Taking Stock

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Taking Stock 22 February 2024

ONCE it became clear that the world had created ludicrous amounts of funny money, and maintained ludicrously low interest rates, the certainty of an era of bad debts was apparent.

Taking Stock and client confidential newsletters loudly warned that property trusts and especially single-unit, highly leveraged, unlisted property syndicates would face their bankers, here and everywhere. It followed logically that then, and now, was not a time to invest in global property.

In recent days it has become apparent that even the world’s biggest economies, with their insatiable anxiety about stabilising banks and asset values, cannot push back a tsunami.

China’s property world has been well prodded, poked, and assessed.

Bond defaults, bad bank loans, retail prices and empty buildings are the focus of examiners.

Not even China’s command economy can imagine a solution for empty cities – ghost cities – built with borrowed money in anticipation of internal migration.

The jobs created by those building programmes in effect eat up the availability of future employment, creating a sugar rush that in logic could not be digested. The labour required built the economy at the expense of tomorrow’s economy.

London experienced similar sugar rushes.

The great migration from the city centre left Oxford Street with dozens of empty shops, many thousands of workers moving to Canary Wharf where the wasteful were building elaborately, as though every suburb of London had streets paved with gold.

That trend has now reversed. The streets are paved with pothole mix, not gold. Oxford Street has beggars and the homeless visible everywhere.  Long-time iconic shops have moved.

Buildings face departing tenants. Values have slumped. The fund managers and banks who financed the construction now face loan defaults, debt servicing problems, and a predictably huge loss in value.

Office buildings in London have fallen in value by 13%. In Canary Wharf valuations are down by a much greater figure.

Ample space is available. Tenants are not. Bankers are stressed.

The problem is worse in the US, San Francisco the worst, with property prices down 40% (source MSCI – real assets), Manhattan 17%, Boston 13%, Los Angeles 9%, in the fourth quarter of last year.

The largest American cities have long attracted global managed fund investments in office properties, apparently attractive because of long leases and constantly reviewable rents.

All of these buildings were built with loans that were all but free of debt-servicing costs when the world was squashing interest rates by printing tens of trillions of dollars, often described as “quantitative easing”.

Many veterans of property markets correctly argued that “free” money never was a basis for good long-term returns, recognising that marginal businesses would not pay their rent when money was properly priced.

The graph of commercial property sales in recent years highlights the slump and highlights the vulnerability of global property funds.

By the fourth quarter of 2021, when money was virtually free, the Americans were enjoying lavish property sales each quarter. So were the Asians.

In the last quarter of 2023 those figures were down by 75% from their 2021 highs. Bankers faint when they see such a cyclical reversal.

Compared to pre-pandemic rates, occupancy rates in the USA were down by 50%, Asia and Europe down by 30%.

Today roughly one-fifth of office space in New York is empty.

The sad Canadian Public Pension fund recently sold its share of a Manhattan office tower for $1.00.

Of course, office space is not the only property category that is terrifying banks and other lenders (private equity, pension funds etc).

Of the $90 billion in loans to bankrupt or highly distressed tenants, some $35 billion is to office building owners, $20 billion to retail buildings, $10 billion to hotels, and $5 billion to apartments, almost none to industrial, the rest to others.

Whereas $90 billion of loans are in obvious distress, another $360 billion are in potential distress (delinquent, late payments).

Distress rewards the cash-rich, who foresaw the almost certainty of a backlash, when money was priced accurately.

San Francisco buildings are being sold at close to half their values of ten years ago, office properties selling at prices similar to the ugly lows after the dot-com devastation in 2001 and the global crisis of 2008.

Banks, private equity funds and pension funds will be in a shiver. So too will be those who were herded into investments in global property funds.

Old-timers will be recalling the 2007-2009 period in America when those who were unable to meet their debt servicing created the “jingle mail”, posting back their front door keys to their lender and fleeing from their homes, foregoing whatever money they had down on deposit (if any).

The banks wore the losses until the government used tax-payers’ money to bail out the banks.

Logically you might respond by observing that commercial building owners have no right to return the keys and flee.

