The Marriott Property Income Fund produced a total return of -4.0% for the 12 months ending 30 September 2019. Despite the fund outperforming relative to the SA property sector (ALPI: -7.7%), it’s performance is still poor and reflective of a tough economic and operating environment.

SA property fundamentals continue to deteriorate with subdued net rental income growth seen in recent company results. Rentals continue to be rebased downward with lower built-in contractual escalations. Landlords are also having to increase lease incentives to retain tenants to avoid costs associated with re-letting space (i.e. tenant installation) and the risk of void periods. These trends demonstrate that the sector is largely a “tenants’ market”. Operating costs continue to outpace rental income growth, primarily driven by municipal charges (the largest cost contributor) growing in excess of 12% according to the latest SAPOA cost report. The impact of this has been recently seen as several REITs have reported higher cost to income ratios.

These poor fundamentals ultimately erode earnings and put downward pressure on property valuations, as evidenced by recently reported valuations. Management teams have responded to this by selling non-core assets to deleverage constrained balance sheets and focus on their core assets. Property developments and acquisitions have been placed on hold, due to debt constraints and the lack of accretive equity-funded deals. The next sensible management action, which has started to emerge, is to rebase unsustainably high pay-out ratios to more sustainable levels, in line with global standards. This allows for more investment into improving the quality of the underlying properties, which is needed to combat these poor fundamentals and achieve more sustainable rental income growth.

The average dividend growth of the stocks held within the Marriott Property Income Fund has been around 4.1% this year. The fund has shielded investors from some of the large dividend cuts seen over the last quarter (ranging from -20% to -100%). The fund also has a 25% exposure to specialist REITs (Equites, Stor-Age & Vukile) which are faring well and still trading at premiums to NAV. These REITs are still attracting capital in a tough market, as seen in recent equity book-builds.

Despite the weak outlook for the sector with subdued earnings growth over the medium term, a lot of the negativity has already been priced in, in our view. The SAPY is currently trading at an attractive yield of 9.8% when compared to its 10-year historic average of 6.8% and the SA 10-year bond at 8.9%.

The Marriott Property Income Fund continues to invest in what we consider to be the highest quality, most liquid REITs. These companies have strong management teams, transparent disclosure, minimal once-off earnings and the most secure dividend outlook in our opinion. We believe that these companies are best positioned to deliver sustainable growing dividends over the long term.