Boom or bust for small cap developers
Small cap property companies should always struggle against their bigger counterparts because of a higher cost of debt and a smaller portfolio, which means less stable earnings streams.
One of their number, the residential developer Becton, will most likely go bust this week because it hasn't been able to meet its interest obligations to Goldman Sachs.
But lately there are other small caps which are bucking the trend as they transform their earnings to focus on areas of high demand and embark on avenues such as funds management to procure highly prized annuity income streams.
One stock Radar has tipped is Ingenia Communities, whose stock is up 36 per cent in 12 months. Under
new management, Ingenia has thrown off its baggage as an ING property trust and is now a focused owner and operator of retirement villages.
Another small cap property company that is managing a turnaround is Folkestone, the property development cum funds management vehicle of Greg Paramor, who previously ran Mirvac.
The company has a market cap of only $55 million, yet its share price chart looks like the Andes in South
America. Currently trading at 15¢, its stock has climbed about 50 per cent since early December, which has seen it pass the 12¢ at which it was recapitalised by Paramor & Co in early 2011.
Understandably, the veteran property investor and fund manager defends the development side of the business: “Property development earnings sometimes are [uncertain], and sometimes aren't [uncertain].”
Paramor makes the point that if you can build a pipeline of activity, investors will come to realise that its profits are not one-off in nature. But this requires scale, something Folkestone's $22 million of cash can't achieve on its own.
His next comment gives the game away:
“We'll end up with about 80 per cent of revenue from recurring income from management fees and 20 per cent from the non-recurring development business.”
Far from being property development, it has been Folkestone's $11 million acquisition of the Austock property funds management business in September last year, which has encouraged institutions to wade into the stock.
Because of the deal, Folkestone is now the largest owner of child care centres in Australasia. Austock was the former landlord of Eddie Grove's ABC Learning Centres, which has been taken over by the not-for-profit company GoodStart Childcare.
Suddenly, Folkestone is transformed! Now it is pursuing the so-called “social” infrastructure space, in which it is buying things like police stations and then leasing them back to the governments for long periods of time.
The funds management businesses are held in separately listed and unlisted vehicles, from which Folkestone receives a fee, and its cash can be used for property development.
On the property development side it says that it has return on equity hurdles of 15 per cent, which might be low for some small cap fund managers, but clearly not for others.