Mall owners: Averting a retail meltdown

SA’s listed property sector appears to be heading for a bloodbath, as a national shutdown is set to dry up already feeble revenue streams.

"The coronavirus has turned the perfect storm into the perfect hurricane," is how Estienne de Klerk, chair of the SA Reit Association and SA CEO of sector heavyweight Growthpoint Properties, puts it.

In fact, the three-week trading ban on non-essential businesses couldn’t have come at a worse time for the sector.

De Klerk says the impact will be particularly dire for shopping centre owners, whose earnings have already taken a sizeable knock from rising rental arrears and bad debt on the back of a growing number of retail store closures.

The problem is that the JSE’s property sector is overweight in shopping centres, with a 56% exposure (in terms of asset value) to retail property versus offices at 25% and industrial/logistics at 17%. The remaining 3% comprises rental housing and hotels.

Keillen Ndlovu, head of listed property funds at Stanlib, believes the cash flow of property companies will drop further over the coming weeks and months as many retailers are bound to ask for rental reductions or deferments.

Though tenants may well have a legal right to a rental rebate during the 21-day lockdown period, any concessions agreed between landlords and tenants thereafter will depend on the terms of individual lease agreements.

But Ndlovu says most landlords will have no choice but to offer some form of relief — or face losing more tenants.

Even so, vacancies and rental arrears are likely to rise as some restaurants and retailers won’t survive a three-week fall in sales.

The income mall owners generate from parking will also take a hit, albeit perhaps only in the short term.

"Meanwhile, landlords’ operating costs will continue to rise on the back of the increased expenditure to sanitise buildings and introduce other hygiene measures. Landlords also still need to pay rates and taxes and service their debt," says Ndlovu.

Sadly, this time around the offshore interests of JSE-listed property stocks or real estate investment trusts (Reits), which account for 47% of the sector’s assets, won’t provide a buffer against the impact of the virus either, given that this sector is largely exposed to Europe, the epicentre of the pandemic.

JSE-listed property companies active in Central and Eastern Europe include Nepi Rockcastle, EPP, MAS Real Estate, Redefine, Growthpoint and Hyprop, while 50% of Vukile’s retail assets are located in Spain. Most of these countries are also in lockdown.

The unfortunate upshot for Reits shareholders will be a sharp drop in dividend payouts, which could deal a devastating blow to many retirees and other income-dependent investors who are heavily exposed to the sector.

Ndlovu is now forecasting dividend growth for the sector as a whole to fall by at least 8% this year. That’s well below the 3% achieved in 2019 and a far cry from the 7%-14% growth still delivered between 2005 and 2017.

But he warns: "Growth estimates for the next 12 months are a moving target, particularly given the renewed possibility of Edcon failing." Despite Edcon already closing about 150 stores over the past 12 months, the fashion retailer remains one of SA’s largest tenants in terms of floor space. There is also still the risk of Massmart closing some Game stores following the recent demise of its DionWired brand.

This year will be the first time in history that the sector posts negative dividend growth, which Ndlovu says explains the staggering share price losses property investors have suffered in recent months.

The SA listed property index has shed close to 50% year to date, which has pushed average dividend yields to an unprecedented high of 20% and a discount to NAV of about 50%. "These are the worst numbers we have ever seen," he says.

The list of JSE-listed Reits that have already postponed interim dividend payouts for their respective December reporting periods continues to grow: Redefine Properties, retail-focused Hyprop Investments, Polish play EPP, Fourways Mall owner Accelerate, and Texton. Others are likely to follow suit, as property companies are forced to hold back larger portions of their cash to service debt and shore up balance sheets. Some may even skip dividend payments altogether.

That poses the risk of companies losing their Reit status as the legislation compels Reits to pay out a minimum of 75% of their distributable income in the form of biannual dividends (or distributions) within four months after the company’s financial year-end. Reits also incur a higher income tax liability if the portion of retained earnings increases.

However, in a letter sent to listed property companies and their corporate sponsors last week, the JSE said given that the Covid-19 pandemic has "unforeseeable and unavoidable" consequences for Reits, it is in talks with the SA Reits Association to find ways to help prevent property companies potentially breach listing requirements and risk losing their Reit status.

Craig Smith, head of research at Anchor Stockbrokers, welcomes the move. "A sustainable solution to the situation can only be achieved if there is a co-ordinated approach between various stakeholders from landlords, tenants, financiers, municipalities, government/utility providers and insurers alike."

Smith says Reits with exposure to the office, student accommodation, residential and hospitality (likely to suffer the most pain in the short term) sectors will also not escape unscathed.

However, he reckons the one sector that should be least affected and even stands to gain over the short to medium term is the logistics sector (modern warehouses and distribution facilities) as more people start to shop online.

"The extent of the potential upside for logistics-focused Reits will, however, be tenant-specific and based on their operations and supply chain efficiency," he notes. The JSE’s largest logistics property owners include Equites, Fortress and Investec Property Fund.

Another key worry for property companies, especially those that have relatively high loan to values (LTVs), is potentially breaching interest cover ratios and loan covenants. When that happens, banks may start to call in loans and repossess properties, which may ultimately lead to a number of company failures.

However, Nedbank CIB property analyst Ridwaan Loonat says the Reit sector as a whole still sits with a relatively healthy interest cover ratio of an average 3.5 times — bank covenants are generally breached when the ratio dips below 2. Still, there is the risk that property values could adjust downwards, especially if tenant defaults increase. Lower asset values would translate into an increase in LTVs.

But Loonat says the general view is that banks could be more lenient under the current circumstances.

Meanwhile, it appears SA’s biggest landlords have launched a co-ordinated effort to help secure the survival of both tenants and landlords. The SA Reit Association, which represents about 50 of the JSE’s largest property companies, the SA Property Owners Association and the SA Council for Shopping Centres met last week in a bid to come up with ways to avert the "retail apocalypse" scenario seen in many areas across the UK and US.

Speaking on behalf of the SA Reit Association, De Klerk says mall owners cannot afford to lose more tenants.

"So collectively, as an industry, we need to help SMEs navigate this tumultuous period."

The contractual terms of lease agreements between landlords and tenants differ, so it is up to individual property owners to negotiate potential relief with struggling tenants.

But De Klerk says deferred rental payments and concessions in trading hours are some of the measures landlords are considering.

Of course, the trick will be to balance the interests of tenants with those of landlords. As De Klerk notes: "The difficulty is that property owners still have to pay their own overheads including debt servicing costs, municipal rates, staff salaries and income tax."

Ultimately, it seems that the only way to minimise the fallout for the listed real estate sector is if the pain is shared equally by landlords, tenants, banks, municipalities, government/utility providers, insurers and the Treasury.