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SA REITs: Tax benefits for investors

SA Real Estate Investment Trusts (REITs) enable investors to invest in property investments in an accessible way by buying shares in JSE-listed real estate companies. When buying SA REITs, investors are exposed to a democratised, diversified portfolio of properties and can buy or sell their shares at any stage, unlike physical property ownership, which requires a larger amount of equity capital and has an inherently longer investment period and higher associated transaction costs.

Most SA REITs offer a mix of retail, commercial, industrial and residential property assets across South Africa. Some specialise in a sub-sector (e.g. logistics) or a geography (e.g. Western Cape), while others hold a diversified mix of sectors.

Metope Investment Managers believes investors can benefit from the local REIT tax regime. To explain this,
an understanding of the REIT structure is necessary.

 

Investing in SA REITs

For listed property companies to maintain their REIT status, they must pay a minimum of 75% of their taxable earnings available for distribution as a REIT dividend each year within a period of four months after its year-end. Due to the Covid-19 pandemic, which hit South African shores in March 2020, REITs were granted an extension of 2 months (in addition to the four-month period), with many companies using the additional time to gain some clarity on the financial position of the company. However, the National Treasury and other regulatory bodies did not allow the payment of distributions as per REIT rules to be waived in the aftermath
of Covid-19 lockdowns. This ruling provided the market with some certainty regarding income returns, even though it presented a greater hurdle for REIT companies, which, when looking back over the past year, they have successfully overcome.

 

Tax benefits:

  • Special legislation allows REITs to pay out a qualifying dividend without incurring income tax within the company, which is then taxed in the hands of the investor as taxable income. This allows all earnings to flow through to investors without attracting income tax at the company level.
  • If held within a retirement annuity or pension, provident or preservation fund, investors pay no tax
    on dividends on REIT investments until they receive their pension payments for the funds. This in contrast to normal company earnings, which are taxed at 28% within the company, before 20% dividend withholding tax is applied to dividends paid out to investors. The ability to reinvest and compound these before-tax distributions within a vehicle such as a pension fund over a very long period is very beneficial to the pension fund member.
  • An important point is that when a REIT sells an investment property, it does not attract Capital Gains Tax (CGT) on any profit from that sale. Therefore, investors benefit since the capital in the fund is reinvested without the erosion of capital due to CGT. Investors will still attract CGT on the sale of their REIT shares as with any share trading activity.
  • Tax Free Savings Accounts (TFSAs): When investing in a TFSA, a special vehicle in which neither income nor capital gains are taxed, it is important to note that some asset classes are better suited
    for inclusion than others. A TFSA is most advantageous for equity and listed property investments, as these asset classes deliver higher real (after inflation) returns than cash and bonds over the long term and are generally not subject to other exemptions.

Interest on cash and bonds benefit from significant income tax exemptions (the amount depending on the individual’s age), therefore there is no additional benefit in holding these in a TFSA. Additionally, there is no inherent underlying growth in income from these investments and capital gain opportunities are limited. Income on equity and listed property investments (in the form of dividends or REIT distributions) is normally taxable in the investor’s hands, as are capital gains above R40,000 per annum. Hence, these investments generate higher tax savings in a TFSA than cash and fixed income.

 

Conclusion

SA REITs offer investors a recurring cash distribution yield that can be reinvested, thereby providing a powerful
compounding effect. This, combined with the tax benefits detailed above, makes the REIT sector an attractive
asset class for long-term investors.

While the sector faced immense challenges when the Covid-19 pandemic hit South African shores at the beginning of 2020, we have seen in the past year that the majority of REIT companies have managed to successfully navigate the pandemic and have emerged resilient, managing to strengthen their businesses and balance sheets as well as support tenants through offering discounts and deferments of R3bn at last count. Metope Investment Managers believe that the sector is poised for further recovery, underpinned by improved balance sheets and a recovery in distributions off 2020 levels.

