Listed Property Trusts

[ithaka]

1/ There isn't a lot of maintenance to be done on these large tilt slab concrete structures. Maybe they are washed or water blasted once or twice a year. Those coloursteel roofs are guaranteed for 27 years before they need repainting. There are a few green plants around most sites that need looking after. Maybe a bit of concrete edging needs fixing when shoppers crash their cars in the car park. Light bulbs will need changing, although with modern lighting technology, this doesn't happen as often as it used to. Toilet paper and cleaners for the shared toilet facilities. A lot of buildings like this are designed as 'really low maintenance'.
SNOOPY

The tenant pays many of these costs.

[Snoopy]

1/ There isn't a lot of maintenance to be done on these large tilt slab concrete structures. Maybe they are washed or water blasted once or twice a year. Those coloursteel roofs are guaranteed for 27 years before they need repainting. There are a few green plants around most sites that need looking after. Maybe a bit of concrete edging needs fixing when shoppers crash their cars in the car park. Light bulbs will need changing, although with modern lighting technology, this doesn't happen as often as it used to. Toilet paper and cleaners for the shared toilet facilities. A lot of buildings like this are designed as 'really low maintenance'.

The tenant pays many of these costs.

I guess you can ultimately argue that the tenants pay all costs, because they are the only income source for the property owning company. But I think you are implying something a little different ithaka? Are you suggesting that for tenants there is an additional 'overall facilities charge' to pay for the 'common facilities' on top of the rent due based on the square metres that the tenant store occupies? Asking because I don't really know the details of these matters, although I was aware that tenants usually pay the in store fit out costs and upkeep as I suggest below.

3/ The interior wear and tear will be looked after by the tenants, at 'no cost' to the landlord.

SNOOPY

[JeffW]

I guess you can ultimately argue that the tenants pay all costs, because they are the only income source for the property owning company. But I think you are implying something a little different ithaka? Are you suggesting that for tenants there is an additional 'overall facilities charge' to pay for the 'common facilities' on top of the rent due based on the square metres that the tenant store occupies? Asking because I don't really know the details of these matters, although I was aware that tenants usually pay the in store fit out costs and upkeep as I suggest below.


SNOOPY

That's correct - in a commercial tenancy (as opposed to a residential tenancy) it is usual that the tenant pays the Operating Expenses (OPEX), which includes the type of things in your original post, plus more importantly the rates and insurance.

[winner69]

KPG accounts FY23

Direct Property Expenses $52.8m


Are these things like rates etc …..which when/if paid by tenants gets included in revenues?

[Snoopy]

Accounting is a story.

Cash is real.

As I said NZD.

9% cash return after ALL expenses on current market cap - I'm saying BS

SailorRob does have a point in that there is a lot of 'alternative profit' reporting about.

To illustrate this I am switching across to another of the protagonists, Investore, because that is a company that isn't in a state of transformation. In theory that means less ability to rewrite the profit story. I.e. the accounts should be harder to fudge. I am using section 3.2 from IPL AR2023 to compare the four (yes you did read that correctly) measures of profit highlighted in the annual report. Ironically the only one I would dismiss as BS out of hand is the official GAAP measure. That is because GAAP profit includes capital value changes of the owned assets. The question then becomes: "Which of the remaining three measures of profit are most real?"

Line Item
1	GAAP Loss/Profit before Income tax	$(150.072m)
	Non-recurring non-cash Operational profit adjustments
2	add back Capital Property Value loss	$185.246m
3	equals Operational profit before Income tax	$35.174m	(Or with tax taken off $30.143m)
	Non-recurring non-cash Distributable Profit Adjustments
4	Reversal of right of use assets movement in net change in fair value of investment properties	$(0.075m)
5	Gain on disposal of investment property	-
6	Net change in fair value of derivative financial instruments	$0.033m
7	Spreading of fixed rental increases	$0.089m
8	Capitalised lease expenses net of amortisation	$0.112m
9	Borrowing establishment costs amortisation	$0.940m
10	Swap termination income	-
11	equals Distributable Profit before current income tax	$36.049m
12	Current income tax	$(4.972m)
13	Tax expense on capitalised interest adjustment	$(0.059m)
11	equals Distributable Profit after current income tax	$31.018m
	Adjustments to funds from operations
12	Maintenance Capital Expenditure	$(2.400m)
13	equals Adjusted Funds from Operations (AFFO)	$28.618m

Notes

(3) Calculation for 'Operational Profit after Income Tax':
$35.174m - $4.972m -$0.059m = $30.143m

---------------------

I have already had a grizzle about the unsustainability of paying dividends from profits at Investore here:
https://www.sharetrader.co.nz/showth...=1#post1013952

So now is the time in a more general context, to discuss the merits, or otherwise, of all four profits reported.

