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National Executive Report to Annual Meeting 2017 – Future of Education House

The purpose of this report is to recommend to Annual Meeting that the National Executive be empowered to sell 180 Willis St, Education House West Block.

Resolution

That this meeting resolves to accept the recommendation of the National Executive that the building at 180 Willis Street, Wellington, known as Education House West Block owned by Education House Limited, be sold and that the National Executive be delegated to arrange for the sale and be authorised to sign any necessary Director and Shareholder Resolutions of Education House Limited to facilitate the sale. 

Summary

Over the past 18 months, NZEI Te Riu Roa National Executive has considered extensive advice about the future of Education House, at 180 Willis St, and has agreed that it is not in the best interests of NZEI Te Riu Roa to continue ownership of the building.

It’s now up to the Annual Meeting to make the final decision whether to accept or reject the Executive’s recommendation to sell. This document explains how we arrived at our recommendation, and outlines the way forward in both the “Sell and Invest” and “Keep and Improve” scenarios.

What led to this recommendation

Education House East Block was built by NZEI Te Riu Roa in the 1960s and Education House West Block in the early 1970’s. Both buildings have been a major part of our history and to many of us today West Block feels like our home. However, it is National Executive’s job to ensure the union is working for all our members, and this includes making financial decisions in the interests of everyone.

Over the past approximately 18 months, we have received extensive professional advice that Education House would need several million dollars spent on it in the short to medium term in order to keep existing tenants and attract new ones.

Even with a major facelift, Education House could not attract the rental returns that would make a major investment in the building worthwhile.

In short, the professional advice was clear that members would get a greater return by investing the equity from Education House elsewhere.

In addition, selling would remove some major financial risks due both to the ongoing and unknown cost of the building’s upkeep and the risk of having most of our equity invested in one building.

It has been a difficult decision to make, but a familiar one; we reached the same conclusion about the East Block of Education House, which is why it was sold in the early 2000s.

What we thought about when the idea to sell was first suggested

Like some members will feel, when we were first asked to consider the idea that Education House be sold, our initial reactions included the following thoughts:

  • This is our home and has been for more than 40 years, we moved in in 1975
  • We like coming here it feels like home
  • It’s easy to get to and from the TAS (Abel Tasman Hotel).
  • We have over forty years of history in this building
  • This might be hard for members as it is such a significant decision
  • The decision must be from the membership

But ultimately we were clear that our work is about people, not a building.

What is NZEI Te Riu Roa about?

Our strategic plan is clear about what we stand for:

  • We are about advocating for quality public education for all tamariki.
  • We are about supporting our members at work and getting them the best possible terms and conditions.
  • We are not about being a landlord and we do not have a mandate to expose our members to unnecessary financial risks.

History (and what’s changed)

NZEI Te Riu Roa established Education House Limited in the 1960s in order to build the front building East Block on Willis Street, and also to allow the union to be involved in commercial activities that would subsidise its core activities.

The construction of the East Block was funded from a combination of borrowing and bearer bonds, which members at the time were able to buy. The bonds covered about 20% ($100,000) of the total cost of $517,000 with the remainder funded by borrowing.

The West Block was built in early/mid 1970s. This time the build was funded almost entirely from borrowing.

The National Executive at the time, and future National Executives, have been adamant that neither the building nor any other commercial activities should be funded by member subscriptions.

Throughout the 60s, 70s and 80s NZEI Te Riu Roa was involved in various printing and publishing businesses, as well as being a building owner and landlord to tenants in Education House.

In the 1980s we decided to refocus on our core activities and get out of the printing and publishing businesses, as this became more of a specialist field.

Then, in the late 1990s we considered whether it made financial sense to continue to own the buildings and continue in the landlord business. A confidential National Executive report “Review of Continued Ownership by NZEI Te Riu Roa through its Membership Owned Company Education House Limited” recommended we sell East Block but also suggested that careful consideration should be given to the ongoing ownership of the West Block as well.

East Block was sold in 2000.

Throughout the years, Education House has held an important place in our collective history.

National President Neville Lambert died in 1993 while in office, and his body lay in state on level 13, which we will have to acknowledge with due respect if we were to ever move out.

We have launched many powerful campaigns from the building. At one stage we hung the “State Schools Great Schools” banner from level 13.

Many of us have worked in, or visited colleagues at Education House for years. To many of us, it feels like home. But it’s the view of the National Executive that practical reasons and risks outweigh any feelings we as individuals have about the building.

These factors are outlined below.

The options: Sell and Invest, or Keep and Improve

National Executive has received advice from several property consultants about the upcoming and ongoing costs of maintaining Education House and has decided it is no longer a good investment for the institute. The advice was based on a range of factors including:

  • The cost of upgrades
  • The likely income from an improved building
  • The cost of insurance
  • The implications of future changes to the earthquake code
  • Other unknown future risks
  • How well alternative investments were

When weighing up the decision, National Executive compared the performance of our $ 7 million AMP investment portfolio – our second largest investment after Education House ‐ with the likely earnings from an upgraded building.

