BLUEPRINT: Masters of the growth curve

Within Australia’s property fraternity, some say they are like “yin and yang.” Indeed, David Southon and David Harrison, joint managing directors of Charter Hall Group, are a formidable team. Despite differences in personality – Southon is described as methodical and calm, while Harrison is seen as hard-nosed but charismatic – their skills are highly complementary.
“The real story is that these two guys – one with an agency background and the other with deep development expertise – have come together to build a small business into one of Australia’s larger property/fund management groups,” says Chris Green, global head of real estate at Macquarie Group. “They have developed a corporate culture and moved a long way up the curve to be able to attract global pension and sovereign wealth funds to invest in and with them.” 
Listed on the Australian Stock Exchange nine years ago, Charter Hall now ranks among Australia’s top listed property companies, with more than A$10 billion under management (€6.59 billion; $8.95 billion). It manages A$6.4 billion in pooled funds and partnerships, A$1.7 billion in retail and direct property funds and a further A$2.2 billion via the listed Charter Hall Retail REIT. More importantly, it is the only property company in Australia with the ability to attract capital from all three primary sources: retail, wholesale and the public markets. 
Harrison says that, throughout his career, his philosophy has been to have diversified sources of equity. “My thesis is that, whether it is retail or the listed market, it is hard to get capital in three out of every 10 years,” he tells PERE. Similarly, the institutional market also can shut down from time to time.
“If you are one dimensional and rely on just one source of capital, you are out of the game for three out of every 10 years,” Harrison reasons. “If you have multiple sources, however, you have the ability to attract capital more often during a cycle – and do the best buying when others are out of the market.”
That philosophy served Charter Hall well during the global financial crisis. While the impact of the downturn shook the group, it did not cripple it to the extent of other firms when their share prices collapsed.
A quantum leap 
In the wake of the global financial crisis, Charter Hall took a quantum leap in 2010 when it acquired the real estate platform of Australia’s Macquarie Group. It paid A$108 million for the management rights to two listed REITs and an unlisted direct business, comprising both retail and wholesale trusts. In turn, the investment bank gained a 10 percent holding in the firm.
The transaction delivered A$6 billion of funds under management to Charter Hall and transformed the medium-sized manager, which was managing A$4 billion at the time. In fact, the deal instantly doubled the size of the firm’s retail business, now called Charter Hall Direct.
“Macquarie’s offshore assets presented a challenge because we previously had avoided offshore markets,” Southon recalls. “However, our stake in these portfolios (of offices and shopping centers) was acquired at an attractive discount to net tangible asset value.”
Since then, Charter Hall has progressively sold down its offshore holdings. Its large US office portfolio was sold to Boston-based Beacon Capital Partners in 2012 (see Oranges and lemons, page 38), and its last remaining offshore assets (a couple of German shopping centers owned by Charter Hall Retail REIT) currently are earmarked for sale. 
Today, just 3 percent of Charter Hall’s assets are still offshore, down from 44 percent in 2010, and Southon says the profit margin on its fund management business has grown significantly since reweighting its portfolio back to Australia. In fact, as of November, it was at 35 percent, up from 22 percent in 2010.
Reading the mood 
In refocusing Charter Hall’s portfolio back to Australia, Harrison and Southon have correctly read the mood of global and domestic investors, whose preference is for Australian real estate. That preference comes, in part, because of the market’s resilience during the global financial crisis.
One case in point is the delisting of the A$1.2 billion Charter Hall Office REIT (CQO), which was privatized in 2012. Canada’s C$76 billion Public Sector Pension (PSP) Investment Board joined Singapore’s GIC Private to each acquire a 42.5 percent in the Australian office portfolio. Charter Hall retained a 15 percent stake and continues to serve as manager.
Subsequently, PSP joined Charter Hall to acquire Bateau Bay Square, a regional shopping center located along the central coast of New South Wales, for A$164 million. The Canadian pension and Charter Hall again joined forces last June, this time in conjunction with Australian super-annuation Telstra Super, to acquire Bankwest Place/Raine Square, a Perth office complex, from the receivers of Westgem Investments for A$458 million.
PSP did not respond to repeated requests for comment, but the pension is thought to have invested some A$1 billion in Australia, mostly with Charter Hall. “PSP sees Australia as the market for yield arbitrage,” one source tells PERE. “It likes leverage because it can use that as a natural hedge to currency risk. If you leverage up to 50 percent in Australian dollars, the only currency risk is on your equity.”
