Property shares: dividend payers to buy

Results for the June reporting period underscore yet again how the pandemic has left listed property’s reputation as a lucrative dividend payer in tatters.

Only three out of the 16-odd companies that released results in recent weeks declared a higher dividend this year than last: SA-focused mall owners Fairvest and Resilient Reit, as well as Central and Eastern European (CEE)-focused MAS Real Estate.

Shareholders of Polish and UK retail companies EPP and Capital & Regional, and SA-focused Fortress Reit (B), are getting zero dividends for the June reporting period while others, most notably Waterfall City developer Attacq, have deferred dividend payouts for the 2021 financial year to 2022.

Income-dependent investors have been hit by a double whammy – not only have most companies slashed or postponed dividends on the back of a drop in distributable income, they’ve also reduced payout ratios. In the past, most real estate investment trusts (Reits) paid out 100% of their distributable profits via twice-yearly dividends or distributions, as it’s often referred to. However, in a bid to shore up cash reserves, most have opted to reduce payout ratios to between 85% and 75% — the minimum threshold for the retention of Reit status.

The property sector’s ability to deliver a high and growing income stream has been curtailed by Covid-related revenue losses, with billions of rands’ worth of rental relief granted to struggling tenants over the past 12 to 18 months. Stocks with a large exposure to regional shopping centres in urban areas and other leisure sectors – bars, restaurants, hotels, cinemas and gyms – took the biggest knock.

Norbert Sasse, CEO of sector heavyweight Growthpoint Properties, says that at the V&A Waterfront in Cape Town — the company’s largest single asset and SA’s most visited tourist destination — rental relief to the value of R292m has been provided to tenants since the onset of the pandemic in March last year.

Growthpoint’s total loss in the form of rental discounts and deferrals for the past 18 months comes to a staggering R666m.

In fact, the company finds itself at the heart of a perfect storm for the sector.

Regarded as a reliable bellwether of the state of SA’s office market, rentals on lease renewals in its R27.5bn office portfolio dropped by 16.1% for the year to June. That’s on top of the 8.9% slide already recorded in the prior 12-month period. Growthpoint’s office vacancy simultaneously surged from 15.5% to 19.9% in the 12 months to June.

Shopping centre vacancies have generally been better contained than those of offices. However, some mall portfolios have taken bigger rental knocks. Hyprop Investments, which owns landmark Joburg shopping centres such as Rosebank Mall and Hyde Park Corner, last week reported an average 23.6% drop on lease renewals for the year to June. Hyprop CEO Morné Wilken says that until there is a marked improvement in the SA economy and real growth in retail sales, rentals and cost recovery ratios will remain under pressure.

Similarly, Sandton City and Eastgate co-owner, Liberty Two Degrees, reported a 26.6% drop in rentals on lease renewals for the six months to June.

At the same time, landlords have received no relief from the government; rather, they will have to contend with electricity, water and rate tariffs that are all increasing.

Dividend payouts to shareholders have been further diluted by a number of stocks issuing new shares via capital raises and dividend re-investment programmes to boost liquidity – they include Growthpoint, Hyprop, Hammerson, Nepi Rockcastle and EPP.

However, the good news is that the property sector is seemingly over the worst. Analysts say balance sheets are, for the most part, strong, with many companies making good headway to reduce debt and loan-to-values. In addition, rental collection rates have either already recovered to pre-Covid levels or are close to them, which will support earnings growth — and therefore dividend growth — over the next 12 months.

Naeem Tilly, portfolio manager and head of research at Sesfikile Capital, expects high single-digit income growth for the sector as a whole over the next 12 months. In the year to date the SA listed property index (Sapy) has delivered an average 6% income return, up from 2020’s multiyear low of 4%. That means now is probably a good time for income chasers looking to share in the sector’s recovery to increase their weighting in listed property. Judging by the Sapy’s 55% rebound since early November, many have already done so. Property stocks are nevertheless still trading about 27% below their pre-Covid levels.

But Tilly stresses that the sector’s income growth prospects will be dependent on a few factors. These include whether SA and other global regions go into future lockdowns, and when offshore counters like EPP, Capital & Regional and Hystead resume dividend payments. That will affect other JSE-listed funds with stakes in these companies, including Redefine, Growthpoint and Hyprop. There is also the risk of a further fall in rentals and a rise in vacancies as SA’s weak economy weighs on local tenants.

Tilly says the risks faced by individual companies can vary significantly and so prospects for each counter need to be assessed more carefully than ever. He says when assessing the best dividend-paying Reits one must consider not just the absolute value of the yield at which a counter is now trading but also the risk attached to future dividends. The currency in which dividends are generated as well as the longer-term rate at which dividends can grow are also key factors investors need to look at.

Tilly says the lower-yielding counters may be regarded as more expensive than their higher-yielding counterparts, but they tend to offer stronger dividend growth trajectories and/or higher-quality earnings. These include German business park owner Sirius Real Estate, UK multilet industrial company Stenprop, self-storage Reit Stor-Age, logistics owner Equites, retail-centred Resilient and CEE-focused Nepi Rockcastle and MAS Real Estate.

Craig Smith, head of research at Anchor Stockbrokers, says there are signs that property fundamentals are bottoming and adds that the recovery of the sector will be supported by the likelihood of limited new office and retail supply being added to an already saturated market over the next few years. "That will have a meaningful impact on rebalancing the demand/supply dynamic," he says.

Smith points out that the SA economy nevertheless still faces many headwinds. But he reminds investors that the Sapy is not purely a play on SA real estate. The sector has a 50% exposure to offshore real estate markets, with the biggest chunk being CEE (23%) followed by the UK at 10%, the rest of the world at 8% and Australia at 5% (see graph). He adds that many JSE-listed counters now have meaningful underlying exposure to international geographies that are already experiencing an economic rebound.

Specific sectors such as the UK, CEE and Australian logistics, CEE retail as well as Australian offices are experiencing strong investor demand, he says.

Kelly Ward, investment analyst at Metope Investment Managers, echoes the sentiment. While dividend growth among SA-focused Reits will benefit from much of the Covid-related rental relief and bad debts now being out of the system, she says SA still faces high unemployment and a weak economy. "So our preferred stocks are largely offshore counters."

Ward singles out Nepi Rockcastle and MAS Real Estate, both of which operate in the "strongest retail markets in Europe". She says CEE retail is expected to bounce back strongly post-Covid. "There’s already been a rebound in foot count and tenant sales across the CEE, but particularly in Romania and Poland."

She adds that MAS Real Estate has resumed dividend payments sooner than expected. "The company has a significant development pipeline in Romania’s retail and residential sectors, which will contribute meaningfully to future earnings."

Ward also sees good value in Resilient, whose 28 malls are mostly in smaller cities, rural areas and townships across SA. It also has a sizeable stake in Western European-focused group Lighthouse Capital. "Resilient owns one of the more defensive property portfolios and has managed to generate positive rental reversions even over the pandemic period," she says.

Garreth Elston, chief investment officer at Reitway Global, notes: "Given SA’s economic reality, we remain comfortable that offshore counters will outperform their SA-focused peers." He says Nepi Rockcastle is at present the sector’s best buy. He says the market has by and large ignored the stock so far this year and so its share price hasn’t recovered to the same extent as that of some of its peers.

"In our view, Nepi Rockcastle’s current share price doesn’t accurately reflect the company’s future value," he says. "The company boasts a well-diversified retail portfolio and should return improved dividends and capital growth over the next two years."