Charter Hall Direct Office Fund

The Charter Hall Direct Office Fund is another unit trust established as a REIT. Charter Hall are a well-known ASX-listed company that manages a number of trusts and funds. The company has a $17 billion portfolio under management. Currently the Direct Office Fund’s valuation is around $840 million and the responsible entity (managers of the fund) is aiming to grow it to over $1.2 billion in the foreseeable future.  There is an offer open to raise $250 million worth of capital through purchase of Wholesale A units. The fund is returning 18.2% annually on Wholesale A units and has returned 17.1% since inception (November 2014 for Wholesale A units).

The fund holds nine properties directly in New South Wales, Queensland, Victoria and Western Australia with close to 100% occupancy. The fund is weighted at around 70% in the Melbourne and Sydney markets, 30% in other capitals. The chart below shows the value of the properties in the Direct Office portfolio against the lettable size of the properties. The size of the point gives an indication of the number of tenants leasing the property. The fund also owns a small carpark in Christie Street, Sydney (worth around $2 million) which not been included in the charts below.

value-v-lettable-area chart

Data: Charter Hall Direct Office Fund PDS. Chart: The Constant Investor.

Of the nine properties shown above, three in the mid-value range have a single tenant. The higher value properties have the most tenants and generally represent inner-city buildings. Two smaller, lower-value properties (bottom left hand corner) are located in North Sydney and there’s a building in the Perth CBD.

The fund focusses on the attraction of long term tenants and co-invests with other entities to maximize fund returns. The chart below shows the distribution of the value of the properties held compared to the average tenancy length of each property. The size of the points indicate whether the fund has a total interest in the fund (larger for complete ownership, smaller for partial ownership of around 50%). The red dots indicate properties under development, the green completed properties.

tenancy-vs-value chart

Data: Charter Hall Direct Office Fund PDS. Chart: The Constant Investor.

The portfolio holds a number of properties with relatively short average tenancy terms on each building (under 6.5 years). It also holds partial ownership of a number of buildings with much higher average tenancies of 12 years and over (the value given above is the value within the portfolio, not the total value of the building). Two of these are under development. One is a development in Parramatta specifically for the University of Western Sydney with a lease term of 15 years. The terms of this lease require the tenant to shoulder all occupancy and capital costs (with the exception of the roof and façade). This results in an investment with low on-going costs to the fund, but consistent, predictable returns.

Partly as a result of this involvement in development, the fund has a gearing target of 30-45%, actual gearing changes over time as the fund settles new properties or sells them. We have discussed the importance of gearing ratios in these types of funds.  Currently the fund has a $435 million debt facility and an interest cover ratio of 1.5. The fund has drawn $230.5 million from the facility and the all-in interest rate it is paying is 4.5% at the date of the Product Disclosure Statement. The debt facility is secured before unit holders. The fund aims to hedge against the interest rate on at least 50% of the funds borrowings.

The fund has a relatively long term lease expiry schedule: the long weighted average lease term is 9.2 years, weighted on the value of the property, not income. It should be noted that many of these longer leases are associated with large tenants who make up a substantial amount of the fund’s property income. The top five tenants by income provide 39% of the fund’s property income revenue. A default or failure on one of these leases would have a substantive impact on income, however the quality of the single-lease tenants is high: Westpac, University of Western Sydney and Aurizon are three of them.

Like many REITs, the fund is not very liquid. The fund anticipates an initial term to run until 2019 when the responsible entity will make reasonable endeavours to provide all investors with the opportunity to redeem their investment, should they choose. This may involve winding up the fund or selling properties at this time. Like some other REITs, the fund expects to make a semi-annual withdrawal offer.

The risks of this investment are much like other REITs that hold property directly. Macroeconomic downturn, interest rates, bond prices: all of these may impact on the fund negatively and we have discussed these before at length. A substantial amount of the fund’s value is tied up in development projects for single tenants. One of these is 900 Ann Street, tenant Aurizon, due for completion 2018 and the other is the Western Sydney University development due for completion December 2016. This is an additional risk, but both projects are well advanced and have general utility on the market. There are currently no future developments underway with the fund.

Unlike some other funds, rather than measuring performance with a benchmark, the fund focusses on total absolute return: performance fees (discussed below) are not tied to an index. Over the long-term the fund aims to return around 10%. Currently, the fund is returning comfortably in excess of that figure.

The minimum investment in the fund is $20 000 and distributions are intended to be quarterly. The fund is available to retail investors. There is no buy spread and the sell spread is 2.5%. The management fee is approximately 0.7% depending on fund expenses and the performance fee is between 15% after a hurdle of a 10% internal rate of return. The fund has a disposal and acquisition fee on properties of 1.5% (this is something like a buy/sell spread for buildings). Of note, the fund has been highly recommended by both Lonsec and Zenith research houses.