Good Interest from Tenants in Hyprop Centres

Wednesday, 9 June 2021. Hyprop, the retail-focused REIT with properties in South Africa, sub-Saharan Africa and Southern Eastern Europe, has made positive progress on its key strategic priorities in the first four months of 2021, including taking steps to strengthen its balance sheet.

The operational update covers the period from January 2021 to end-April 2021, CEO Morne Wilken said: “The Group’s key priorities are repositioning the South African portfolio, increasing the dominance of the properties in the South-Eastern European portfolio, pursuing the non-tangible asset strategy, strengthening the balance sheet and preserving cash.”

After raising R358 million through an accelerated bookbuild in May, and with more than R1 billion of proceeds from the sale of Atterbury Value Mart, expected to transfer before July, Hyprop’s loan-to-value ratio is expected to improve to 35.8% by year-end from 38.8% at 31 December 2020.

“We are encouraged by the positive signs of improvement of the trading conditions of some for our South African tenants, although we are still cautious about the outlook as Covid-19 infection rates are increasing and the impact of a third wave is uncertain,” Wilken said.

“The roll-out of vaccines in Europe is progressing well and we are optimistic about further relaxation of restrictions, and in a recovery of footfall. There is an expectation that herd immunity in Europe will be reached through vaccinations by the end of October 2021.”

In South Africa, the vacancy rate across the group’s well-positioned malls has improved to 2.6% at end-April from 3% at end-December. Turnover and trading density have recovered relative to 2020, but growth in foot count remains muted.

Some of the highlights in the South African portfolio include the opening of iconic brand stores, such as Superga, Fabiani, Wellness Warehouse and MRP Sport at Somerset Mall, which remains fully let. Rosebank Mall more than halved its vacancies and the first storage facility in the Hyprop portfolio as well as the first SOKO District will open in July. Hyde Park Corner has attracted new tenants and concepts, such as The Finish Line, which offers a range of athleisure brands and Swiss-engineered performance running shoes, ON. The mall will also welcome KōL, a Japanese restaurant that will offer curated contemporary Japanese cuisine and flexible co-working space.

“Consumer behaviour continues to evolve, and we will continue to reposition our centres to navigate through these challenges,” Wilken said.

In Eastern Europe, strict lockdown measures imposed by most governments in the first quarter of 2021 to combat rising Covid-19 rates had a significant impact on trading in most of Hystead’s malls. Overall, vacancies remain below 1% and cash collections are being monitored closely. Management took the opportunity presented by lockdowns to accelerate the completion of capital projects, prior to re-opening the malls. Refurbishment of Skopje City Mall has progressed well, and the food court at the Mall Sofia is now complete.

In the African portfolio, vacancies have remained relatively unchanged, despite continued subdued trading. Ikeja Mall in Nigeria is fully occupied, and continues to be highly cash-generative, but shortages of US dollars make it difficult for retailers to import stock and for mall owners to repatriate dividends. While Ghana has made good progress in rolling out vaccines, there are still some lockdown restrictions in place. However, trading density in Cedi was up 18.5% (+16% in US dollars) in the first four months of 2021 compared with the same period in 2020.

“While the operating environment remains challenging and many uncertainties remain around the speed of halting the spread of infections, we are pleased to note early signs of stronger consumer spending in many of our malls,” Wilken said.

“Hyprop remains committed to creating safe environments and opportunities for people to connect and have authentic and meaningful experiences, by owning and managing dominant retail centres in mixed-use precincts in key economic nodes in South Africa and Eastern Europe.”

Why Environmental Impact Needs to Be Top Of Mind For Property Owners and Their Ecosystem

Since the establishment of the REIT regime in 2013, the industry has faced many challenges from an Environmental, Social and Governance (ESG) perspective, such as climate change which has brought sustainability into the spotlight on most political and business agendas. In light of this, reporting on environmental issues has become more critical than ever as tenants, consumers and investors demand greater transparency on how property owners operate and manage their assets on a day-to-day basis.

