The implications for the Commonwealth Bank bringing its property trusts in-house

Colonial First State Global Asset Management (CFSGAM) is a subsidiary of the Commonwealth Bank (CBA) and manages more than $140 billion in funds including $20 billion in listed property funds. 

The two listed funds are CFS Retail Property Trust (CFX) and Commonwealth Property Office Fund (CPA). 

CBA has proposed that the management rights of CFX and CPA be internalised and that wholesale property funds and shopping centre management rights of CFSGAM be purchased by CFX. 

Provided the payment for the management rights is not excessive, the internalisation proposal should succeed. 

The Gandel Group, which owns 15.5% of CFX and has first right over the stake in CFX owned by CBA (and owns of half of Chadstone Shopping Centre), presumably will be supportive. 

Internalisation is a positive for CFX as is estimated it will improve earnings by 2% to  2.5% because of the size of the platform and the potential cost savings generated. 

Costs savings through internalisation would also increase earnings by between 2% to 2.5% for CPA. 

The most important driver behind the proposed exit of the CFSGAM property business by CBA is the increased capital requirements for holding equity investments under Basel III. 

More demanding capital requirements are being imposed by APRA on equity investments by banks. 

Internalisation of management and sale of the investments in CFX and CPA by CBA will prospectively enhance return on equity of the bank albeit marginally. 

CFSGAM manages $20 billion in property assets across Australia and New Zealand, including 44 shopping centres and 38 office buildings. 

Seventy percent of the assets are in three listed vehicles being CFX, CPA and the Kiwi Income Property Trust which is listed in New Zealand. 

The Australian listed funds are: 

• CFX which specialise in retail property and has assets of $8.4 billion, a development pipeline of $1.3 billion and market capitalisation of $4.8billion. 

• CPA, which specialise in office property and has assets of $3.7 billion and market capitalisation of $2.7 billion. 

CFSGAM also manages unlisted property funds and assets. 

It is proposed by CBA that these management rights be sold to CFX.  The funds and assets are: 

• CFSGAM property retail partnership which is an unlisted fund with $1.2bn in retail asset and four investors, including CPPIB and the Future Fund. 

• Private Property Syndicate which is an unlisted diversified fund with $550 million in assets. 

• The DPIF Office and Industrial Funds which are in wind-down. 

• Co-owned assets managed on behalf of third parties valued at $2.7 billion. 

Sale of the management rights for the unlisted funds and assets to CFX introduces a clear conflict for the CFX management team. 

It also raises the question whether investors in these unlisted property funds would countenance a shift of management into a listed entity where alignment of interest will be uncertain. 

Principal focus of management of a listed property trust will be increasing net operating income, measured six monthly, where increasing assets and funds under management will be factors driving performance.  This contrasts with the focus of unlisted property investors seeking long term total returns on assets. 

If CFX proceeds with acquisition of the management rights for unlisted property funds and assets it would be detrimental for unitholders as the lack of management alignment with investors would place at risk the continuing retention of the management rights of the funds. 

Soon after CBA announced the plans for listed trusts, Dexus brought a 14.9% of stake in CPA, raising speculation about a full takeover. 

CPA and CFX will be susceptible to takeover in the belief that new management will be more successful because of greater skills or economies of scale.  Certainly the share prices will be underpinned. 

Approval of internalisation of management of the listed CBA vehicles is expected and will enhance earnings provided the price is reasonable.  CFX at current price yields 6.8%.  CPA yields 5.6% on a 75% payout ratio.  Both represent fair value with prospects of growth in distribution. 

A hostile takeover offer for CPA after internalisation of management is a real possibility. 

CFX in contrast is less certain until there is clarity regarding the purchase of unlisted property trust and asset management rights.  If they are not acquired by CFX then the prospect of a takeover offer at the current prices will strengthen.