But many such owners, like Trump, structure their debt in shell companies, with no assets to support the loan other than the building.

Dopey bankers, even dopier fund managers, and all-care-no-responsibility private equity funds will fund anything for an apparent price (a higher rate).

Those invested in these funds will soon learn, when delinquent loans lead to default.

Sales at half price might amuse the buyers but not those whose money has blown up.

In NZ the stress will be lower, our banks generally more cautious if only because they are better supervised, have more credible regulations, and exist in a country with a lower appetite for risk.

Yet even here there are bankers who right now are discovering the stress that follows their willingness to lend up to 70% of the purchase price on commercial buildings.

The borrowers that were classified as “premium” by the banks now observe valuation losses that would embarrass the lenders if the loans were not serviced. So far there have been no ugly defaults though players like Du Val are forcing lenders to become shareholders to avoid default. One owner of multiple Wellington properties refuses to have his buildings valued.

In NZ very high construction costs, based on high material and labour costs, high compliance costs, and a regulatory attitude that building owners regard as “over the top”, require tenants able to pay high rentals, often subsidised by taxpayers.

Rental demand in Wellington has usually risen when Labour governments have grown public service numbers, as Ardern and Robertson displayed between 2017 and 2023. Their mistakes have ended.

What we are seeing in China, Britain, America and in many other countries is symptomatic of a changing era, the end of funny money, the end of “free” debt.

New Zealand bankers will be on red alert. Property investors need to be watching carefully.

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PERHAPS the best decision Fletcher Building made in very recent years was to exit the vertical construction sector, having seen the issues faced by the likes of Hawkins, Mainzeal and many unlisted construction companies.

Fletchers had made childish errors under the hapless leadership and governance of the Mark Adamson/Ralph Norris era. 

Adamson, readers may recall, was the unwise Brit whose reckless, and often juvenile, public statements so damaged the credibility of his brief reign at Fletchers.

It was Adamson who told the media that all his executives, paid in millions, were grossly underpaid.

It was Adamson who instructed staff to bid for and win every large-scale tender, often leaving his rival bidders miles behind in his wake.

Constantly warned of risk, Adamson surged on. Others copped the flak when the speed wobbles were apparent.

Norris was Chairman when Adamson was appointed.

Norris had not long left his role as CEO of CBA Bank where his legacy was to be defined by a Royal Commission finding on the culture and behaviour of that bank.

Yet neither Norris nor Adamson were exceptions. There had been decades of remarkably unintelligent governance and leadership at Fletchers.

What Sir James Fletcher had created, using all his practical and political skills, began to fall apart as others sought to diversify from core skills, and pursue empire-building and vanity projects.

Hugh Fletcher, an academic and a poor manager, was haughty and arrogant, seeking to borrow to build assets globally, sometimes without much reference to his board of directors. His era left deep scars.

Did he believe Fletchers was a dynasty, a fiefdom? He will not be recalled for his building of a platform of stability.

One feels some sympathy for those who at that time were seeking to govern a large enterprise, yet having a CEO whose personal agenda did not seem to be controllable by a board.

Fletchers made easy money selling energy assets bought cheaply from the Crown.

It blew up billions through misguided attempts to become dominant in paper.

It evolved from Fletcher Challenge Industries Ltd into Fletcher Energy, Fletcher Paper, Fletcher Forests and Fletcher Building.

Now Fletcher Building retains the name of Sir James Fletcher but is nothing like the tightly-run company that was once a division run by real men like Jack Smith (a legend).

That era had long ended but just seven years ago a number of those real, experienced construction giants who had worked for Sir James Fletcher appealed to Fletchers to hold a meeting with the old-timers who had a long history of completing projects profitably.

They have retired but they still care.

I recall how one attendant at a 2017 meeting told me how they felt patronised and scorned by a modern Fletcher “manager”, on a modern corporate wage, running Fletchers in a “modern” way.

The group left, shaken and stirred, in despair, at the James Bond-like gung-ho response.