Unlike PSP, GIC first invested in Charter Hall via its funds some seven years ago. Today, the sovereign wealth fund’s total investment is in excess of A$500 million. 
GIC, which has investments with several Australian fund managers, declined to comment when approached, citing a policy of not commenting on individual investments. However, given its strategy to invest with select partners around the world, industry observers say GIC is likely to continue to invest in partnerships with property managers like Charter Hall, which can offer them access to quality assets.
Relationships also matter. Andrew Glass, who looks after Charter Hall’s A$2.5 billion in pooled funds, returned to Australia to join Charter Hall in 2009 after a stint with GIC in Singapore.
A shrewd buyer  
Over the years, Charter Hall has carved out a reputation as a shrewd buyer of real estate. This was especially true last year, when the firm engaged in a round of frenetic acquisitions and divestitures totaling an estimated A$3 billion.
The hard-nosed agent in Harrison has successfully sniffed out enviable off-market deals such as the purchase of Brisbane Square in the central business district of Queensland’s state capital. Charter Hall partnered with Telstra Super, one of Australia’s most active industry superannuation funds, to buy the building for A$300 million in 2010.
The building was pre-leased at A$300 per square meter and, upon completion in 2007, Brisbane’s market rents had risen to A$500 per square meter. “Even today, we still have tenants paying A$320 to A$330 per square meter, and market rents average A$600 per square meter,” Harrison tells PERE.
Brisbane City Council, the anchor tenant, is halfway through its 20-year lease, and Charter Hall will receive market rent for two-thirds of the 38-story building over the next few years when rent reviews come into effect. Based on expected rent revisions, the value of Brisbane Square should be about A$420 million, Harrison says.
Although Telstra Super declined to comment for this report, the superannuation has co-invested with Charter Hall on some A$1.2 billion worth of assets. In 2013 alone, it partnered with Charter Hall on two transactions – the purchase of Bankwest Place in Perth and the acquisition of eight neighborhood and sub-regional shopping centers from supermarket giant Woolworths for A$226 million.
Tapping in the supers 
Decision-makers like Greg Lee, who runs the property division of the A$13 billion Telstra Super, are astute custodians of members’ savings and choose their partners cautiously. In a testament to its abilities, Charter Hall has attracted several such superannuation funds, including the A$25 billion Retail Employee Superannuation Trust; the A$41.1 billion VFMC, which invests on behalf of public servants employed by Victoria’s state government; and the A$20 billion Funds SA, owned by South Australia’s state government.
James Druce, equities analyst with Commonwealth Bank Research, likes the long-term prospects of Charter Hall for its ability to leverage the growth in Australia’s superannuation industry. He notes that Australia’s superannuation industry has grown at a compound rate of 12 percent annually since its inception in 1992, and the Australian Treasury has forecast growth of 7 percent annually from 2015 to 2020.
“We believe Charter Hall is well placed to capture that growth through its wholesale, listed and retail funds,” Druce commented in a recent report initiating coverage on the stock.
In addition, fund manager Peter Davidson, head of property securities at BT Investment Management, notes that Charter Hall is the only one of the larger listed Australian property companies targeting the self-managed superannuation market. “It is the fastest-growing segment of the superannuation market,” he says. “It represents one-third of the Australian system (now standing at A$1.75 trillion).”
Macquarie’s Green believes there is no other firm in Australia that has the breadth of relationship with Australian institutional investors that Charter Hall has. “The property types (industrial and grocery-anchored centers) they are in – and are good at – are the sectors that institutions want to invest in,” he says. “The outlook for those two segments is strong for the next three to five years.”
Ken Atchison, an asset allocation consultant who advises small superannuation funds with a collective investment of A$3 billion, adds: “They tick all the boxes. We are quite comfortable with them as manager of some of our clients’ funds.”
That assessment is typical of other fund managers who spoke to PERE on background. Indeed, they say Charter Hall has managed its business in line with the investment appetite of large investors, who typically want sector-specific funds.
Building a brand 
“We came into the market at a difficult time,” recalls Southon, who founded the company in 1991 with two partners – Cedric Fuchs (now an executive director of the unlisted Charter Hall Direct business) and Andre Biet (since left the group). “There was a run on property syndicates and trusts in the early 1990s, and Australian banks were over-exposed to property in a declining market following a sustained period of growth. Consequently, the industry faced a significant liquidity crisis.”
