REITs: RES and VKE Initiation – Buying on time?

We are initiating coverage of Resilient REIT Limited (RES) and Vukile Property Fund (VKE).

While the retail sector has been resilient and recovered better than expected post-Covid, several risks remain in South Africa: infrastructure issues, semi-migration, slow economic growth, and the upcoming elections. Property costs are rising faster than inflation, due to municipal costs, the need to build a sustainable supply of water and electricity and increased maintenance. We also expect security costs to rise into and around the elections. As interest rates remain high, consumers continue to come under pressure, which in turn has an impact on retailers, the demand for space and the ability for REITs to pass on rental increases.

That said, retail REITs are fairly defensive in the current economic climate. In South Africa, direct retail REITs have low vacancies and are achieving positive rental reversions. RES and VKE are expanding their offshore footprint, with new investments in Spain. Spain offers a stable operating environment with quality infrastructure, declining inflation, growing tourism and higher forecasted real GDP growth than South Africa or France. Cap rates are rising in Spain, and net yields on investments are lower than the WACC and South African investments, putting pressure on short term DIPS.

For both RES and VKE, increasing financing costs will put pressure on DIPS. VKE has guided LTV reaching 44%, and RES has suggested LTV could rise to just over 39%. RES has interest caps and swaps, recently expired and expiring (+-R2bn) in FY24, and RES will feel the effects of higher interest rates in its FY24 earnings. RES has been selling off its stake in Hammerson to maintain distributions and fund infrastructure spending, which is not sustainable. VKE on the other hand has increased its EUR debt and reduced higher-cost SA debt, although it has been selling higher yielding assets to buy lower yields in Spain. For VKE, in our view DIPS will come under pressure.