REITs are looking more attractive as the interest rate cycle is turning. In our REIT initiation roadshow, we argued, based on co-integration and causality testing, REIT prices could decline in line with cuts in interest rates. However, we caution that not all REITs are impacted equally. In this report we outline the current sustainability of distributions for the 20 largest JSE listed REITs. Over the past few years, many REITs have reduced their payout ratio’s as well as reduced distributions. We consider whether the cycle has bottomed out. The current average forward distribution across these entities is a 9% yield.
Of the 20 REITs, MAS Real Estate is currently withholding distributions, and Fortress Real Estate Investments is currently unable to pay distributions due to its MOI and share class structure. While REIT best practices suggest the disclosure of FFO, we find that FFO often does not translate to cash flow. Most distributions are cash and thus if the company does not have the cash from operations, it would need to sell assets (reducing future earnings) or raise more financing (decreasing future earnings due to higher finance costs).
Our assessment of cash flows and earnings, highlights the sustainability of the current guided distributions into the near future. We find that, while from an FFO basis 83% of distribution-paying REITs appear to be paying a sustainable or borderline sustainable distribution, when assessing the cash flows and taking into account some company-specific issues, that number drops to 44%.