the eventual owner to take much more of the building cost risk. Accordingly, the limited-risk “gravy train” is about to be either severely curtailed or at least properly priced by the builder. As this new era takes shape, it is clear that developers that have very large amount of property under management are in a better position to take the greater risks.

Currently, Dexus manages a diverse $45bn real estate portfolio, so if it was to buy control of AMP Capital and retain the mandates, its assets would rise significantly.

Dexus has a development pipeline of about $18bn that it has either pre-sold or will seek owners.

Mirvac has property under management of about $29bn, but well over half is residential. Its office assets sit at about $7bn. It also has a strong development pipeline. Mirvac is confining its thrust to AMP Capital’s $8bn office portfolio.

Both bidders are actively selling their credentials to the major clients of AMP Capital, and the amount Dexus pay will in part be related to how many mandates continue.

Unlisted property developments are an important part of the portfolios of major publicly available superannuation funds, particularly industry funds. If the higher interest rate environment creates turbulence in these property markets, how they will be valued in the books is going to be an increasing issue. The government forces disclosure of these properties but does not require valuation methods.

In the listed space, we have seen a clear example of what can happen in the property development arena. Last year Dexus bought all the shares in APN Property Group. APN Property controlled two listed satellite companies: one specialising in industrial property and the other in convenience stores.

Shares in the industrial property satellite, now called Dexus Industria, were valued above $3.70 before the takeover.

Soon after control passed, the satellite company announced it would buy a third of the Dexus Jandakot Airport in Perth, plus properties in western Melbourne and Sydney. It also announced a $350m share issue at $3.45 apiece. Dexus Industria is now trading around $3.16 but has been as low as $3.02. It may have fallen lower but for the fact that the company is buying back shares on the basis that the $3.55-a-share book value of the assets is much greater than the sharemarket valuation.

Industry fund Cbus Super later bought a third of the Perth airport development for an undisclosed price but Dexus has now revealed that it was the same price as paid by Dexus and Dexus Industria — and points out that the fall in Australian Property 200 accumulation index since the APN acquisition was more than the decline in Dexus Industria stock.

Dexus Industria now has a staggering $378m in potential development projects. The Perth airport project and the others are no doubt fine developments, but the dramatic way the satellite company was expanded will need to be explained to the institutions in AMP Capital that are more accustomed to a conservative approach.