The results show that if we sell Education House, and invest the proceeds in our AMP portfolio instead, we would have an additional $4.2 million in equity in five years’ time.

We felt this comparison was compelling.

The chart below shows the value of our combined investments in both the Sell and Invest and Keep and Improve scenarios. The better result from selling and investing is mainly due to a combination of avoiding capital costs related to refurbishment and better returns expected from investing the net proceeds.

A comparison of the projected return on investments if we sell or do not sell, from 2016 to 2021; the 'sell' option increases to $20M by 2021 while the don't sell option shows less than $16M

Assumptions:

  1. The AMP Return on Investment assumed for projected returns is 38% (c.f. a 6.84% average rate achieved over the last 10 years) with all returns being fully reinvested.
  2. Projected capital expenditure on Education House is based on consultants’ reports indicating a total of just over $5m required in the next few years mainly for replacement of windows ($2.2m) and modernisation of floors ($2.2m).
  3. The “Don’t Sell” projection assumes a rise in the building valuation of $0.5m per year out to $12m by December
  4. The “Sell” projections assume proceeds of $9.5m based on December 2016 valuation less potential selling cost of $250K.

In addition we looked at the risk of putting the bulk of our investment in one place. In December 2016 Education House was independently assessed at $9.5m making it the highest value asset we own.

The next highest value asset is the AMP investment portfolio of around $7 million. From a financial point of view this large $9.5million investment in the building represents a disproportionate weighting of investment in the property sector that leaves us vulnerable to risks associated with the current climate of the Wellington property market. By contrast, the AMP investment is spread over a variety of investments therefore reducing the risk of exposure to a single market sector.

Keep and Improve

The building is in average condition but will need several million dollars spent on it in the short to medium term in order to keep existing tenants and attract new ones.

Key considerations for “Keep and Improve”:

  • The advice we received was that there is an oversupply of office space in Wellington and less demand for space at our end of town – the Parliament end is more
  • Even with a major facelift, we could not expect the level of rental income that would make a major investment in the building
  • If earthquake code requirements were to change requiring strengthening of the building‐ beyond its current assessment of 70% of code‐ this will cost at least $18million.

In addition we are facing the following costs in the short term. These were estimated by our quantity surveyors.

Item 2017 Cost Estimate
Paint and repairs to the roof $135,000
Replace roof (at the same time windows are replaced) $260,000
New windows $2,350,000
Painting and sealing the outside of the building $320,000
Scaffolding to do above $450,000
Total outside of the building (if roof replaced) $3,380,000
Modernise floors $200,000‐$650,000 per floor X 9 $1,800,000 ‐ $5,900,000

Four floors of Education House have already been renovated along with some smaller tenancies. In most cases we have spent less than was estimated, but even in a conservative scenario any new costs are likely to be significant.

We have already budgeted to paint the roof and outside of the building in 2017 but this does not address the issue of deteriorating windows or roof.

How would we fund an upgrade?

In the Sell and Invest vs Keep and Improve graph above, we allowed for approximately $5.1million dollars of reinvestment over the next five years to cover work on the exterior and continuing work on an upgrade of some floors.

There are three options for funding this work: Increasing membership subscriptions, borrowing from a bank, or taking money out of other investments.

1. Subscription increase:

To fund the $5.1m required over even the next 4 years would require an increase in subs of around 7.3% over and above any CPI increases.

This would be contrary to the general policy of maintaining separation between ‘business as usual’ union activities from investing activities.

2.  Borrow from a bank:

This would involve (a) prioritising repayment commitments, (b) restrictions on title, and (c) interest costs being subjected to market rate increases.

Annual interest costs would likely increase to $408K within four years based on an interest rate of 8%. Because most tenancies are locked down for the next four years, we can’t assume recovery from rental income. This interest cost would therefore need to be funded from either a subscriptions increase of approximately 2‐3% or draw down of investments.

While separate investments were retained, the net effect would be having borrowed to invest which makes little sense.

3. Exit existing investments:

This would further compromise the balance in spread of our overall investments. For example, $5.1 million over the next 4 years taken from a diversified AMP portfolio to fund a single property.

Although preferable to the other two options, this will result in an equivalent amount of income lost. AMP investments have been providing gross returns of around 8% over the last 5 years which means this loss would also require funding from subscriptions or even further draw down of investments.

In summary, the Keep and Improve option puts NZEI Te Riu Roa in a significantly worse financial position, but it does mean we can remain based in the building we call home.

Sell and Invest

The estimated market value of the building has been put at $9.5 million. If the building is sold, any proceeds from the sale would be invested.

