NOMPU SIZIBA: Real estate investment trust (Reit) Investec Property Fund has released its annual results for the 12 months ended March 2019. The company reported a normalised distribution growth of 5.1% year-on-year, with shareholders getting a final dividend of 73.51 cents/share, bringing the total dividend to 142.32 cents/share. The company has characterised the South African market as a challenging one, with net property income rising a mere 0.8%.
Positively, though, the company’s vacancy rate was reduced to 2.4% from 4% in the year prior. Meanwhile, the company’s international assets have yielded positive returns and are expected to do so in the short to medium term.
To give us some insight on what’s happening in the property market I am joined on the line by Andrew Wooler and Darryl Mayers, the co-CEOs at Investec Property Fund. Thanks very much for joining us, gentlemen. I see you note that your average income or net property income growth on your properties in South Africa was about 0.8%, which is markedly different from the 5.7% you achieved in the year prior. So how would you characterise the market in the period under review?
ANDREW WOOLER: I think it’s certainly been a very challenging last 12 months and the market is well aware of the headwinds that SA property faced in that space. The 5.7% last year was a great result and, certainly looking back over the last 12 months, 0.8% is reflective of those challenging times. We saw similar operating metrics remain very, very robust. The vacancy rates shows a coming off, from 4% down to 2.4%, which I think in the current environment is a great achievement.
It really has been a focus on filling space and making sure that we have a limited or no-void period. In the current market it’s quite a good result.
NOMPU SIZIBA: On that point, I see as part of your strategy you talk about revenue security and growth, so what is it you had to do to incentivise your tenants? And I see that you’ve had to agree to reductions of rent in many instances in your recent lease renewals.
DARRYL MAYERS: The big thing for us is actually giving less incentives and more realistic rentals. For us it’s about early engagement with tenants. So, in some cases strategically we’ll accept a lower rent for a shorter period to reduce the voids. At least you are able to recover the operation costs and the creep that we are finding with rates and taxes. So the intention for us is around 1.7%, which we find fairly low in the market. So we are seeing realistic rentals with low incentive, as opposed to over-incentivisation and keeping our rentals high. So with the real market rentals tactically we are doing deals to fill voids and, as market conditions change, we are not locked into long-term lower leases.
NOMPU SIZIBA: Understood. So your cost-to-income ratio rose to 18.8% – that’s two percentage points up from the year prior. What are some of the cost challenges you guys are facing?
ANDREW WOOLER: Number one has certainly been on the rates expense side. So we’ve seen rates across the portfolio increasing by around 25%. Certainly the cost of occupation for our clients and tenant base across the portfolio becomes a lot more challenging. And obviously as you have void periods your ability to recover both rates and associated prices or op costs obviously diminishes. So that’s certainly been a key driver.
From a fixed-cost perspective, I think we are running at about 3.5% fixed costs across the portfolio – security, cleaning and the like. So that is well under control. I think the last question raised by Darryl was around incentivisation. So certainly the cost associated with attracting or retaining your existing tenants is a lot higher in today’s environment than it was two, three, four years ago.
NOMPU SIZIBA: I see you are one of the property companies affected by the Edcon restructure. Which of your properties were affected, and to what extent is that going to impact your earnings going forward? And I suppose you guys decided along with others that it’s better to try and help save Edcon, as the alternative scenarios may have been less palatable.
ANDREW WOOLER: We were exposed to 10 properties in the portfolio, with a total of around 27 000 square metres. I think it was probably 3 000 square metres that would have caught us by surprise. So for us it was no surprises. I think for sure it was about SA Inc more importantly than a short-term view on just preserving income for our shareholders.
One has to take into account the massive impact this would have had in the job market, a massive knock-on effect it would have had in the malls if they were retrenching or closing stores. So for sure it was an SA Inc decision. We believe that if we give them some headroom to operate and they can trade their way out of this environment, it’ll be good for everyone. At the same time we hope that the rental reduction was just a more realistic way of reporting earnings. We are actually getting the income that they are offering as opposed to advancing money to enhance our income. And for that we took a lower side of the equity. I think increasingly for us it’s not about investing in the retail market. It’s not our core business, and we stick to managing properties, collecting rent and giving those returns to shareholders.
