Changing attitudes to quoted sector

What is the purpose of publicly quoted property investment companies? If that question is not already on the top of investors' agendas, it will be shortly. MEPC, the UK's fourth-largest property company, has announced that it is being taken private by institutional investors GE Capital Europe and Hermes Pensions Management.

Its shares have been among the worst performers in what has been a badly underperforming sector for most of the past two years.

Meanwhile, Prestbury, the AIM-listed vehicle launched by two of the UK's most respected entrepreneurs, Nick Leslau and Nigel Wray, will shortly announce plans to liquidate and hand the sale proceeds to shareholders. Unlike MEPC, its management will have no ongoing interest in the business and will not profit directly from asset sales.

The management, which owns roughly 35 per cent of the equity, made the move after extensive consultations with investors frustrated by the share price's inability to move in line with the 140 per cent rise in net asset value over the past two years.

The two corporate developments highlight a sea change among institutional investors' perceptions of quoted property companies. Alistair Ross Goobey, chief executive at Hermes, has been outspoken about the shortcomings of quoted property companies.

Speaking at the first annual conference of the European Public Real Estate Association in Barcelona last week, he decried the lack of strategic focus that has characterised most companies. "We can see no merit in investing in what is effectively a rent collection organisation," he said. "We can see no merit in investing in the Rolls-Royce lifestyles of so many property company managements."

Meanwhile, Ross Goobey concedes that shareholders themselves bear some of the blame.

Property company managements, not just in the UK but in the US and Europe, have been staggeringly indifferent to the corporate governance movement that has swept most other sectors. Property company accounts have remained opaque while managements have maintained reward structures that do not align their interests with those of shareholders, said Lorna Matheson, senior analyst of European property at ABN-Amro Asset Management, speaking at the same conference. What investors want, shareholders say, are accounting methods, corporate standards and rates of return that mirror those of other sectors.

In short, investors no longer view property equities as a proxy for direct real estate investment, and are unwilling to accept rates of return equal to those of property. They want equity market returns from property equities and companies incapable of delivering them are losing the competition for capital. "The point of a public real estate company is to be able to use the real estate as an operating platform," says Patrick Sumner, divisional director of European property at Henderson Investors. Simply buying a group of assets and collecting rents can never deliver equity-like rates of return on investment, Mr Sumner says.

But what accounts for the sea change in attitudes, not only in the UK but in the US and Europe as well? After all, the asset-collecting strategy that still predominates in many markets was clear and credible for many years.

"Shareholders are used to 15 per cent returns on equities and they think property companies are not going to produce that," says Rupert Faure-Walker, managing director at investment bank HSBC.

"Shareholders want managements to be seen to be adding value," he says. "Managements who do this either by self-liquidating or by a well priced buy-out are adding value and can come back to the City time after time." Meanwhile, the share price performance of the quoted real estate sector over the past two years has forced company managements themselves to question the merits of public ownership.

In the US, several real estate investment trusts, including most recently Phillips International, which is selling a portion of its portfolio to Kimco and liquidating the rest, are returning capital to shareholders.

Gary Boston, Reit analyst at Salomon Smith Barney, notes that the big incentive for companies to go public is to obtain ac

cess to the public capital markets where equity will always be cheaper than debt finance. However, with company share prices trading at significant discounts to net asset value, new equity cannot be issued without diluting the value of the existing shareholders. "In that case," Mr Boston says, "you have to make a choice. If long term the stock trades below NAV, it may not be a good reason to be public."

Meanwhile, John Kukral, senior managing director at New York-based Blackstone Real Estate Advisors, says that part of the race to a public listing was spurred by the expectation that being big offers competitive advantages. "There was a theory back in the US that real estate is the last capital-intensive business and that capital-intensive businesses have to consolidate. But if you don't really believe that there's any efficiency to be gained from owning 100 buildings instead of two buildings, then it's not capital intensive."

If absolute size is not critical, then the race for capital is not either.

"Therefore real estate is not capital intensive and should not be held in large public companies," Mr Kukral says.