As described above, the advice we have received is that the combination of avoided upgrade costs, and earnings from investing the proceeds from the sale elsewhere would result in a net benefit of about $4.2 million over five years.

NZEI Te Riu Roa would remain based in Wellington central either as tenants of the existing building, or we will move to another building.

NZEI Te Riu Roa currently pays about $414,000 per year to Education House Limited in rental. This has been factored into the financials above.

Any future rent we pay will depend on whether we remain in the building, or move closer to the CBD.

Consultant advice and Net Present Value calculations

The National Executive engaged two different consulting firms to give us advice about the future of Education House. In summary, their advice was as follows:

  • The building is of medium quality. With the exception of recently refurbished parts the fit out is dated, there is limited street profile. To attract and retain tenants we need to continue to strip out cubicle offices, install air cooling and fresh air systems, replace ceilings, lights, carpet and paint. We also need to replace the windows, seal and paint the building and replace the roof.
  • There is good car parking and road access.
  • Due to Wellington property market factors, refurbishment and reinvestment will not result in substantial increases in returns. Education House is in the less desirable part of town as the CBD has drifted north. As well as this, there is a strategy for government tenants that does not involve our end of town. Because of this, reinvestment doesn't result in significantly better returns. Our rental return is around $200 per square metre. We simply aren’t in the area of town where landlords can achieve $500 + per square metre.
  • Education House will not be able to fund the refurbishment and reinvestment currently required. It doesn’t generate sufficient surplus income to pay for what needs doing.
  • In our circumstances spending significant money on the building has a negative financial result. Both consultants calculated Net Present Value (NPV) from a variety of upgrade options as below. The resulting negative NPV calculations mean that in each of the four options below, involving additional cash outlay of $4.9, 6.7, 7.3, or 12.7million being required over the future ten year period.
Option Cost/investment NPV over 10 years
Deferred maintenance $2.3M -$4.9M
Basic works $6M -$6.7M
Moderate upgrade $7.8M -$7.3M
Modern upgrade and strengthening $14.6M -$12.7M

From Twenty two presentation

Assumptions:

  1. NPV discount rate of 5% and initial value of EHL at $8m (from 2015).
  2. Deferred, Basic and Moderate options assume all works can occur with tenants in The $14.6m investment option requires complete vacant position with no relocation, buyout, or tenant fitout costs included in the cost estimates.
  3. Rental paid by NZEI Te Riu Roa for its occupancy is excluded from rental income to show cost of occupancy and allow comparison of options.

Financial performance of the building over the last ten years

The graph below illustrates that, on the basis of a straight investment decision alone, the comparison between investing in Education House as compared to a diversified portfolio does not stack up, let alone having to contemplate the magnitude of future expenditure required to further invest in the building going forward.

Chart explains ROI of our AMP portfolio compared to EHL from 2007 to 2016; in general the AMP portfolio shows a higher return

Notes:

  1. The data used for the above graphs confirms that total revaluation gains achieved for Education House over the last 10 years fell just short of capital expenditure spent over that time
  2. The AMP portfolio is a relatively conservative diversified portfolio across all market sectors with less than one third invested in growth markets
  3. Returns shown are gross e. excluding any deduction for tax obligations

Conclusion

When we considered all the factors, financial performance over time, costs and risks we are facing, the Wellington property market and the potential to do better with our money invested elsewhere the obvious conclusion was that we should sell the building. This is why we are proposing the sale.

Process

If the decision is to sell

We will likely take a lease until 2021 to match the time on other existing tenant leases.

An initial plan which steps out the process of putting the building on the market has been developed. We will seek professional advice on this process to ensure we achieve the best possible price. We will run a contestable process to select agents and then likely sell through a tender process. A minimum price will be set based on the most recent valuation at the time.

There are no specific plans about where NZEI Te Riu Roa may be located in the longer term. That decision will depend on the factors of price, lease, availability, and premises fit for purpose. Staff have been reassured that we will be in central Wellington with an earthquake standard as high as we can achieve.

If and when NZEI Te Riu Roa leaves Education House we will need to work through a process to acknowledge the wairua of the building and take this with us. The National Executive will work with Te Reo Areare on this.

Proceeds of the sale

There are no specific plans for the proceeds of the sale. We will have to pay any tax liability and the costs associated with selling. The remaining funds will be invested according to advice taken at the appropriate time.

There has been no consideration given to buying another building at this point.

Having sought and obtained professional advice about the best option for our future accommodation, National Executive will consult with Te Reo Areare, Area Councils and National Leadership groups.

If the decision is not to sell

We will continue to maintain the building, and manage tenants and returns.

The cost of mitigating risk will likely grow because of post‐earthquake requirements.

We will need to further explore how to best fund work to the outside of the building, from the three options as referred to under the heading “Funding options for building upgrades”.