Competition sees some property firms distribute one-off items.

Posted On Wednesday, 14 February 2007 02:00 Published by eProp Commercial Property News
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With competition increasing and listed property companies seeking to outperform each other in a buoyant market

Angelique de RauvilleProperty Correspondent

With competition increasing and listed property companies seeking to outperform each other in a buoyant market, some companies are distributing trading profits and others nonrecurring items to their unit holders. Although analysts do not have a problem with this practice as long as there is full disclosure in financial reports by companies concerned, they generally prefer earnings that are generated from the existing property portfolio.

If the earnings come from the existing portfolio, they are easier to predict and this gives investors a good indication of the investment risks attached to the various listed property companies.

Angelique de Rauville, MD of Investec Listed Property Investments, says there are some listed property companies and funds that distribute trading profits, and that Investec Listed Property Investments prefers quality earnings “being generated from net rental income from investment properties”.  Trading profits can include the sale of a property and the distribution of those capital profits. Another example of a once-off item is the sale of listed property units at a profit and the distribution of that profit. The group recognises that these “anomalies and trading profits” do exist.

“We have a tolerance for them on the basis that there is full disclosure in the reporting of these and we prefer prudent management of this once-off income by, for example, management unwinding expensive fixed-interest rates and re-fixing interest rates at lower levels for longer periods of time to benefit long-term and sustainable growth of a company as opposed to being paid out as a once-off “sweetener” to investors,” says De Rauville.

Investec Listed Property Investments recognises many property companies and funds are declaring sensational results, taking advantage of, in part, some of the once-off opportunities. De Rauville says while these growth figures are not sustainable in the long term, in reality, investors in listed property stocks can be short-term players, in search of yield. “Investors have the benefit of liquidity and therefore (of) chasing stocks that are going to produce superior earnings growth, whether this growth is being achieved from once-off trading opportunities or not.”

Andre Stadler, MD of Catalyst Fund Managers, says that real estate investment is primarily about income return and “sustainable income growth”. “For investors to feel comfortable with what the sustainable income growth of a company is likely to be, it must be clear what portion of the income from the company is from noncontractual sources, which is income that is not derived from the contractual leases but is rather a one-off item relating to developments or trading profits,” says Stadler. He says development or trading profits should be “clearly detailed” to investors. Stadler says there is a lot of competition among property companies, who have to outperform peers to achieve ratings, which allow them to efficiently fund future activity. The unsustainable items boost growth and achieve these objectives.

“Historically, the sector focus was on positioning itself as a proxy for holding direct (fixed) real estate, but in a more liquid and efficient manner. What we are starting to see now is a move towards an operational focus where the companies are becoming more equity-like and revenue growth is also achieved through external sources such as development trading, management fee income and yield-enhancing acquisitions and disposals.”

Stadler says in Catalyst’s assessment, not enough attention is paid to what portion of a company’s distribution growth is through external and non-sustainable sources. Property funds such as property unit trusts only distribute income deriving from the underlying property portfolio. In law, property unit trusts are not permitted to have trading or development profits. “There are a few property loan stock companies whose policy is not to distribute capital profit, which goes back into the portfolio.”  Stadler says it is important to ensure that investors clearly understand how much of the distributable income is once-off noncontractual income. “Full disclosure gives investors a better opportunity to assess the risk of the earnings from those property funds and price them accordingly,” he says.

Macquarie First South property analyst Leon Allison says Macquarie First South prefers capital profits to be excluded from distributions because they are not recurring and not as sustainable as core lease income from the underlying portfolio.

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