At the time, Southon was working at Eurolynx Properties, which managed a number of property funds through Heine Funds Management. “We could see that there might have been a more cost-effective way for Eurolynx to service its unlisted property trusts during this very challenging period in the Australian property market,” he says. “We submitted a proposal to the Eurolynx board to provide these services externally, allowing us to establish our own business with the potential to attract other clients requiring specialist property skills.”
Despite being a newly-minted company, Southon and his partners understood the importance of brand. “We tossed around a few names,” he recalls. “We didn’t want it to be named after an individual because we recognized that value is built around businesses rather than individuals.” 
Charter Hall came up because it sounded “secure and solid” at a time when everyone, especially banks, were searching for some stability in the property sector. To reinforce that image of stability, Southon and his partners took their first publicity shots at the NSW State Library, with its imposing columns and sandstone walls in the background.
“It seemed to work and, as often is the case, perception became reality,” Southon adds. “We gained the confidence of the banks and a number of major corporate and high-net-worth clients.” 
In those early days, Charter Hall focused on cash flow and property services to third-party clients, including workouts for banks and solutions for corporates. For example, when IBM Australia had difficulties selling its office campus at West Pennants Hills, a northern Sydney suburb, the firm solved the problem by establishing one of Australia’s first property income securitization schemes. It facilitated the structured transaction using a 15-year triple-net sale-leaseback to IBM, raising about A$78 million from high-net-worth investors and a syndicate of foreign banks to fund the deal. The IBM transaction provided a significant endorsement and positioned the boutique business as institutional quality.
Taking it to the next level 
By 2004, Southon and his partners realized that, to move the business to the next level, they would need to increase the size of its balance sheet and expand its management capability. As a result, Charter Hall sold a 50 percent stake to a large Australian group, Transfield Holdings, and Southon identified Harrison as the person most likely to assist with driving the future growth of the business.
Contemporaries in their undergraduate days at the University of Western Sydney, Harrison and Southon individually had built their careers in different yet complementary aspects of the property industry. Upon graduation, Harrison went on to build a highly successful career of his own, quickly moving from being a valuer to running the commercial agency business for Raine and Horne Commercial, one of Australia’s largest home-grown property agencies.
“In 1994, I bought the business in partnership with a large conglomerate, Hong Kong-based First Pacific Davies,” recalls Harrison, who ended with a 20 percent stake and reinforced his reputation as a high-flying dealmaker. “We grew the (agency) business from 20 to 900 staff in about 10 years.” 
That growth was boosted by the purchase of Byvan, the biggest independent manager of 200 shopping centres in New South Wales. In 2000, the British firm Savills bought First Pacific Davies’ agency business, including its Australian operations, to establish an Asia-Pacific footprint.
Harrison had been toying with the idea of starting a fund management business when Southon approached him in 2004. He regarded Charter Hall as a “nice little business that chugged along,” but he liked the brand more and insisted on a total restructuring of the firm if he was to be part of its future. Southon and his board agreed, resulting in the departure of Biet. 
In divvying up responsibilities, Harrison took on investment management, transactions, capital raising and interfacing with investors. Southon assumed operational oversight for Charter Hall, dealing with property and support services needed for a sustainable, scalable platform.
Meanwhile, Harrison wasted no time in preparing the listing of Charter Hall on the Australian Stock Exchange and quickly assembled a portfolio for Charter Hall Property Trust. That trust was stapled to Charter Hall and floated as the Charter Hall Group, raising some A$270 million in June 2005. The newly public entity had some A$400 million under management and, within 30 months, that amount grew tenfold to A$4 billion. 
Fostering long-term relations 
Bolstering Charter Hall’s standing and strength in the market are long-term relationships with the likes of John Gandel, one of Australia’s richest men. “In the wake of the global financial crisis, the whole property sector was struggling,” says Peter Kahan, chief executive of the Gandel Group. “We believed it would consolidate and produce opportunities.”
In May 2009, the Gandel Group committed A$82 million to Charter Hall and its core funds to give itself exposure to offices and other property types. The family office currently holds approximately 18 percent of the stock, 6 percent of Charter Hall Retail REIT and interests in other funds. Other major investors in the parent company include AMP Capital (6 percent); Commonwealth Bank (10 percent) and Macquarie Group (11 percent).
