The JSE’s R300bn real estate investment trust (Reit) sector, which has been hammered because of corporate governance concerns as well as ailing profits over the past two years, finally seems poised for something of a rerating.
Industry players say the SA Reit Association’s new best practice recommendations (BPR) for financial reporting, released last month, will improve transparency.
That in turn should help restore battered investor sentiment.
The SA listed property index is trading at seven-year lows and roughly 35% below its record peak, reached in late December 2017.
The main goal of the reporting guidelines, which will be adopted by the industry from next month, is to encourage all Reits to use a standardised set of financial reporting measures.
Ultimately, this will make it easier for investors to understand and compare the performance of individual property stocks.
The review of the BPR guidelines, first published in 2016, is believed to have been prompted by last year’s unprecedented Reit sell-down.
The collapse was triggered by various reports accusing Resilient Reit and its former stablemates — Fortress Reit, Nepi Rockcastle and Lighthouse Capital — of insider trading, share price manipulation and publishing false and misleading statements. The latter related specifically to the consolidation of the Resilient group’s BEE entity, the Siyakha Trusts.
In March 2018, the group became the subject of an investigation by the Financial Sector Conduct Authority (FSCA). Given that the four companies represented as much as 40% of the sector’s total market cap in early 2018, the probe raised questions about corporate governance, transparency and the sustainability of earnings for the listed property sector as a whole.
Incidentally, the release of the updated BPR guidelines coincided with the conclusion of the last outstanding FSCA investigation into Resilient. That all four companies and their directors have been cleared of any wrongdoing has no doubt brought a sigh of relief to shareholders, and analysts believe it will allow the sector as a whole to move on.
The new guidelines were issued after 14 months of consultation with the JSE, the Association for Savings & Investment SA and the Reits themselves.
SA Reit Association chair Estienne de Klerk says it was imperative for the sector to revise its financial reporting standards and to issue more "robust performance measures to reinforce the sector’s track record of transparency and trust".
The new reporting guidelines introduce internationally recognised performance measures that relate primarily to how Reits account for income earned from their operations.
They also propose standardised ways to calculate key metrics such as NAV and loan-to-value ratios. And SA Reits will no longer be able to apply certain non-International Financial Reporting Standards financial metrics as broad principles, as they have in the past.
The most significant change is a new metric known as funds from operations (FFO) per share, which will replace distributable earnings per share (DPS) as the sector’s primary performance measure. According to Investopedia, FFO refers "to the figure used by Reits to define the cash flow from their operations".
Peter Clark, portfolio manager at Investec Asset Management, welcomes the move to FFO away from DPS (also referred to as dividend per share).
"It is an internationally recognised metric and a better representation of a Reit’s underlying operational and earnings performance," he says.
"There is a clear calculation methodology for FFO, which should create better consistency and comparability across the sector." He says FFO will help investors understand the rating and growth of any given company.
It’s also a better measure to assess performance when it comes to the rewarding of management.
Though FFO is not intended to be a pure cash metric, Clark says it should closely reflect the cash-generating ability of a Reit.
"Historically there has been too much reliance placed on DPS."
The adjustment from distributions to FFO is, however, likely to create some near-term pain for a number of Reits because it will eliminate any remaining elements of "overdistribution".
This refers to the once common practice of many property stocks to add one-off earnings and trading profits to their income payouts, which effectively inflates dividend growth.
Clark says FFO across the sector is now likely to be up to 10% lower than current DPS numbers.
Dividend growth for the sector as a whole has already slowed from about 5% on average last year to between 2% and 3% this year on the back of lower rentals and higher vacancies in many property portfolios. "But FFO will ultimately provide a cleaner and more sustainable earnings base," he says.
Given that adoption of the BPR is voluntary, it remains to be seen how keen SA Reits will be to sign up.
Clark says Investec Asset Management will push for adoption by all companies in which it invests.
"We expect and encourage other investors to do the same. Companies choosing not to adopt the BPR will be penalised for it."
Craig Smith, head of real estate research at Anchor Stockbrokers, says the second-edition BPR document is a definite step in the right direction because it will improve the overall level of transparency and disclosure in the sector and, in the process, improve investor confidence.
However, he says that as the recommendations evolve, the SA Reit Association should look at introducing additional standardised reporting guidelines for other property performance metrics such as rent-to-sales ratios and trading density growth.
He believes greater transparency around property valuations and the introduction of international valuation standards also need to be addressed in future BPR reviews.
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