Is Emirates REIT’s Dividend Sustainable?

Emirates REIT’s (EREIT) Q3 results and investor call was held a few days ago in which they updated shareholders on performance.

We’ve detailed EREIT’s problem asset, Index Tower, in previous articles. Index Tower continues to under perform, registering just a 31% occupancy rate, up from 26% in Q2 2017 and 24% in Q3 2016. Sluggish uptake is largely due to weaker demand for DIFC office space and EREIT’s ongoing failure to rent parking spaces and the ground floor retail area. Equitativa, EREIT’s manager, attempts to gloss over poor performance with the following more positive spins:

1. Index Tower as a single asset is now operating above break-even, as the fixed costs of service charges are now being offset by office leases, implying its not a net detractor to the portfolio and any new leases flow straight to the bottom line.
2. They’ve apparently signed “pre-lease” agreements with prospective retail tenants (whatever that means).
3. Index Tower is already achieving 60% of their initial target rental income due to higher than expected rents from fitted-out spaces vs core & shell.

Still, 69% of EREIT’s Index Tower space being income-less whilst Equitativa collects management fees isn’t going to get shareholders smiling.

Sustainable Dividend?

The focus for this article is on the sustainability of EREIT’s  generous 8%+ current annualized dividend.

EREIT’s prospectus states that 80% of the REIT’s Net Profit must be paid out as dividends. The issue is that EREIT’s Net Profit continues to be dominated by Revaluation Gains, which are a non-cash item. In fact, looking at the Q3 update below we can see that Revaluation Gains made up a massive 87% of Net Profit.

If EREIT has to pay out 80% of Net Profit, that’s a total of $25.3mn for Q3 alone. When compared to Net Rental Income for Q3 (which is the actual cash coming from the investment property portfolio after expenses), we see that Net Rental Income of $11.8mn covers less than half of the expected dividend accrued in the most recent quarter.

On a longer time horizon, the table below illustrates how dividends to be paid outstripped Net Rental Income generated by the property portfolio for several years. In effect, EREIT continues to distribute its assets back to investors as opposed to purely “rental income” and realized gains.

Investors should be aware of the difference, as one is less sustainable than the other. To put it another way, today EREIT’s dividend is determined more-so by property prices vs rental income.

We propose that EREIT change its dividend policy to be linked to Net Rental Income and Realized Gains of properties actually sold, instead of Net Profit, which continues to get get skewed by unrealized Revaluation Gains. We believe this more accurately reflects the performance of the portfolio and produces a more stable and sustainable dividend over the property cycle.