Extracts from Property Innovation: Madison Property Fund Managers

Marc Wainer

Madison Property Fund Managers

There has been considerable press speculation that property funds could be targeted by private equity players. Private equity funds generally target companies which have got strong cash flows (to service the debt that they raise in order to fund the buy-out) and assets which, in the opinion of the private equity holder, are trading at a discount.

In the case of property funds the underlying assets are, in fact, trading at substantial premiums to the stated NAV. This begs the question: does stated NAV accurately represent the realisable value of the assets? On average, assets in property funds are geared at around 40% and if a private equity player is to make a bid for the linked units they would only have capacity to gear another 35% to 40% on the value of the underlying assets, excluding the premium that they would be paying. Depending on how a particular transaction is structured, CGT and STC could also be a factor and linked unitholders will expect a premium above the ruling price as well as taking into account the fact that, at the very least, they would have to pay CGT on the profit of their units.

Taking all of these factors into account it would appear that on the face of it property funds are not attractive to private equity players. However, if one assumes a lower interest rate environment during the next few years and strong income growth from the underlying properties there may be speculators who believe that over a 4 to 5 year term there would be sufficient upside for them to undertake the buy-out of a fund. There would be certain cost savings in respect of the unlisted fund relating to a portion of the asset management fees, listing fees, etc. which could improve the yield by an approximate 25 basis points, although this on its own would not be sufficient to justify a commitment.

A great deal of the speculation has been fuelled by the fact that in the USA, Sam Zell’s Equity Office Fund has been the subject of a buy-out, initially at 32 billion US Dollars which is now up to 38 billion US Dollars and whilst internationally there may be opportunities for private equity players, the conditions and interest rates in South Africa are not comparable.

There is however inevitably an ebb and flow between private and listed. Certain funds could be taken private at a forward yield of 8%, the portfolios worked for a few years as our property market globalises and relisted at a forward yield of 5%.

Stuart Chait

Property Partners

Private equity is popular today because investors have greater freedom to take risks and indulge in behaviour that listed fund managers cannot. They can borrow more money and they can operate outside the glares of press and public exposure. Private equity’s popularity today also shows just how much money is washing around the world looking for decent returns.

Anything, including listed property, is a potential target for private equity. The recent sale of USA Reit, Office Equity Fund shows that. There’s a special reason why South African listed property is particularly vulnerable. There are not enough direct property development or investment deals available to satisfy private equity investors, particularly the big ones. If you want an immediate opportunity over R1 billion it has to be in listed property. Also, our yields are still higher than the rest of the world and that is another attraction.