SNOOPY

[Snoopy]

GAAP Loss/Profit before Income tax

This one is easy to dismiss, albeit with one small caveat. An increase (or decrease for that matter) of the value of an investment property 'on the books' does nothing to increase (or decrease) cashflow. Sure you can borrow money against an increasing property value, and pay that money out as a 'dividend'. But such a dividend will carry no imputation credits which is a sure sign it is an 'asset transfer' unconnected to income from 'running a business'. So this first 'profit measure' fails the SailorRob income test.

SNOOPY

P.S. The caveat I mentioned relates to the debt to asset ratio of a property company:

Investore AGM2023 presentation: slide 8:
"During FY2023, $75m of bank facilities were refinanced.and extended for a further two years to November 2025. As part of this refinancing, Investore also renegotiated its banking covenants with its banking syndicate, removing the covenant relating to its weighted average lease term of Investores portfolio, and reducing the LVR (Loan to Value Ratio) covenant from a maximum of 65% to a maximum of 52.5%."

Changing the market value of properties held does affect the loan to value ratio of the property portfolio held. And so does borrowing against a property to pay a dividend. So you could say revaluations and devaluations of property indirectly affect the dividend paying capability of that property company.

[Snoopy]

'Operational Profit; is the base profit figure I would use. But deriving a profit in this way means that certain accounting conventions have to be followed. In particular, some of the profit may be 'non-recurring', and some of those 'non-recurring' adjustments may be unexpected. Some would say (and I am one of the some) that while reporting a profit like this is 'accurate' it is also misleading. The obvious follow up question is, what adjustments should we make to 'operational profit' to provide a sustainable view of that profit? For unless the 'Operational Profit' is sustainable, you cannot pay a reliable dividend from it.

SNOOPY

[Snoopy]

This is the post that you have been waiting for: 'Operational Profit' with the correction factors.

Look back at part 1 of this series and lines 4 to 10 provide the one off adjustments that create 'Distributable Profit'.

Starting from line 4, recording 'right of use assets' on the balance sheet is part of an accounting construct to bring rented assets onto the books of a company that needs to use those assets to produce a profit. But to balance out the fact that you have put on the balance sheet assets that a company does not own, you have to introduce onto the other side of the ledger an offsetting lease liability. The net effect of this is that over a rental contract for the asset, the 'right of use assets' and associated 'lease liabilities' gradually diminish so that both are zero by the end of the rental contract.

We are told this 'right of use asset' reversal of $0.075m is somehow connected to the revaluation of investment properties (there was a $185.246m downward valuation in Investore properties in the Investore FY2023 result). I believe this $0.075m further downward profit adjustment is connected to the investment properties that Investore owns (Investore is in the business of owning investment properties after all). However, Investore is in the business of selling the utility of 'right to use' assets, not buying such a utility. So maybe this adjustment is because 'right to use Investore assets' are no longer as valuable because an underlying connected rent contract has either:

a/ gone bad,
b/ been cut short or
c/ had rent terms renegotiated in a way that is unfavourable to Investore.

Thus Investore has suffered a double whammy here. The first hit being the write down in the value of the building itself as a 'general rentable prospect'. The second hit being the loss of a specific rental stream in line with the diminution in value of one or more specific rental contracts. I admit I am making this explanation up on the fly, starting from what I do know to come up with a plausible explanation. So I am willing to be corrected by someone who really knows this stuff.

Moving on to line 5, it is quite logical to remove profits from a property sale, if this is a one off non-repeating event (Investore are in the business of managing properties, not selling them).

Line 6 and line 10 relate to 'derivatives' and 'swap rates'. These are commonly use to stabilize borrowing interest payments into consistent amounts, when the underlying terms of the borrowings contain a variable factor that Investore wants to eliminate. But accounting rules require such contracts to be revalued annually to reflect the 'what if' effect of such contracts being broken at balance date. Over the life of these derivative contracts, the annual revaluations and devaluations will balance out. IMO it is correct to remove these 'derivative adjustments' from each annual result if you want to correctly assess the operational performance of the business.