“We were looking for people with an excellent track record in real estate and in situations where we also could bring our own real estate expertise and capital to contribute to long-term growth,” says Kahan.
In addition, the Charter Hall team has demonstrated the ability to create value. “There are many instances when they have bought well in off-market deals and added value to the properties,” Kahan notes. “Charter Hall has an extensive network in the marketplace and the value-adding skills to enable this to happen.”
In total, the Gandel Group has investments in Charter Hall and its funds that are worth well over A$300 million. The Melbourne-based family office is a happy investor, Kahan says, noting that its investment in Charter Hall has significantly outperformed the benchmarks for A-REITs in Australia. One source tells PERE that Gandel’s investment has doubled in value since 2009.
Still, it is fair to say that not all partners have enjoyed a positive experience with Charter Hall. For example, Malaysian developer TA Global recently parted ways with the firm, buying out the 50 percent interest of its joint venture partner for A$97.8 million. TA Global’s executives declined to comment on the break-up, although they noted the developer is content to go it alone on the A$600 million residential project known as Little Bay Cove, located in Sydney’s highly-sought Eastern suburbs. 
Industry sources suggest there clearly was a clash of corporate culture between the Malaysians and Charter Hall. Several months before the official break-up, the strain in the relationship was grist for the industry’s rumor mill. One source says: “TA Global wanted to speed up the project, but Charter Hall was reluctant to do so.” 
The truth is that Charter Hall probably was looking to exit residential development, a legacy business from the days when it was a much smaller company. Frankly, residential development has become increasingly the odd man out in the overall scheme of things for the group.
Instead, Charter Hall has chosen to focus on retail, industrial and office – sectors in demand with institutional investors. Its latest fund launch was the A$400 million Core Logistics Partnership wholesale fund, and the firm has a 50 percent stake in an industrial development company, CIP, which has built more than one million square meters of industrial and logistics properties.
Gauging future growth 
John Kim, REIT analyst with independent brokerage firm CLSA, notes that Charter Hall has grown its funds under management at a compound rate of 31 percent year-on-year since 2009. “We believe that growth of 6 percent to 10 percent will continue and that margins will continue to improve, particularly as demand appears resilient and embedded rental growth supports asset values,” he says.
Some investors, however, are wary of Charter Hall’s rapid growth. “I worry that, when growing funds under management is front-of-mind, a firm might be buying assets just for the sake of buying,” says a senior executive of a state government superannuation fund, who asked not to be named. “Charter Hall is juggling with many funds – a situation that potentially is open to conflicts – but I have to say that, so far, they have been successful and have established themselves as leaders in their market segments.”
Harrison is defensive. “Having digested the A$6 billion Macquarie platform, we’ve got a fair bit of experience in scaling up the business and handling growth,” he tells PERE, adding that is it reasonable for those not familiar with the group to express concern.
“We’ve been good buyers and good sellers” Harrison adds. “We have divested A$1 billion worth of assets in the past year in order to recycle capital when total returns have maxed out.”
Besides, Harrison notes that Charter Hall has a natural ‘handbrake’ through the presence of its wholesale partners on its investment committee. They have the final say on all acquisitions or disposals. 
Kim believes Charter Hall may face some near-term headwinds from A$580 million of capital recycling – one of the reasons its funds under management growth slowed in the second half of 2013. A bigger balance sheet would provide the group with flexibility to maintain and grow its recurring earnings, he says. It also would allow the group to warehouse assets for sale and give it flexibility to participate in fundraisings.
The management of Charter Hall, however, takes pride in having a small balance sheet and keeping debt to a minimum (currently 9 percent), seeing it as a way of “future-proofing” the business. “One of the attractions of our business model is that, when the market turns down, acquisition fees will be replaced by divestment and performance fees,” says Harrison. “We are not like our REIT peers, which own assets on their balance sheets and, if the market falls, are going to fall with it. In a falling market, we will continue to generate income from divestment fees as we will sell assets.”
Another benefit of Charter Hall’s model is margin expansion. “Roughly 35 percent of our fund management revenue is profit,” says Harrison. “As asset values rise in line with rental increases, we get extra revenue for doing nothing. With fixed rental increases, our minimum rent review is 3.8 percent. So even without cap rate compression, we get A$380 million in appreciation on our A$10 billion-plus port-folio. And that will add A$2 million to our bottom line.”
