Dividend retention policies are undermining the case for Reits investment
CAPE TOWN - DIVIDEND retention policies among South Africa’s real estate investment trusts (Reit) may undermine their equity investment case over the medium term, GCR Ratings said in a credit research report yesterday.
This was in spite of the fact that GCR believed that retaining dividends was supportive of the credit profile of Reits, the credit rating agency said in a research note.
By law Reits are required to pay out at least 75 percent of distributable income as dividends, subject to the Reit passing a solvency and liquidity test.
Many Reits have chosen to retain dividends to bolster their balance sheets during the economic uncertainties of the Covid-19 pandemic, and after many tenants were forced to close their doors through pandemic lockdowns last year. South Africa’s Reits provided more than R3 billion of relief to tenants last year.
“Liquidity and funding risks remain. GCR believes that, with a few exceptions, leverage headroom remains limited, while covenant risk remains elevated,” the credit rating agency said.
The majority of GCR's Reits rating downgrades and negative outlooks over the past 12 months were of predominantly South African based property portfolios with large exposures to vulnerable asset sub-classes, and/or very high leverage levels and weak liquidity.
Reits with moderate to strong geographic diversification to international markets, which were likely to rebound more quickly from the 2020 global recession, had typically shown stronger credit profiles.
“The rating differences observed reinforces GCR’s view that an entity’s creditworthiness is strongly underpinned by the operating climate(s) of the territories it operates in, balanced against the Reit’s underlying asset and financial management,” GCR said.
John Jack, the chief exectutive of Galetti Corporate Real Estate, said Reits needed to maintain relatively conservative debt levels to be an attractive investment, a factor that had become increasingly challenging in the midst of the Covid-19 pandemic.
“The pressure on Reits has created an interesting dynamic in the sector, with various new strategies coming to the fore as a response to the disruption,” said Jack.
The asset disposal route was the most prevalent, but some funds were also collaring their cross holdings and borrowing against it, depending on their level of debt in the business, he said.
He said locally, there was strong demand for South African real estate investments from Dubai and European Investors looking for prime yielding assets.
“These properties typically need to have a strong lease covenant in place with as close to a AAA credit rating as possible, and moreover a long-term lease agreement over the property to reduce and risk of vacancy. These lease agreements range between 10-15 years with rental reversions only seen after the 10-year period,” he said.
GCR said short term operating risks for South Africa’s ReitS should ease, allowing greater stability for them, if the less restrictive Covid-19 lockdown levels remained in place.
In general however, SA Reit performance fundamentals would remain under pressure in the short term.
The longer term trajectory was dependent on how Reits adjusted the use of their properties to meet the evolving requirements of tenants and their customers, the credit rating agency said.