LIne 7 talks about the spreading of fixed rental increases. Rental agreements may have a fixed component, a turnover component and an inflation adjusted component. I am guessing that 'fixed rental increases' must be referring to new rental contracts rolling over old rental contract that have expired. But that is primarily because otherwise the concept of a 'fixed rental' contract 'increasing' is a contradiction. I see from the reconciliation of profit with cashflow statement (IPL AR2023 p33) that this $0.089m is a 'non cashflow item'. If that is true, it makes even less sense to add it to this years distributable profit. Sometimes these adjustments are quite baffling to me and this is one of those times. My rule of thumb is that if I don't understand something like this, I leave it out. Explanation from someone who knows what is going on here would be welcome.

Line 9 talks about 'loan establishment costs' which are being amortised away. Any asset that is amortised away will reduce profit but not cashflow. This adjustment is telling us that the amount being amortised is actually free cashflow that could be used to boost dividends. That fits with the SailorRob paradigm of 'show me the cash'. So I think our nautical friend would be on board with adding this cash to our potential dividend pile, even though it is strictly 'not profit'.

Looking back on Line 8, the talk there is of capitalised lease expenses net of amortisation. So forget the amortisation reference. These sound like lease expenses capitalised during the year. If these lease expenses had not been capitalised, then they would have been paid out reducing profit. But since they were capitalised, the net effect of the capitalisation was to increase the profit of Investore, and a cash payout was saved. Thus that 'saved cash' is available to pay an increased dividend. Makes sense!

I have covered Lines 4 to 9 from my post 1935, and agree with most but not all of the adjustments made. Make of that what you will.

SNOOPY

[Snoopy]

'AFFO' stands for 'Adjusted Funds from Operations'. The only difference between this and 'distributable profit' is that 'Maintenance Capital Expenditure' has been removed. I did a double take when I saw that phrase. I know what 'maintenance expenditure' is, and I know what 'capital expenditure' is. But 'maintenance capital expenditure'? What is that? Fortunately the waltzing ironman provided us with an excellent reference on this topic (thanks waltzingman).

https://www.taxtechnical.ird.govt.nz...-vol5-no09.pdf

Upon reading the above, my explanation for what 'maintenance capital expenditure' is, is as follows.

If Investore builds a new toilet block, that is 'capital expenditure'. If they keep stocking those new toilets with toilet paper, then that toilet paper is part of 'maintenance expenditure'. Now cue a drunk who comes in late at night and smashes a toilet seat and cracks the connected toilet bowl. Replacing those damaged components is 'maintenance capital expenditure'. Why?

It is clearly a class of 'capital expenditure', because toilet bowls in general are expected to last a long time. But it is also just 'maintenance' because all you are doing is restoring an existing asset to the condition it was in before. I.e. just fixing up a single toilet unit doesn't give your toilet block any extra earning power. All you are doing is restoring your capital equipment to the condition it was in before it was damaged. An advantage of expenses being classified as 'maintenance capital expenditure' is that it is immediately tax deductible. It doesn't have to be capitalised and subsequently depreciated over many years.

Investore takes the view that such expenditure 'doesn't count' from the point of view of having profit on hand that could be distributed as income. I don't agree with that position. Are Investore really saying that it is 'business as usual' if one of their big box stores has a partially smashed up toilet block inside of it? Interestingly, I think the Kiwi Property Group agree with me. From KPG AR2023 p75

"Dividend payments are based on a range of factors, including with particular reference to the Group’s adjusted funds from operations
(AFFO), which is the primary basis on which dividend amounts are determined. AFFO is a non-GAAP performance measure used by
the Group to determine underlying and recurring cash flows from operations."

I note that being a non-GAAP measure, there is no standard way to calculate AFFO. But both IPL and KPG include 'maintenance capital expenditure' when adjusting their income statements. So I guess there is room for professional disagreement on this matter. IMO AFFO is the figure that Investore should be using when considering the income stream needed from which dividends are paid - not the 'Distributable Profit' from post 1938.

SNOOPY

[LaserEyeKiwi]

VHP takes a -$208.6m portfolio devaluation, NTA drops to $2.96c per share. Still well above the $2.35 current share price.