Pranita Daya: The impact of a reduced payout ratio will be felt only in the first year
Pranita Daya: The impact of a reduced payout ratio will be felt only in the first year

Income chasers who’ve invested in listed property because of the sector’s historic ability to deliver inflation-beating dividends are no doubt wondering if it’s still the best place to stash their cash.

Dividend payouts have come under mounting pressure over the past 12 months as SA-focused real estate investment trusts (Reits) increasingly battle to fill the empty spaces in their buildings and convince cash-strapped tenants to renew leases at higher rentals.

The average dividend growth achieved by the property sector as a whole has already decelerated from 8%-12% a year between 2013 and 2017 to just 3.5% this year (see graph). In fact, a number of SA-focused property counters have in recent months declared a drop in income payouts for the first time in their JSE-listed history.

What’s worse, listed property investors are not only losing out on the income growth front. The sector has also been exposed to hefty capital losses over the past 18 months, and the SA listed property index is now trading at seven-year lows and at about 34% below the record peak reached in December 2017.

More bad news for income-dependent investors is that companies are now starting to introduce lower dividend payout ratios. That will place further pressure on the sector’s already anaemic dividend growth prospects.

Legislation adopted by the JSE in 2013 compels Reits to pay out at least 75% of their distributable earnings to shareholders in the form of a distribution or dividend, but SA Reits have until now typically paid out 100% of their income.

Last week, sector heavyweight Redefine Properties announced it was reducing its payout ratio from the usual 100% of distributable earnings to 93%.

It is the first SA Reit to do so. Delta Property Fund, which has a large government-tenanted office portfolio, has also cut its payout ratio, so that its interim dividend for the six months to August 31 tumbled by a hefty 69% year on year: from 39.40c to 12.19c a share. Rebosis Property Fund, which earlier this week declared a 30% drop in distributable earnings for the year to August 31, has skipped its dividend altogether.

As a result, Keillen Ndlovu, head of listed property funds at Stanlib, has adjusted his dividend growth forecast for the next 12 months down to 0%, from 2%-3% four months ago.

Adopting reduced payout ratios may be a new trend among SA Reits, but Ndlovu points out that it is common practice among offshore Reits to retain 10%-20% of their earnings to help fund building maintenance and upkeep or service interest costs.

It has to be said, though, that the dividend cuts made by Rebosis and Delta come on the back of both companies being financially stressed, while Redefine’s new 93% payout policy appears to be a prudent measure to ensure reinvestment in its properties. Even so, Redefine’s reduced payout ratio means that the 4% dividend growth that shareholders had been forecast to receive for the year to August 31 has now shrunk to zero.

So instead of paying shareholders a cash dividend of 51.81c a share for the second half of the financial year to August 31 (4% up from 49.80c in 2018), management is retaining about R200m in earnings and paying investors only 48.13c a share.

That brings the dividend for the full year to August 31 to just more than 97c a year, which is the same as that paid to shareholders in the 2018 financial year.

Fourways Mall owner Accelerate has indicated it will also adopt a reduced payout ratio. Ndlovu expects most other SA Reits to follow suit over time, with ratios typically being reduced to as low as 90%.

"The key issue will be for Reits to try to limit the amount of tax leakage on unpaid dividends," Ndlovu says.

Naeem Tilly, head of research at Sesfikile Capital, agrees that the adoption of lower payout ratios on a broader scale will be dependent on an individual Reit’s ability to reduce its tax charges. Reits don’t pay company tax on their distributable earnings as long as they pay the full amount out to shareholders. If they were to withhold 10%, for example, they would have to pay tax on that portion. SA’s corporate tax rate is a flat 28%.

However, Tilly notes that a Reit can offset certain deductions and allowances, which will reduce its tax liability. In Redefine’s case, for instance, management won’t incur any tax on the 7% of distributable earnings it plans to withhold.

Redefine CEO Andrew König argues that the company’s reduced payout policy is an efficient way to raise capital, especially given that there is no tax leakage.

"It has become very difficult and costly to raise capital in an environment where most SA Reits are trading at discounts to NAV. So we have had to come up with creative ways to conserve cash for capital expenditure," he says.

"The retained earnings are not lost to shareholders, as we will plough the money back into our local property assets. That is in the interest of shareholders as it will support property valuations and sustainable income growth over time."

Be that as it may, the introduction of reduced payout ratios in an already weak dividend and capital growth climate may well prompt some investors to look for potentially better returns in the bond market. But analysts say investors should adopt a longer-term view as the listed property sector’s performance should start to improve from 2021 onwards.

Pranita Daya, real estate analyst at Anchor Stockbrokers, says companies that successfully restructure their balance sheets in the downturn and use retained earnings to make value-enhancing improvements to their buildings will benefit from higher income growth when the economy turns.

Daya stresses that the impact of a reduced payout ratio will be felt only in the first year. "The adoption of a payout ratio will have a negative one-off impact on dividend growth in the year following implementation. However, assuming a consistent payout ratio, future growth should improve due to retained earnings being invested to enhance and grow the property portfolio," she says.