It may not be the metric listed landlords like to talk about, but many property trusts are now paying out more in dividends than they have in free cash flow.
Macquarie analysts have found 15 out of 20 of the major real estate investment trusts are paying distributions above their free cash flow.
That measure is not the one typically adopted by property trusts. Instead, a majority report earnings as funds from operations as their standard.
“This measure ignores incentives paid to tenants, commissions paid to leasing agents and maintenance capex required to maintain the real estate,” the Macquarie analysts, including Rob Freeman, wrote in a recent note.
“We accordingly continue to focus on free cash flow generation of the REITs, which, disappointingly for half the sector, does not adequately cover the distributions being declared.”
The Macquarie analysts estimated free cash flow by deducting maintenance capex and incentives from reported operating cash flow.
They found only five property groups out of 20 were paying distributions covered by their free cash flow: Aventus, Charter Hall, Goodman, Stockland and GPT.
By implication, “the remainder are paying distributions that are partly debt/equity funded”, they wrote.
Their analysis also found half the property trusts were increasing their dividend payout faster than their earnings, as measured by FFO.
“Clearly it’s not sustainable, you dig yourself into a hole for those that do it,” said Resolution Capital’s Andrew Parsons.
“Fortunately the balance sheets aren’t too bad at the moment, so they can do it in the short term, but the longer they do it the deeper the hole they dig. It’s certainly not as extreme or excessive as it 10 ten years ago.
“But these things need to be nipped in the bud before they do develop into something more significant.”
Major landlords, including Vicinity and Scentre, which owns and manages Westfield malls in Australia, have reined in their dividend policy in recent months.
In February, the country’s biggest owner of freehold pubs, ALE Property Group, announced it had borrowed money and dipped into cash reserves to fund a higher distribution payout.
SG Hiscock’s portfolio manager, Grant Berry, endorsed the major retail landlords’ decision to dial down their distribution growth.
He also noted maintenance capex and incentives could be lumpy as landlords worked through their assets. That could be more evident in smaller portfolios, he said
“While some landlords may not be spending much money because they have got long leases, which cushions spending requirements, they may encounter a potential cost burden down the track.
“Therefore, we take a more through-the-cycle approach to smooth out headwinds and tailwinds expenditure requirements.”
Macquarie analysts noted the large number of listed property trusts now trading at either discounts or only slight premiums to their net tangible assets.
Those stocks trading at discounts could be vulnerable to corporate activity, Macquarie said.
However, SG Hiscock’s Mr Berry cautioned on the need for a longer-term view on NTAs.
“We don’t want to fall into the trap of thinking REITs are cheap at the top of a property cycle just because they may be trading below NTA. Public markets are likely to lead the private market through the cycle.
“That’s why we like the retail stocks. Their NTAs haven’t come in as hard. In addition to that the retail malaise [narrative] and the Amazon [effect] have been holding back their security prices and that’s where we generally see the best value.”
