It was deal that looked good on paper. Investa Property Group’s $590 million takeover of the Clarendon opened the door for the group into the New South Wales residential property market.
However, as it turned out at yesterday’s annual general meeting the purchase fell short of expectations and the board has decided to write down the residential goodwill by the full $93 million.
Investa’s managing director John Arthur said it was no secret that in the period between the group contracting to buy Clarendon in late 2004, and completing the purchase in September 2005, the market in NSW for residential land and contract housing plummeted at a pace and to an extent that, frankly, “we did not predict”.
“Precisely why this happened in what seemed at the time relatively favourable macro economic conditions has been the subject of a lot of lively debate.” Arthur said. “What we do know is that in September 2005 there was a dramatic fall in consumer confidence, probably fuelled by a mix of factors including oil price rises, fear of inflation, fear of interest rate rises and concerns about the state of the NSW economy generally,” he added.
Arthur said add to this a lack of urgency in buyers prompted by affordability worries, and you have a stalled market.
“As called out by a number of industry participants, market conditions appeared to be improving in early calendar year 2006. But the interest rate rises in May and August 2006 put an end to that.
“These adverse market conditions have pushed our NSW residential cash flows further into the future. In the land business the inventory is of course still there awaiting sale,” he added.
Arthur said the group was attracted to Clarendon for two reasons, the first – it gave Investa a land bank in NSW of nearly 4,000 lots, where the group previously had no geographic exposure.
Secondly, through the contract housing business, it gave Investa the ability to generate additional sales and margin through bundling house and land packages in markets where lot sizes are shrinking as developers struggle to create affordable product for their customers.
Yesterday, Arthur said the good news is that the weight of population growth alone must be building demand, but the question is – when will this demand release?
“In these circumstances the board was naturally concerned about the book value of our residential business. In May, shortly after I began as Managing Director, we called in Ernst & Young to do a valuation of our entire residential business. Their work indicated a goodwill value fall within the range of $47 million to $93 million.
“The board considered this and, as the Chairman told you, decided to write down the residential goodwill by the full $93 million. This reduced the carrying value of our residential business by 11% from $834m to $741m. The board believed that going to the top of the write down range was the most prudent course, particularly having regard to continuing uncertainty around interest rates, and ongoing severe weakness in the NSW residential market generally,” he added.
Arthur said on the earnings front Clarendon Residential’s FY06 EBITDA was $53 million, 9% less than market forecast made in October 2005, and around 13% of group earnings. The return on average funds employed was 7.1% – outside our target range of 10% -15%.
“There is no doubt that this exposure is hurting us now while the NSW market struggles. But all cycles turn, and the NSW market will improve. It’s just a question of when.
“…People ask me when I think that will happen. My frank response is that I don’t know. I do know that NSW is chronically under building its housing stocks, but I suspect that a combination of continued uncertainty around interest rates, and NSW consumers sitting on their hands waiting to see if affordability relief comes with the NSW election next March, means more tough times for residential businesses, until at least the end of the current financial year,” Arthur concluded.
Meanwhile, Investa’s two funds management businesses are both doing well in strong markets.
The commercial developments business is poised to make a meaningful contribution to group earnings.
By Nelson Yap
