Western Cape property: boring is the only game in town
Amid the madness of the pandemic, Cape-focused property firm Spear is one of the sector’s more predictable bets
If boring is the new sexy, then Spear Reit is increasingly likely to pop up on investor radars.
Growing earnings uncertainty has become the new norm among real estate investment trusts (Reits), but the JSE’s only pure Western Cape-based property play still scores fairly high in terms of predictability.
The small-cap company, which was co-listed by industry veteran Mike Flax less than four years ago, is one of the few property counters still delivering on its dividend growth promises. Last week, Spear declared a decent 6% dividend growth for the year to end-February in line with its May 2019 guidance, which cemented the company’s uninterrupted track record of inflation-beating dividend growth since listing in November 2016.
Spear owns a portfolio of 32 properties worth R4.18bn.
These are a mix of retail, office and industrial buildings as well as two hotels — the swanky 15 on Orange in Cape Town’s city centre and DoubleTree by Hilton in Woodstock.
The bulk of its assets are located in and around Cape Town and therein lies one of the company’s major strengths.
As Spear CEO Quintin Rossi puts it: "We only have to focus on our own backyard, which we know very well. Our entire asset base is within easy reach of every Spear team member."
Rossi believes that being small, nimble and physically close to tenants has helped the company to adapt quickly to the Covid-19 operating environment and restructure leases with struggling tenants where necessary.
He says: "Being in the trenches is the reason we could still achieve such good rental collection rates after lockdown."
Spear managed to collect 98% of rentals in March and 92% in April.
In the first half of May, rental collections were sitting at 64%. That’s despite its hotels generating no income since March 27 when government first imposed a lockdown on non-essential business.
Other performance metrics recorded in the year to February are equally impressive.
Occupancy levels were maintained at 97% while rental growth of 1.95% was achieved across the portfolio on lease renewals — no easy feat given the depressed economy.
Most other property funds had already been forced to drop rentals or risk losing their tenants, even before the Covid-19 pandemic hit SA’s shores.
Rossi says despite there being no playbook on how to navigate the Covid-19 crisis, Spear doesn’t intend changing its investment strategy.
"We will continue to focus on what we know. We believe the Western Cape will remain SA’s most compelling real estate investment hub. So Robben Island is the furthest we’ll go offshore."
However, like most of his peers, Rossi has given no dividend growth guidance for the next six months, saying it’s too early to make earnings forecasts given how difficult it has become to gauge tenant failure and vacancy prospects. But he stresses that the company is sufficiently capitalised to fend off the Covid-19 storm with R200m in cash on its balance sheet.
He says even in a "low road" operating scenario where the company earns zero income from its hotels and collects only 60% of rentals for the full year to February 2021, Spear will still break even after paying all its operating expenses and debt interest.
Analysts like the fact that Spear’s business and balance sheet is easy to understand and uncomplicated.
"What you see is what you get," says Stanlib senior property fund manager Nesi Chetty.
That has no doubt supported the company’s investment case and its ability to outperform the sector.
While Spear’s share price is down 42% year to date, it has delivered a total return of 20% since listing in November 2016 (to end-February) versus a -23% return from the overall listed property index.
Chetty believes Spear is also in a stronger capital position than most other property companies.
"The company has done adequate stress tests to ensure sufficient liquidity headroom to absorb rental declines over the duration of the Covid-19 lockdown. In addition, it has enough cash available to draw down on to pay dividends."
Metope Asset Managers investment analyst Kelly Ward places Spear among her top small cap stock picks. "The portfolio is small and focused, which allows management to be very hands-on in tenant negotiations."
However, both Chetty and Ward caution that the resilience of Spear’s portfolio, like that of all other property companies, will be tested over the next few months. "There is no doubt that the outlook for rental collection will deteriorate the longer SA remains in lockdown," says Chetty.
Ward echoes a similar sentiment. "It remains to be seen how long the lockdown will be in place in the Western Cape and how the phased reopening of the economy rolls out."
After all, the province is heavily reliant on tourism, and the hotels sector has been particularly hard hit.
Though hotels represent a relatively small portion of Spear’s overall portfolio (11% by asset value and 7.5% by income), Ward says earnings from Spear’s hotel operations are unlikely to come close to 2020 levels over the next year given that the sector is likely to continue to take strain for "months to come".