Within a low interest rate environment, property has its place as a defensive asset. As a result, Harrison expects Charter Hall to grow at 10 percent per year. “I am not saying that we want to be a A$15 billion, A$20 billion or A$30 billion company,” he says. “We seek to grow where it will give us the greatest earnings growth and return on equity. We are the only (listed property) group that can boast a 12 percent return on equity, and we want to significantly increase the return on equity invested with us.” 
Charter Hall Group 
Founded: 1991
Listed: 2005
Headquarters: Sydney
Number of offices: Five, plus 21 regional hub offices
Key executives: David Southon and David Harrison
Total number of employees: 300
Total assets under management: A$10.3 billion, as of June 30
Total space under management: 56 office buildings (1.05 million square meters); 96 retail centers (900,000 square meters) and 39 industrial assets (800,000 square meters)
Oranges and lemons 
How a challenge from a US hedge fund turned sour 
In the wake of the global financial crisis, a growing band of US hedge fund managers were trawling through a weakened listed Australian property sector, which had been hobbled by a lack of available capital. Among such multi-billion dollar groups like Appaloosa Management and Och-Ziff Capital Management was Daniel Lewis, founder of New York-based Orange Capital.
Through the end of 2010, Lewis quietly had acquired shares in an underperforming listed property trust managed by the Charter Hall Group. By January 2011, he had become a substantial shareholder in the Charter Hall Office REIT (CQO), with a 5.09 percent stake. 
Almost immediately, Lewis fired his first salvo, challenging management plans to sell half of the REIT’s $1.65 billion US office portfolio to Australian superannuation funds. While most of corporate Australia still was in holiday mode – and after failing to elicit a satisfactory response from management – he took his complaint public, with the release of a seven-page letter to the Charter Hall board outlining his concerns. 
Sensing blood, other international hedge funds, including Point Lobos and Luxor Capital, bought into CQO. Working in concert with Point Lobos and Luxor Capital, which held 19 percent of CQO between them, Orange Capital raised shareholder activism to new heights in Australia, seeking to replace Charter Hall with their own manager.
Lewis declined to rehash history when approached by PERE for comment for this report. However, at the time, he told this correspondent: “Our role is not to be an agitator but, as a unitholder, we’ve expressed our view – which is to say that there are alternatives, such as selling or spinning off the assets. We’d prefer that to the proposed joint venture (with Australian super funds).”
In the final showdown, the trust’s Australian share-holders rallied around Charter Hall and voted 68 percent to 32 percent to retain the manager at an extraordinary general meeting.
In hindsight, it was perhaps a clumsy initial move by Charter Hall to sell some US assets to the joint venture. Reflecting on the episode, Charter Hall’s joint managing director David Southon says: “CQO was trading at a significant discount to net tangible asset value, and the US hedge funds saw an opportunity to attack its register.”
Agitating for a liquidity event 
According to Southon, the hedge funds’ strategy was simply to force a liquidity event by breaking up the trust’s portfolio, selling the assets individually and returning the proceeds to shareholders. “They were aggressively agitating for a liquidity event,” he says, “and attempted to achieve this by attacking our corporate governance and ultimately calling for a vote to remove us as manager.”
Notwithstanding the unsuccessful attempt by the US-based hedge funds, Southon says Charter Hall already was investigating a potential window of opportunity to divest its US assets. “Through an on-market process run on our behalf by Bank of America Merrill Lynch, Beacon Capital Partners was identified as a potential buyer of the $1.65 billion portfolio.” 
CQO, established by the Macquarie Group as Macquarie Office Trust, had almost half of its assets in the US through a motley of arrangements. These included joint ventures with Maguire Properties, a leading Southern California real estate investment trust, and the New York-listed Brandywine Realty Trust.
“We were sharing management fees with joint venture partners while still having to maintain a significant team in the US to manage those assets,” says Southon. “From a business perspective, it was more profitable and posed few risks to repatriate that capital to reinvest in Australia. For CQO unitholders, the transaction enabled proceeds from the sale of the US portfolio – at close to net tangible asset value – to be returned to them, leaving the trust with predominantly Australian assets.” 
Free of its US baggage, CQO was approached by Macquarie on behalf of Singapore’s GIC Private and Canada’s Public Sector Pension Investment Board to buy the remaining Australian portfolio in late 2011. Once again, unitholders, including Orange Capital, met to decide on the future of the trust. This time, they overwhelmingly approved the sale and privatization of the trust, which was renamed the Charter Hall Office Trust.