WITH listed property prices having had such a strong run over the past few years, JSE-listed property companies wanting to broker empowerment deals have to put on their thinking caps.
Two property groups have instituted an innovative structure that may point the way for others to follow.
Analysts agree that conventional ways of creating empowerment unit holdings through bank financing may not be financially viable. When prices go up, yields go down, making it difficult for deals to be financed through debt, as interest rates are higher than the yield.
Fewer than 10 of the 30 property companies and funds on the JSE have concluded empowerment deals, although more are expected after the property sector empowerment charter was signed in March.
Companies such as Growthpoint Properties and Vukile Property Fund have concluded empowerment deals relatively easily, as both had a large unitholder that wanted to sell its stake. This facilitated empowerment transactions without having to issue new units, meaning no dilution for unitholders.
ApexHi Properties and Hospitality Property Funds have opted for different structures to create an empowerment unit holding.
Last week, ApexHi announced a new structure that would result in empowerment unitholders owning 10% of the company.
CEO Gerald Leissner said the structure would introduce C class units and provide interest in the company at a cost of R150m. This is a substantial saving on the R800m it would have cost to buy the stake on the open market.
Leissner said there would be no dilution for unitholders, as it would issue 250-million C units to A and B unitholders.
The units will be given to the unitholders who will be obliged to sell 30% to empowerment unitholders at R2 a unit.
The group decided to split its structure into A and B units with A units getting preference of income over B unitholders, with the A units priced on a lower yield than the B units.
The A units offer a more secure income with lower risk, while the B units offer a higher return but with higher risk.
However, the B units, which were meant to be priced at a much higher yield, were in demand due to the confidence people had in ApexHi, and consequently traded at a low yield, said Leissner.
Leissner said it was difficult to introduce an empowerment partner in a market where prices had run. The company did not want existing unitholders to be forced to sell units at a discount.
“We looked at an innovative structure to accommodate an empowerment partner.
“We are creating a unit where income is delayed. C units will earn nothing for about two years, then earn substantial growth for a few years and then flatten out.
“A and B unitholders are getting cash now in exchange for giving away income in the future.”
Leissner said whether or not cash up front would equal the loss of future income depended on how well the unit performed.
“I believe R2 is the right price. If the A and B unitholder who sells C units at R2, buys back shares at R2, he is in the same position — he has lost nothing.”
Gerald Nelson, MD of Grapnel Property Group, which conceptualised Hospitality Property Fund’s listing, said Hospitality was launched with a view to introducing an empowerment partner up front.
“That was part of the reasoning behind creating the split A and B units. The reason for creating (the units) was that banks were prepared to lend to a much higher loan-to-value ratio than if there was a single unit.”
The property fund’s dual system is similar to ApexHi’s. A unitholders have a preferential claim to dividends with units set at an initial yield of 9,8%, while B unitholders get the balance.
B linked units are riskier, with higher projected yields. A units are expected to appeal to the cautious investor, while B units would appeal to investors with an appetite for greater risk and greater potential returns.
Mariette Warner, head of property funds at Stanlib Asset Management, said she expected creativity on the part of property companies in terms of the structuring of empowerment deals.
“The convention of using bank financing is no longer viable because of the run in prices.”
She said ApexHi and Hospitality’s structures were viable options in a climate of high growth, “because they are based on future earnings growth. The danger is when the earnings cycle turns negative, but that is probably still some years away.”
Leon Allison, property analyst at First South Securities, said when income yields dropped below the funding rate, it became difficult to finance empowerment deals in a conventional way.
“Black economic empowerment partners often need to fund transactions with a high level of debt. If the funding rate is above the investment’s income yield, there is a shortfall and the transaction is not self-funding.”
She said companies needed to come up with innovative structures to make the deals workable.
“If a deal is not self-funding and the empowerment stake is offered at a discount, it is dilutive to shareholders,” she said.
