Eureka Report | Alan Kohler | Sentinel Adds Medical and Unloved Mining to Australian Property Portfolio
June 10, 2021
Today I’m talking to Warren Ebert, who is the Founder, Executive Chairman and Chief Investment Officer of Sentinel Group Australia. I last spoke to Warren five years ago which was a long time and I should’ve spoken to him before now because Warren is an interesting character, particularly in terms of commentary on the commercial property market. But also, he’s got a pretty good formula for providing a decent yield to income investors. He says he’s averaging 8 per cent, paid monthly. His trusts own various types of commercial property, retail, industrial and office, quite a few medical clinics and so on now, and much less retail than he used to. He used to be 60 per cent retail and now it’s 30 per cent retail, so he’s moving into industrial. But, look, it’s interesting and it’s a good alternative for people to get some income from. Here’s Warren Ebert, Founder, Executive Chairman and Chief Investment Officer of Sentinel Group Australia.
Warren, let’s just start with a reminder – since it’s been so long since we’ve spoken last – a reminder of what your business does.
Alan, Sentinel is a property funds management company who bought our first property, 15th of January, 2010. Since then, we’ve purchased over $2 billion dollars’ worth of property. We don’t buy residential, but we’ve got everything from chook farms to ferry terminals at Airlie Beach, shopping centres, offices… We try to – like the other great Warren, Warren Buffett – you’ve got to be fearful when others are greedy and greedy when others are fearful. We buy either sectors that people don’t like or in areas they don’t like and we’ve sold $829 million worth of property in the last four years and we’ve averaged an internal rate of return of just over 20 per cent and that’s your cash return to investors…
And what sort of yield do you average?
At the moment, we’re averaging distribution of 8 per cent, paid monthly.
Paid monthly, right, okay. What sort of gearing do you typically use?
At the moment, we’re at 54.56 LVR and with an interest cover ratio of 4.76.
Why do you use LVR, loan to value ratio? Is that the best way to measure gearing?
That’s the way the banks do it, that’s how they loan you money on what the property’s worth. If you want money off them, you’ve got to do it their way.
Do you have a separate unit trust for each property?
Not now, Alan. We started that in the early days because the average age of our investors are 64, so most of them have enough money, even though everyone would like a bit more, but they invest with us for income and a lot of those lost money in the GFC so they were very concerned where they were investing. Early days, we did all closed end single asset funds, but as we went along, all properties can have a problem at some time during their lives, so we found it much better to have open ended funds where you’ll have a group of properties but they’re very sector specific, so we’ll have an Industrial Fund, we’ve got a Regional Office Fund, we’ve got a Home Maker Fund and Shopping Centre Fund. We have only a handful of properties that are in single asset closed end funds now, the open ended is a lot easier to manage. Up here in Queensland, if you want to transfer some of your units to your family or to your superannuation fund or something like that, you have to pay stamp duty up here in Queensland, where that’s if it’s in a closed-end fund. Where if it is an open-ended, widely held fund, you don’t have to pay stamp duty, so there’s advantages there. We just had one of our Victorian investors last week who wants to transfer the units from joint names with his wife into his own so with that there’s no stamp duty. Once investors feel comfortable that you’re not going to put them into something they don’t like, our investors are very happy with that now.
Tell us about your fees, are you still charging a percentage of income rather than net asset value?
We’re just in the process of changing that at the moment, Alan, because the way yields have gone, when we started, we’re buying properties at around that 10 per cent average yield, so if you were getting 7 per cent of the next income, you were getting $7,000 dollars for every $100,000. Now they’re at 5 per cent yields, on a $100,000-dollar property, you would only get $3,500-dollar management fee and you’ve still got as much work. We’ve been forced to change…
I’m disappointed to hear that, Warren, that was a real point of difference that you had.
We still have a point of difference because we are the cheapest in Australia, Alan. I can send you the list of the other 30 funds…
Well, why don’t you just tell us what your fee is going to be then?
Our management fee works out at 8 per cent of net income, but that’s a yield change – I think we’re about 0.65 of net asset value.
You think? Come on…
What do you mean, you think?
Well, Alan, we’ve got 50-something properties and there are some changes. When we started off, it was a different fee structure. As it’s changing – I’m very good, as you know, but I can’t keep track of 56 of them. I can certainly send you the figures, but I’m pretty sure it’s 0.65 of the asset value. The average across all of our competitors is about 1 per cent, so we are still far less than everyone else.
My impression was, when I last spoke to you, your sort of methodology was to try to buy beaten up properties that you could fix up a bit and improve the rent, is that right?