Today we have a building company with vertical integration, controlling materials and labour, with apparently fat margins in materials, unable either to tender wisely, and worse, bent on buying at inexplicable prices into other sectors of the market (pipes, as an example) here and in Australia.

Curiously, despite decades of dreadful governance and poor financial performance, and despite damning analysis from the likes of the late Brian Gaynor, we still have Fletchers in the portfolios of our poorer fund managers.

Probably bound by the same rules that saw it buying Synlait Milk shares at $15, one index fund manager confessed that it owned 23 million Fletcher shares, an investment that must have cost its hapless investors many tens of millions.

Some now argue that Fletchers needs a new leader who will restructure the tendering systems and restructure the pricing of materials, abandoning the 30% rebates to builders.

The contract tendering system is broken. The lowest bidder is often not the best suited for the job.

Real cost discovery is not enabled by granting contracts to the lowest bidder.

Major contractors know the system is gamed, and too often transfers unfair risk to sub-contractors.

Building materials are falsely priced, the rebates effectively meaning the retail market is gamed.

But these are not the reasons Fletcher Building has a share price of roughly one-third of what it was in 2006.

Put that down to dreadful governance (with a lack of real, in-depth relevant sector knowledge) and too often a culture of blame and fear, within a framework of greed.

Perhaps Fletchers should look to the old-timers to guide them on the principles that might produce a worthy company.

During my discussions with old-timers and with those who really are working to bring transparency to the building sector, I was repeatedly offered this warning: “Be wary of those who say they are offering to work for free.”

They point to the opaque world of rebates and other kickbacks. These practices preclude transparency.

It may be they lead to unfair assumptions.

But a 30% rebate on a $1 million invoice for materials is $300,000 of revenue that must go somewhere. Who pockets it?

The building company that says it would not add on a margin to materials required might be telling the truth.

There is no need for a margin if the hidden rebate is available.

The old-timers refer to the extraordinary wastage in the construction process, caused by delays in co-ordinating and managing the sub-contractors.

Horror stories abound. Big companies insist on using specified electricians and plumbers. When those skilled people are needed, but not available, time delays cost money. Sites might be idle for weeks.

The contracts often do not allow the use of those electricians and plumbers who are available on the day they are needed.

The old-timers refer to cost escalation. Concrete, asphalt, cedar, gib board . . .  they talk of price increases that seem, at retail level, nonsensical.

Is the Fletcher story the right catalyst for a Royal Commission into construction and building materials, led by engineers and old-timers?

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Wellington Airport

Wellington Airport (WIAL) has announced details of its new issue of 6.5-year fixed rate bonds, maturing on 4 September 2030.

The interest rate will be no less than 5.80% per annum but might be higher based on the indicative margin range and underlying rates.

These bonds have a credit rating of BBB.

Minimum investment is 10,000 bonds.

WIAL is not expected to pay the transaction costs for this offer so clients will be charged brokerage.

The bonds will be listed on the NZX debt exchange.  An investment presentation for the issue is available on our website here:


If you would like a firm allocation of these bonds, please contact us by 9am tomorrow, Friday 23 February. Payment will be required by Thursday 29 February.

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Summerset Group Holdings

Summerset (SUM) has announced that it plans to issue a new 6-year senior bond and expects to release full details of the bond offer next week.

Summerset is one of the leading retirement village operators in New Zealand, with 38 villages either completed or in development.

The initial interest rate has not been announced, but based on current market conditions we are expecting a rate of approximately 6.25%.

At this stage it is likely SUM will be paying the transactions costs for this offer, so it is likely that clients will not be charged brokerage. This will be confirmed next week.

The bonds will likely be listed on the NZX.

If you would like to be pencilled on the list for these bonds, please contact us promptly with an amount and the CSN you wish to use.

We will be sending a follow-up email next week to anyone who has been pencilled on our list once the interest rate and terms have been confirmed.

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Travel Dates

Our advisors will be in the following locations, on the dates below:

29 February – Kerikeri –David

1 March – Whangarei – David

5 March – Lower Hutt – David

20 March – Christchurch – Johnny

21 March – Napier – Edward

22 March – Napier - Edward

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee & Partners Ltd

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