Converting to a REIT positions Attacq well in the listed property sector, building on our unique competitive advantages.
Melt Hamman, chief executive officer
The key event in the review period was converting to a REIT on 29 May 2018. This was a natural step in the company's evolution with important benefits: attracting a wider shareholder universe and generally lowering the cost of capital.
Our strategy differs from our REIT peers as we own and control a long-term development pipeline at Waterfall. This development pipeline, split between Waterfall City and Waterfall Logistics Hub, creates the platform for above-market average growth in distributable earnings and capital.
Since listing on the JSE five years ago, we have completed 38 developments, including the Mall of Africa, adding over 526 000m2 of gross lettable area to our portfolio. We are launching our first residential development, The Ellipse, which will support the, 'live, work, play', environment in Waterfall City. The intention is to complete the first 250 residential units by March 2020, in line with the anticipated completion date of the new head office for Deloitte.
Under the REIT structure, our focus has shifted from only capital growth to cash yields to support the distributions and distribution growth. Our share price is currently trading at a low distribution yield, given that we were operating as a capital-growth entity and only converted to a REIT in the penultimate month of the review period. To compete more effectively with our REIT peers, we need to improve our distribution yield and interest cover ratio by increasing net rental income and reducing debt. We have made excellent progress by increasing distributable earnings per share by 280.71% and improving our interest cover this ratio from 1.1 times in 2017 to 1.6 times in the review period. We are targeting a minimum 2.0 times ratio within the next three years by recycling capital through exiting non-core investments and reducing debt with the proceeds.
Overall, it was another challenging year, characterised by minimal economic growth and political uncertainty. Despite those headwinds, we are using our simplified business model and focused strategy to meticulously reassess our portfolio and extract further value from existing assets while disposing of non-core or mature assets. We improved our capital structure by selling three investments in the period and applying proceeds of R524.0 million to improve gearing or recycle into our Waterfall development. We also restructured most of our debt (as detailed by the chief financial officer), reducing our average cost of debt from 9.2% to 8.7%.
In the prevailing economic climate, we are also paying close attention to the key metrics of vacancies, arrears and trading densities. Post-year end, we improved vacancies in our South African portfolio from 7.8% to 5.1%. Proactive management and close relationships with our tenants reduced arrears to an acceptable 2.8% of total rental income. We are extremely proud of the annual growth in our retail trading densities of 5.3%, the weighted average lease expiry profile of 6.8 years, as well as the cost of occupancy (average rent to turnover ratio) of 7.7%, which is well below the IPD benchmark of 11.0%. We believe that these are exceptional results under challenging economic conditions.
Waterfall precinct – key value driver
Uniquely, we are developing a new city and logistics hub at Waterfall, arguably the best located development of its kind, in the centre of Gauteng, the centre of South Africa's economic hub. This will be an integrated and highly efficient 'work, live, play' city environment, anchored by Mall of Africa, surrounded by commercial and light industrial properties and complemented by a wide range of residential offerings. With around half of the remaining 975 008m2 bulk in Waterfall now serviced, the opportunity is significant.
Our development roll-out spans the next 15 years, obviously depending on economic conditions, and we are confident that Waterfall will be a strong driver of capital and distribution growth for years to come. Our target is to roll out 70 000m2 of developable bulk per annum, depending on market demand. In the review period, our effective interest in completed primary gross lettable area (PGLA) was 103 541m2. Construction is under way on another seven developments, totalling 65 479m2 effective PGLA and detailed in the performance review.
We completed several developments in the Waterfall precinct, including the award-winning PwC Tower, Gateway West office building, and first phase of Waterfall Corporate Campus. In the Waterfall Logistics Hub, we completed the award-winning regional distribution centre for BMW South Africa, the Dis-Chem warehouse and the Massbuild warehouse extension. Notably, we continue to secure top-calibre tenants, attracted by Waterfall's compelling advantages.
The scale of our Waterfall pipeline requires an adequately resourced and full-focused, hands-on team. Accordingly, our in-house main-disciplined development team is based at Waterfall. Since enlarging the team over the last year, progress in developing this pipeline has accelerated. Giles Pendleton joined as head of developments in March 2018, bringing renewed energy, passion and focus to the team.
Internalising the team and controlling the remaining bulk also provides the flexibility to establish appropriate joint ventures. We currently have joint ventures with Zenprop, Equites, Barrow Properties, Atterbury Property Holdings Proprietary Limited and its subsidiaries (Atterbury group), the Moolman group and Sanlam for specific capabilities, with some as co-investors and others as co-developers.
Across our Waterfall portfolio – retail, office and mixed-use, light industrial, hotel or residential - our focus remains on densification. We are effectively populating a new city by attracting tenants keen to take advantage of all the benefits offered by our 'work, live, play' concept.
Europe and Africa – additional value drivers
Over the last year, we have exited a few global investments and our European investment is now concentrated in our strategic shareholding in MAS (refer to Manufactured resources). This shareholding reduced to 22.8% during the year after we elected not to participate in MAS' two capital raisings, instead deploying surplus cash into our Waterfall development and reducing our interest-bearing debt. MAS remains a significant part of our portfolio at 10.8% of total assets or R3.1 billion. Although MAS has lowered its distribution guidance growth to 15.0% for 2019 in a more competitive market, it is well funded and appropriately focused.