Alan, that’s sort of the formula, but they’re not always been up, some of them are just not quite of loved. We’re certainly not a buyer of the new 10 and 20 year leases, because we can’t find value there. I think a lot of people are buying assets now that there is no chance that they can get their money back. If you buy a property with a new 10-year lease, well tomorrow it’s got nine years and 364 days, so it’s very hard to add value. So, yes, we’ll buy property either in unloved areas. We’ve been an active buyer in Darwin, we have about half a billion dollars in assets north of Mackay now and we also buy the sectors that are not as loved. We’re terrible, we buy mining sector because our investors are happy to get the distribution from that. Still pretty much the same – something that needs some work, whether it’s the location or the tenant or some work to the property.
What do you mean, the mining sector? What are you buying in the mining sector?
Well, we have 21 properties in Mackay and while it’s a reasonably diversified economy, we have a lot of engineering companies that’ll be doing work on mining machinery. We actually own the Adani headquarters in Townsville, so we couldn’t get any more deeper in the poo if we tried. I think we’ve got 14 properties in Townsville and a lot of that is leading towards the mining and even the residential sector is being driven by the mining. Massive mining influence up in the North and we’re about to start a residential subdivision, which is only a very small part of business in Sarina. And in January, there was 34 houses/properties that came up for rent and there was 400 written applications. That’s being driven by the mining sector up there. There’s a lot of mines that have been developed and expanded out in the Galilee and Bowen Basins that never get any press because it’s not very beneficial for the mining companies to promote it, but there is a lot happening up there.
It is interesting that you go through short leases rather than long-term leases. I mean, I think the conventional wisdom in property is the longer the lease, the better. Take us through why you prefer a short lease?
We’re buying a property down south at the moment, Alan – and I won’t say where it is because people would work it out – it’s got four and a half years to go, it’s an $80 million dollar asset and we’re buying that at a yield of 7.8 per cent. If that property had a lease of 7 to 10 years, the yield would probably be 5 per cent. We’re a yield buyer, we’re not a company that has been developed for funds under management, we look at how do we get the highest distribution to our investors every month, so we go for the sectors where there isn’t the competition. While, of course we would like to have a 10-year lease if we could get an 8 per cent yield. But some of these now you’re seeing are in the 3 and 4 per cent yield and by the time you put a stamp duty on that, it’s pretty horrific. Whenever we buy an asset, we look at how do we get out of this? If you buy a property with a shorter-term lease, say four years, if in four years’ time you can get a new lease you can actually sell it and add value. Whereas, if you buy a property with a 10 or 20-year lease, you’re not going to be adding value for nine years or 19 years…
Obviously, the shorter lease means higher risk, is that right? Is the trade-off, the old risk/return trade off?
Yeah, the risk/reward ratio, that’s right, Alan. But when we buy those properties with shorter leases, we’ll talk to the tenant. This one that we’ve got down south, they’re in a sector where they need to be. They’re actually needing more space now, it’s very hard to see them moving…
What sort of property is it?
It’s got a health-related tenant in there. It’s a commercial office with a health tenant in there. It’s much easier take a view on what the tenant may do in three or four years’ time. Where taking a view in what a tenant may do in 10 years’ time, I think is much more difficult. While you can count on income for 10 years, we always look at how are we going to sell this and how are we going to get our money back or make a profit on it? With the shorter-term leases, there’s certainly a lot more work but making money wasn’t supposed to be easy.
I think you’ve been moving a bit into health industries, how many medical clinics do you own now?
We bought three up in the Mackay region about three months ago. We have a large property down at Cleveland that is now zoned for medical facilities, so we’re looking at putting specialist centres and x-ray clinics and a number of other assets and we had another one opposite The Royal Brisbane, Alan, which we sold. We found that we got offered too good a profit to refuse. We have been making a bit of a push into the medical but it’s a very popular sector at the moment and we’re having trouble digesting the yields that people are paying. So we bought three up in Mackay and we had a very attractive yield up there and Mackay’s a very wealthy area so we see it going forward, not backwards.
How do you handle capital gains in the open-ended trust? I mean, I presume with the closed-ended trust, once the property is sold you distribute the profit to the unit holders. What happens in the open-ended funds?
In the open-ended, I’m not the tax expert, but we try to reinvest as best we can. If there’s a taxation liability for our investors, we make sure we return enough equity for them to pay the tax so they’re not out of pocket. Most of our investors, Alan, the last thing they want is money back, they’re after income to live off and when we return equity, our investors aren’t really happy with that. They know if they were getting 9 or 10 per cent distribution in a new asset, they’re not likely to get that. That’s not a real issue for us.
