Pay attention to quality, says Nedbank
INVESTORS and analysts tend to focus on distribution growth but do not necessarily pay enough attention to the actual quality of the underlying property portfolios of listed property companies and funds.
The quality of the property portfolio will influence the long-term earning prospects of the companies and funds concerned, says Nedbank Corporate Property Finance MD Frank Berkeley.

Berkeley says investors and analysts tend to focus on distribution growth in the listed sector because it is “easily measurable”. He says that while distribution growth is important, other factors that must be considered are the long-term quality of earnings.

“And by that we mean how sustainable are those earnings in the long term. Are they generated by actual property returns or trading income in other investments, for instance shares in other listed property funds?”

The other important issue is to look at the quality of the actual assets and their manageability. “By that I mean if you have hundreds of smaller properties, they are far more difficult to manage effectively than a few large, quality properties,” says Berkeley.

He says listed property funds should also consider acquisitions of high-quality properties even if they dilute distributions in the short term.

This is because in the long term these assets will deliver sustained growth.

Investors and analysts should also visit a selection of the underlying properties of a listed property fund to see what state they are in. “They should ask, do they need a revamp or are they well-maintained?”

Berkeley says there is a danger of some listed property landlords delaying maintenance to maintain or boost distributions.

“Sooner or later, the chickens come home to roost. The quality of the portfolio starts dropping and then rentals start to drop because tenants don’t want to be there and you get into a vicious circle,” he says.

Leon Allison, property analyst at Macquarie First South, says traditionally there has been a prime focus by the market on distribution growth of listed property funds. But Allison says he thinks that there is a gradual move away from it being the sole criterion.

Regarding companies making property acquisitions that could be dilutive to earnings, he says he thinks it is “not impossible” that companies can “get away” with doing a deal that is “marginally dilutive initially as long as the long-term growth potential is apparent”.

Allison says it is possible that some companies may feel under pressure to maintain a certain level of distribution growth and that there is a danger they could perhaps spend less on maintenance than they should in order to meet these expectations of higher growth.

Hyprop Investments, which is regarded by the market as a blue-chip retail focused property fund, says it would still have acquired its retail jewel, the Canal Walk Shopping Centre, even if it had been dilutive.

The property was acquired five years ago when interest rates were dropping so the acquisition was not dilutive to earnings. Also the income growth at the centre increased because of a reduction of vacancies in the first year, which boosted earnings, says Pieter Prinsloo, MD of Hyprop.

Prinsloo says the board approved the transaction “based on its scarcity value and the quality of the centre” and the company would have still bought it if it had initially earnings dilutive. Over the long term, it’s the right decision to focus on quality assets rather than just chasing short-term distribution growth,” he says.

“Property is a long-term investment.”

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