Is innovation operational and strategic only? Innovation is not limited and applies to various levels. Based on this we decided to take a look at where Proptech fits in with the REITS by first looking at how they work.
Innovation and the listed property sector (REITs)
As discussed briefly in my reply to Elias’ 1st episode on innovation within the property sector in SA – innovation (even incremental) is lagging in the property sector. Why is this the case?
Well, I am here to try answer this question through some of my experience and insights as a corporate finance analyst for a listed property fund here on the Johannesburg Stock Exchange, in Joburg, South Africa. I have just left this post but was with this company for a little over 5 years, and while my experience is company-centric I do have insights into how the sector operates (as one would through attending conferences etc.) and why it is the slow beast that Elias alludes to in his podcast.
Let me start off by explaining something… listed property companies globally have adopted a framework to ensure that private companies invest in property (rather than the government owning a lot of buildings and land). Why is this important? Well a collective piece of the pie can be shared with investors and the government has less risks to manage as holding land and property comes with a cost… so this framework is called Real Estate Investment Trusts or “REITs”.
Here’s the kicker… if you take on this framework and become a REIT you have to:
(1) distribute at minimum (at least) 75% of your net profit to your investors;
and provided you meet the first criteria you get:
(2) exempt from paying company tax [which in South Africa is 28% ~ quite a beast].
Okay, got it??? There are companies listed that have to distribute most of their profits. Oh, and by the way, given that the revenue is derived from leases escalating year-on-year (contractual therefore certain) we should theoretically expect distributions to increase every year… provided of course that costs are managed correctly.
Here-in lies the problem, investors in REITS expect income to increase as time goes on, leaving the focus of property landlords in the listed sector to focus on enhancing this equation for short-term goals. A further problem is exacerbated when you add the fact that South Africa has one of the largest mall spaces per capita in the world ~ this is astounding especially given we are a developing market. I don’t blame the industry however, as banks and the government continued to support this boom, why? Because it created employment through the construction sector ~ a key sector of the economy. This discussion is for another day however.
Anyways, back to the story, REITs are focused on ensuring they get through the next increase in distributions and forego even little changes in their operating models thereby forgoing any innovation altogether… it’s a sad sad situation.
There is however one company that is bucking this trend… Emira. I would invite you to take a look at their website and app that they created to assist them in the marketing of space. They have used digital transformation to their own advantage and years ago (3/4 years ago) when they told the market, heads up our distribution growth is going to slow down, they were clever in what they invested their money in ~ technology ~ don’t take my word for it… have a look: https://bit.ly/3bWBHN2.
So where does this leave us now? What to do… in my opinion two options:
1. Do as Marc Weiner explained in a talk he gave at the SA REIT association conference in 2018, “let’s forgo some of our distribution growth to try as a collective (sector) and put that money to use to create more jobs in our organisations. Ultimately, our shareholders are going to get a slightly lower distribution but everybody’s rating would be the same” https://bit.ly/2yUuRJi. Yes, I get your point this was a call to arms for jobs… but why can’t it be a call to arms to take on innovation and PropTech. Perhaps, there should be guidelines for adopting PropTech that can be set by the SA REIT association, I don’t know. But one things for certain, if REITs got together and said… boy oh boy we are operating in uncertain times we should collectively agree that 0.1% of our distribution payments should be set aside for PropTech, would this create jobs? Hmmmm… at the same time…. Wouldn’t it make their businesses more efficient by helping both costs & revenues? I don’t know… food for thought anyone?
2. Surely, PropTech can be classified as Capital Expenditure? If this is the case, and, please forgive me if this is a stab in the dark, but if it can be… then it would be easier to absorb this cost in these businesses. I am not a CA, so I don’t know, but it could be an option.
One thing is for certain, the current model, where REITs are focused on the short-term distribution growth is not sustainable and as technology progresses these companies will get left behind. As Elias alluded to, they need to innovate as there are scary trends that are coming through from developed markets that should be case studies for the wave of change that is set to happen in South Africa. Ignoring these imminent changes is dangerous as certain technology can be the differentiator between those that make it and those that don’t.
We want to welcome Makis to the team as one of our new members who will talk about his perspective on the industry from a strategic and financial point of view.