The other big shift that’s been going on is online shopping. Have you been moving out of retail and into industrial as a result of that?
We certainly have more industrial than we do retail, where I think probably the last time we spoke, Alan, we would have had probably 60 per cent of our portfolio would have been retail, now it’s down to 30 per cent. The home maker, bulky goods sector, hasn’t been affected too much. As a matter of fact, they’ve done really well if you look at your JB Hi-Fis and your Good Guys and Spotlight, all of those tenants. Retail is a dynamic business, it’s always changing. If it didn’t change, we’d still be shopping at corner stores instead of Woolworths and Coles. If you’re going to be buying retail, I don’t think you want to be buying a subregional shopping centre with a Coles and Woolies and a couple of DDFs like Kmart and Big W and 60-70 fashion stores, that’s very difficult. You’ll see some of them are converting to trying to get as much medical in as they can, get some more services. We’ve got one of our larger centres where we’re looking at converting a large part of it to office for Government tenants, because the one thing that shopping centres have is a lot of car parks. Typically with a shopping centre, you have to buy one car park per 10 square metres of lettable area, or three for 50 m2. If you can convert some of that bigger space into office, it’s a good utilisation of the space, but it’s always challenging Alan, it’s not easy, but once again, making money’s not supposed to be easy.
I read a piece the other day that said – I think it was about the UK – and it said the UK has 40 per cent more shops than it needs. Do you think that kind of thing is correct, that Australia has more shops than it needs now?
Certainly Townsville does, it’s got a lot, it has too many. While I say that about Townsville, our northern and regional areas aren’t quite as bad. I think if you have a look at the cities – and I think Melbourne’s probably a bit worse with another lockdown – it’s amazing that very few in the city, when you look at the turnover for, say, your liquor and coffee shops and some of those, they’ve actually been up over the last 12 months. If those people aren’t shopping in the city, they must be shopping in the suburbs. I think there’s too many shops in some areas and not quite such a problem in other areas. We found in our portfolio, the regional locations – we’ve got centres in Orange, Bathurst, Dubbo, some of those regional areas are really booming. The enquiry we’ve had from major retailers, we’ve got more enquire now than what we’ve had over the last five to seven years. I think Australia is going through a pretty dynamic change.
This is structural, isn’t it? Long-term change, as online shopping increases, you need fewer shops?
Yeah, certainly, I can’t argue on the online shopping, but I don’t think it’s quite as bad as people make out. I was at a conference a couple of years ago and – forgive me, I can’t remember the name of the CEO of JB Hi-Fi, but a fantastic retailer…
Sorry, Richard, if you listen to this.
He’s now gone to Premier, he’s now working for Solly Lew.
Best of luck to him! But I found that Richard said that when they opened a store in an area, they would find that their online would more than double, because if you bought a TV or a radio or something from JB Hi-Fi online and there’s a store in the area, if you have a problem you go into the store, you felt more comfortable. Once again, it’s a challenge, Alan. Fashion is certainly doing it fairly tough, I think that’s where people are buying things online. I haven’t found out how you have a coffee online yet, but no doubt someone will come up with it. But we’re still herd animals, people want to go and have a coffee or a meal at a restaurant. I know the takeaway meals, that has been a bit of a boom with Deliveroo and those type of companies. There’s always opportunities – as I say, if you get rid of some of your retailers and you put in more medical and health because that areas growing, if you can convert some of it to offices, there’s an opportunity to make money. If everything was static, then you don’t find the money making opportunity. It’s a challenge, but you can still find some wins.
What’s your view about office with working from home? There’s obviously been a boom in working from home as a result of the pandemic.
Well, I’m not a believer in that at all, Alan. We moved into new offices and I look forward to you coming up and visiting them. We moved into these in the 4th of January because my belief when we went into a lockdown that people would get sick of it and we’ve developed our offices to be, call it COVID-friendly. We’ve got 1,800 metre workstations, we have bigger boardrooms, we have concertina doors for two boardrooms. We moved in here on the 4th of January, the week after we went into lockdown, so we could still keep all of our people working and have the right space. If you want the same amount of people, you’re going to have more office space and certainly, some people want to work from home and there’s an interesting article in the paper yesterday where I think one in four people are having sex during the boss’s time while working at home. I think if boss’s knew that, they mightn’t be paying them as much…
Only one in four?