Fast forward to 2021, when broad socio-economic challenges, coupled with environmental issues, are taking precedence, the property sector requires collective effort to position itself for recovery. It has been a year since the onset of COVID-19, and one thing the pandemic has highlighted is it will be the businesses that prioritise their environments and communities that will come out stronger on the other side. Consequently, it is not surprising that we have swiftly moved away from sustainability being regarded as mere corporate philanthropy but a more concerted effort that is integrated within businesses’ core strategies and values. For that reason, listed REITs and property owners should further entrench sustainability into the ethos of everything they do.

As an industry, the property sector has been proactive and fared relatively well in terms of sustainability compared to other sectors and we should applaud the industry for taking up a leadership role. Many of the property funds and their respective portfolios have been awarded green-star ratings, are LEED-certified, and most consistently seeking innovative ways to reduce energy consumption and manage waste to protect their respective environments. As much as the sector has forged the path with regards to responsible property development and management, the industry should not take a back seat but rather improve by adhering to the global, best-in-class sustainability standards that will position the asset class favourably.

For new, smaller entrants within the property sector, it is understandable to be overwhelmed by the sustainability elements of owning and managing properties given the traditional challenges such as limited access to funding and incentives or even the misunderstandings associated with costs versus benefits. However, it is encouraging to see that South African REITs are ensuring they have measures and policies in place that hold them accountable. Furthermore, as an industry body exposed to 28 JSE-listed REITs, it is reassuring to see members tirelessly working to prioritise their environments sustainably.

As the property sector navigates this challenging cycle, the key to surviving and thriving will be environmental sustainability. Here are some benefits why sustainability should remain at the forefront of every property owner and managers’ business:

 

Long term rewards

According to the 2019 MSCI South Africa Green Annual Property Index, green-certified buildings have proven to deliver higher returns compared to non-certified properties, with green-certified properties averaging 7.6% and non-certified ranging about 5.1% growth. Despite the impacts of COVID-19, which have negatively affected property values, it is still worth noting that green-rated properties achieved higher capital growth, therefore holding their value better amidst a subdued economic backdrop. Also, given the current trading environment, there is no doubt that property investors would gravitate towards green-rated properties, given their defensive nature. The defensiveness can be attributed to their ability to outperform non-green-certified buildings on critical investment metrics of occupancy, net operating income and operating cost ratios. Although the rewards may lag, particularly in South Africa, the long-term rewards still outweigh the immediate shortcomings.

 

Cost Saving

Contrary to popular belief, developing properties in a sustainable way does not always result in significantly higher costs, and green building features are not just expensive add-ons. If anything, the costs may even be equivalent to conventional buildings. Further to building sustainably, the cost of occupancy becomes lower when green and innovative initiatives are introduced for the day-to-day running of buildings. These efficiencies may include improved energy performance, lower utility bills, decreased operational and maintenance costs, healthier indoor environment with better air quality, resulting in well-positioned properties that attract and retain tenants in the long run. The abovementioned factors indicate that the future savings exceed the upfront costs, making green buildings both affordable and sustainable – a win-win.

 

Enhanced competitive advantage for capital

With the growth of impact investing, ESG has rapidly become an integral part of the investment decision process. So much so that a company’s ESG performance contributes towards modelling the stock to determine prospective returns. Locally, we have seen ESG teams from institutional investors play an active role within the investment committees and engage more with management teams to better understand matters such as climate risk and overall sustainability performance. Therefore, prioritising the environmental issues alongside the social and governance aspects will enhance the company’s investment value proposition.

Amidst climate change and other social issues making global headlines daily, the sector’s stakeholders are placing more pressure on REITs and property owners by demanding further transparency due to the increasing importance of how these companies interact with and impact their communities. Ultimately, as an industry, we all need to come together, assist the new, smaller players and set out a uniform roadmap on how we can work towards meeting the environmental expectations while ensuring the overall business objectives are achieved. At the end of the day, it is the properties that showcase green design and overall environmental consciousness that will stand out from the crowd.

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