Our Rest of Africa retail investments contributed R42.4 million to our 2018 distributable earnings. While the June 2018 book value at 3.8% of total assets is a small portion of our portfolio, it remains one of our value drivers. We expect upside in the long term as the commodities cycle turns, and benefits flow from management's focus on filling vacancies and tenant retention to optimise net income and asset value.
Sustainability – across the capitals
We keenly understand the complex interplay between the capitals or resources that underpin our long-term sustainability as a company. Our approach is detailed throughout this report, but I comment specifically here on the natural and human capitals.
Because we control the design and construction of our buildings, we can guarantee the standards of quality and efficiency throughout their life cycles. Our developments are designed for environmental efficiency and ease of management by integrating critical functions such as maintenance and cleaning. This turnkey approach reduces lifecycle and occupation costs.
By integrating our design, construction and asset management criteria, we deliver smarter, more efficient buildings that minimise environmental impacts and lower operating costs.
Environmental sustainability is both an ethical responsibility and good business. We therefore take a long-term view on our potential impacts – negative and positive – in all project design and planning by minimising resource consumption, introducing alternatives such as solar power, and maximising reuse and recycling.
To illustrate our approach in action, 63.8% of our office and mixed-use portfolio is green-certified (including PwC Tower's silver LEED certification, which is currently being finalised), and all buildings in our South African portfolio can operate for two days without council water. During the year, the Mall of Africa's 4 755kWp photovoltaic system came into operation, increasing our electricity recovery ratio.
Although green-rated buildings may cost more to develop initially, their users and broader society benefit across the lifecycle.
We believe that a motivating and collaborative culture will naturally attract the right people. During the year, we worked with an external specialist to assess the alignment between our corporate culture and ability to attract and retain the people we need. Encouragingly, results indicated a close fit between our targeted and existing cultures.
Our rate of employee turnover is unacceptably high at present, a function both of the uncertainty that accompanies management change (detailed by the chairperson's review) and the pressure on disposable income that encourages people to switch employers frequently on the perception of better benefits. We understand that more needs to be done to build a sustainable base of skills, and we are committed to this goal by developing the full potential of every person and rewarding them appropriately. To retain staff, we issued share awards to all employees in October 2017 and we will repeat this in October 2018.
Equally, we view a diverse workforce as a goal in itself, beyond mere compliance. Given that diversity has been proven to stimulate creativity and support balanced decisions, building a representative workforce is a key performance indicator for executive management.
Our ambition to be South Africa's premier property company depends on attracting the best talent from all parts of society to be part of the motivating culture our leadership is actively creating.
South Africa's phase of low economic growth is constraining consumer spend and corporate expansion, translating into weak property fundamentals and headwinds for our sector.
Our retail portfolio has proven its defensive qualities, reflected in average annual trading density growth of 5.3% under challenging conditions as well as an affordable cost-to-income ratio for our retail tenants. This portfolio should continue to provide sustainable growth in distributable earnings.
Despite the uncertain and difficult market conditions, the development of Waterfall is expected to continue, albeit at a slower pace. The location, as evidenced by existing and secured future tenants, remains an attractive proposition for corporates considering office consolidations in new, modern, green-rated premises.
Internationally, we expect to benefit from increasing distributions from MAS, underpinned by its income-generating investments as well as acquisition and development pipeline. We will not pursue any further acquisitions or expansions in the Rest of Africa.
We will continue exploring opportunities to recycle capital, with a view to redeploying funds into earnings-accretive developments and reducing debt to improve our yield and to better align with our REIT peers.
As a REIT, distributable earnings per share is our key financial performance metric. We have revised our own guidance on distributions after MAS lowered its projected distribution for 2019 and lower-than-expected cash receipts from the Rest of Africa retail investments. In addition, weakening economic conditions have affected the timing of planned disposals of non-core assets and the pace of Waterfall development activity. We are, however, confident that the future roll-out of Waterfall will enhance our existing quality portfolio and deliver above-market average distributable earnings growth.
We believe that our revised ranges of distributable earnings growth of 7.5% to 9.5% and 13.0% to 15.0% for the 2019 and 2020 financial years, respectively (previously 20.0%), are more appropriate. We have elected not to provide guidance for the 2021 financial year, given increased uncertainty in the macroeconomic environment.
To achieve our targets for 2019 and 2020, we will focus on growing our rental income, disposing of non-core investments to recycle capital and developing our Waterfall pipeline. These targets assume:
- MAS achieving its revised distribution growth target of 15.0% for 2019. We have applied a rand/euro exchange rate of R16.50 for both the 2019 and 2020 financial years
- Only interest actually received on the Rest of Africa portfolio, and therefore we have not budgeted for any cash income in the 2020 financial year
- Achieving forecast contracted rental income and anticipated market-related renewals
- The expected roll-out of the current and planned development portfolio
- No unforeseen circumstances such as major corporate tenant failures or macroeconomic instability.
At every level, our people are proving their commitment and we are most grateful for your contributions. We also value the input and support of our other stakeholders, which underpins our continued growth.
Morné Wilken made a significant contribution to our group during his eight-year tenure, setting the tone with his dedication, energy and deal-making ability. I thank the board for its confidence in appointing me to succeed Morné as well as my exco colleagues for forming such an effective team.
Chief executive officer
24 October 2018