NOMPU SIZIBA: You indicate that you have every faith that the property market will improve in the South African market in the longer term, and of course most of your assets are here – about 88% of them. But in the short to medium term you are expecting material growth to come from your offshore investments, and you indicate that last year you were making significant investments in your European business. Just tell us about the offshore businesses.
DARRYL MAYERS: In the last few years we built up what we refer to as some great offshore optionality. So through our platforms in Australia, the UK, and to that extent Europe that has come around as well in 12 to 18 months, I think we’ve got some really great assets in two developed markets.
The European logistics platform that we invested into in May last year, the fundamentals and the underlying macroeconomics across Europe certainty support that strategy. With the result coming out of logistics in Europe, certainly what we’ve seen is much greater leasing. We’ve got a great pipeline that has been identified, and then we’ve bolted on most recently a light industrial platform. That is by the same guys on the ground in Europe. So we are very, very excited about what that will become.
So over time we’ve got equity commitments into Europe in terms of logistics of €150 million and in €65 million there’s a lot of muscle. So the better part of €215/220 million. Yes, we think that’s quite exciting over the short to medium term.
NOMPU SIZIBA: You are eyeing some six of your South African properties to dispose of. That will amount, according to your estimates, to around R600 million. What will you be using the proceeds there for?
ANDREW WOOLER: We have an absolute focus on capital recycling and making sure that we put shareholders’ capital to use in the best manner. And so sometimes we are a seller of assets, certainly not a forced seller, with a focus on enhancing shareholder returns through active capital management. The proceeds could de-lever the balance sheet further, so we are very comfortable at 35%. It creates more headroom for us in order to transact either locally or abroad, and certainly will help us fund those commitments into Europe over the next 12 to 18 months.
NOMPU SIZIBA: Is that also a way of keeping your debt in check? Where are your debt levels currently?
ANDREW WOOLER: Our gearing currently sits at just over 35%. We have a target ratio of between 30 and 35%. We like to keep it as low as possible. Again, there are lots of opportunities around, both locally and abroad, and we like to have the headroom to be able to transact. And equally, going into the environment that we are in at the moment, having that balance-sheet headroom is important, purely from a conservative or prudent perspective.
NOMPU SIZIBA: Yes. Now, we know that being in property is a long-term game, and the South African market has been rather lacklustre, but you are hopeful about the future with the “new government”. What are you hoping will transpire with a re-energised new government?
DARRYL MAYERS: Well, we are pointing in the right direction, first of all. I think for the first time, again, it’s pretty much like the Edcon deal. We have to get our domestic affairs in order in South Africa in order to bring confidence back. Growth has been missing. While the whole world was growing over the last decade, we’ve been going sideways and now we are facing headwinds abroad, which certainly would have a further impact on the South African market. So I think it’s great that we’ve now got a strong leadership with President Ramaphosa. He has a mandate to govern now and to deliver on growth and jobs, which they had promised in the election campaign. We are comfortable and quite encouraged by the fact that he has engaged extensively with business and investors, which is a very positive sign for us.
I think it will just be important for the new administration to take the steps to implement the structural reforms to the economy and address all the budgetary and Eskom challenges that we face. It’s positive. Will there be an immediate reaction? Certainly not. For sure there is catch-up and the average person in the street has got debt, he has issues.
And I think with the impact on retail we see limited growth in the commercial or office sector as a result of this. So there are headwinds. But again, we are a South African operation and 85% of our assets are here. We’ve got real hands-on skills and I think we have to put those to the test now and show the market that we can deliver on our promises to become recognised as South Africa’s leading Reit.
NOMPU SIZIBA: Thanks to Andrew Wooler and Darryl Mayers from the Investec Property Fund.