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JSE-listed real estate investment trusts are starting to hold some earnings back to manage operating costs in a weak market

Two prominent fund managers are urging property companies to lower their dividend payout ratios to fall in line with international practice, saying they should hold back income to pay increasing operating costs and reduce debt in a torrid economic environment.

They have also warned investors not to expect the same kind of dividend growth they received in recent years since SA property companies began converting to the internationally recognised real estate investment trust (Reit) structure at the end of 2013.

The Reit capital structure is used globally by property companies in the US, Canada, Netherlands and the UK. SA companies adopted the structure because foreign investors were more familiar with it and understood it better than the property unit trust and loan stock structures that used to exist locally.

We may see payout ratios come down in SA. We have seen early signs of this but largely from distressed funds like Delta and Rebosis.

Reits enjoy tax benefits, the most valuable of which is that tax on their dividends is paid by shareholders and not the companies themselves. To keep their status in SA, Reits must pay at least 75% of their distributable earnings as dividends. In SA, Reits pay as much as 100% of their income, while in the US and UK it is common for a typical fund to hold back as much as a quarter of its income.

The head of listed property funds at Stanlib, Keillen Ndlovu, said due to weak economic conditions in SA Reits have to be more frugal and consider reducing dividend payout ratios.

Recently property companies reporting results have seen little or even negative dividend growth as they struggle with vacancies and rental reductions.

Conditions are difficult and property funds are struggling across SA, Ndlovu said.

“If they reduce the payout ratio now, it’ll take the pressure off them and they can use the earnings to focus on challenges such as bring their debt levels down,” he said.

As payout ratios overseas are 75%-90%, Ndlovu said, Reits retain some of the earnings to fund a portion of their operations or service interest costs.

“We may see payout ratios come down in SA. We have seen early signs of this but largely from distressed funds like Delta and Rebosis,” he said.

Ian Anderson, chief investment officer at Bridge Fund Managers, said JSE-listed property companies have used non-recurring cash flows to support dividend payments.

SA Reits should pay dividends using sustainable income and be more conservative, cutting payouts by as much as 10%.

SA Reits have also used income not derived from property rentals to support dividends.

“They have used capital-raising fees and other non-sustainable operating cash-flows, such as underwriting fees or money raised by their subsidiaries,” Anderson said.

“They’ve actually tended to pay out more than 100% of their sustainable income and this needs to change. I don’t think 75% or below is needed, but in time we would expect payout ratios to drop to around 90%, leaving 10% of their operating cash flows for ongoing operating expenditure,” he said.

Delta Property Fund, SA’s largest listed state-tenanted landlord, recently reduced its payout ratio to 75%, the minimum allowed by SA Reit legislation, while mall owner Rebosis Property Fund, headed by Eastern Cape businessman Sisa Ngebulana, skipped paying its interim distribution and will only deliver a final dividend.

Reducing the dividend payout could have serious tax implications for listed property stocks.

Ndlovu said a property company’s earnings that are not paid are subject to 28% corporate tax. To maintain its Reit status, a property fund has to pay out its final distribution unless it earned no income.