[Laughs] People are a bit shy, Alan, so I suppose they don’t want to own up. I think if you’re a younger person wanting to learn, I think you need to be in front of the boss. I think it’s very hard getting a promotion if you’re working from home. Some people with call centres, I understand how that works. But for businesses like ours, the reason that we do all the services, the leasing, the project management, the facilities is so that people can all sit down together and work through the issues. I know some of the larger banks, the reason that they don’t have all their people back at work is because they just don’t have enough desks. They went into the hot-desking and sharing and all that other stuff, now if they want them back in the office they just don’t have enough room. I don’t think this working from home will last. If you’re in a Government sector that actually doesn’t do much, I think you can be as productive at home as you can be in the office. But if you’re a business that likes to achieve result, then I just don’t see it working. I think we actually have a property in Canberra and while the Government moved out early last year, they didn’t move back in April because it was an older style fit-out with bigger offices, more space, so they need that extra space. We have another property in New South Wales that has the police and when I was there before Christmas, I said, “Gee, it’s a big meeting room, you going to be making this a bit smaller?” I think they said that they have to have one person per 4 square metres in all their meeting rooms now and that won’t go back. They said, “The police can’t be getting either this virus or any other virus.” I think it’s changed a lot of work practises, as it has with shopping. I think structural change, as you said before, Alan, I think there’s a lot of changes happening and I think it’s going to be fantastic for regional areas and particularly North Australia and North Queensland. I think we’ve got a fantastic decade ahead.
I suppose the proof of it is in occupancy rates. Have you noticed any decline in either office or retail for that matter?
Certainly, in office people have been scared and the Government we have here, they don’t force their workers to come back to work so you’ve got still not as many people back in the office, but I’ve noticed where we are in Queen Street, the queues at the sushi bar at lunch time, where four or five months ago you might have had two or three people, now it’s up to 20 people. They’re still not all back in work and I think in Victoria a couple of months ago, not this lockdown, the one before, I think the following day there was going to be 50 per cent of Government workers – it was mandated 50 per cent to come back to work, instead of that they stayed at 25 per cent. There’s certainly issues at the moment and that’s going to take them a while to overcome. I think in Melbourne, there’s a lot more offices in the suburbs getting built, people staying out of the CBD. For some I’ve seen the incentives in the CBDs – well, the CBD in Brisbane have certainly gone up, landlords got scared very quickly and offered much bigger incentives because they didn’t want to have vacancies. They weren’t going to sit, but I think once it settles down, particularly in Queensland, we’ll be back to where it was 18 months ago. Certainly not recovering overnight, I know that. But in the retail – in our centre up in Cairns, we have higher foot traffic now than what we did February 2020. It’s a different type of shopper. Cairns, it was reasonably reliant on international visitors, we had three luggage stores, well now we only have one, people just aren’t travelling as much, but we filled one with a medical clinic. There’s challenges, Alan, but that’s what we turn up to work every day for, for another challenge.
Speaking of challenges, obviously the 8 per cent yields or distributions you’re getting now are terrific with interest rates so low and the term deposit rate in the banks under 2 per cent and so on. What happens when interest rates rise, both to the competition between yourself and term deposits, but also your capitalisation rates?
Alan, I won’t argue with you on that point, but I’ve been getting told for at least seven years to lock in interest rates because interest rates are going up and I didn’t, and they haven’t. One day, they will, I don’t doubt that. But I just can’t see them going back to where they are. I’ve always been of a belief that interest rates in Australia are dictated by Sydney housing. Most people in Sydney buy near the top of the market and they just can’t raise interest rates, they’ve got 0.25 per cent, 0.5 per cent – but when that happens and I read your report loyally, even though we haven’t spoken for five years, Alan, I still read it every week and I know a lot of people are talking about inflation, but with inflation you get a rise in real assets. With inflation, you can actually sell into a rising market. You don’t want to be waiting until interest rates get too high, but with the first couple of increases in inflation, if you want to sell, you can sell. Given that we’ve got almost five times interest cover and we put away for every one of our properties every month and I think in our office fund at the moment we’re putting away 14 per cent at income, so we’re prepared for a few interest rate rises and we’ll still keep paying the same distribution, so we’re fairly relaxed with that and I look forward to a bit of pain for some of the others who have been paying too much for assets. I look forward to interest rate rises.
Great, good to talk to you, Warren.
That was Warren Ebert, the Founder, Executive Chairman and Chief Investment Officer of Sentinel Group Australia.
Australia and New Zealand Property Journal