Making a case for government

Many people have exited the government-tenanted business. Bad press and perceived challenges are cited reasons. But Delta Property Fund's Sandile Nomvete and Bronwyn Corbett see more opportunities than pitfalls.

By David A Steynberg

It's a growth story even the most talented writer could not conceive. In November last year, Delta Property Fund listed on the JSE, more than doubling its assets from just seven to 20. It needed to raise R980 million to use as gearing and ended up oversubscribed with just over a billion rand.
“Listing was a growth story: it was all about taking advantage of capital available in the listed environment,” Delta CEO Sandile Nomvete tells in his new Bryanston offices, the smell of carpet glue floods the air. “We just felt the time had come from a Delta perspective to enter the capital markets to raise sufficient funds for growth purposes. It's fairly competitive and going the traditional route of getting debt funding was no longer sustainable.”
Delta is by virtue a government and quasi-government landlord. With the rough time the state has had in the media in recent times, banks have become a lot more cautious to lending to unlisted companies dealing with government. Especially given the high debt ratio required.
“For us the market had shifted and we needed new sources of funding,” says Nomvete. “And being listed does offer you access to capital, even though equity is the most expensive form of capital. But it's a viable opportunity as long as we're giving our unit holders better than what they would have had had they just put that money into the bank. And that speaks to the yield that we came onto the market with which was 9.6%. 
“With interest rates, if you're getting 5.5% on cash visa vie 9.6% with property, that was the rationale for coming onto market.”
The fund was significantly oversubscribed on listing, something chief financial officer, Bronwyn Corbett, says “was an obvious indication that the market had turned and there were significant capital in-flows; and to some extent the market was maybe becoming more confident with the sovereign exposure of the fund”.
Prior to listing, Corbett and Nomvete travelled across the country educating potential investors about the risks and rewards of investing in a government-tenanted landlord fund. Perceived risks relating to the inability of Delta to collect rent, the enforceability of lease agreements and whether those agreements meant anything in the first place were questions the Delta team had to address and mitigate.
“We as Delta have never shied away from the fact that those risks do exist,” Corbett says, adding that Delta emerged out of Motseng Investment Holdings which has extensive facilities management experience. “You just need to be able to understand those risks and be geared up to deal with them.”
But it's the sovereign underpin of government that makes Delta worth its salt, and one of the main reasons for its phenomenal growth in just six months after listing.
“The reason why we like the sovereign underpin from a fund perspective is because private-sector companies can get affected by the roller coaster ride of the economy,” explains Nomvete. “Government, however, provides critical services whether the economy is booming or bust; there are key services government just can't do without: we still need a transport, health and police department. For us it's a very stable income.
“With this in mind maybe the discount the market has been placing on government could actually be smaller. You can't compare a government lease with a lease on a coffee shop owner. How can you think it's better than supplying government? There's no way. That individual who has a coffee shop in a shopping centre must be riskier than government. Surely? With one proviso: as long as you as a fund have the right systems and people in place to collect those rentals.”
Since listing the fund has bulked up its asset management team to ensure consistent efficiencies with 45 properties from its previous 20.
“Our cost to income ratio of 18.8% which we achieved with 20 assets is very competitive on average and is something we pride ourselves on,” says Nomvete. “So going forward we will try and use this as a competitive advantage.”
Wherever this fund can save money, says Nomvete, it will give it back to its unit holders. But it's not only savings investors can look forward to. Nomvete predicts aggressive forecasts for 2014 and 2015.
“In terms of distribution for February 2015, we're sitting at a 20% return,” he says. “This is significant.”
Corbett concurs: “This is actually unheard of in a market where the sector averages are sitting.”
Nomvete attributes this again to having a stable tenant in the form of government.
“We have long-term leases, stable income and because we've managed to control our costs very well, there's a huge benefit,” he says. “Through the new acquisitions we have zero-rated the vacant space in those properties. That's potential value uptick we can give back to unit holders that are looking for even better distribution than we have forecast, which is significantly above the sector average. A 20% growth in distribution is just unheard of. And it's not from a low base.”
Nomvete believes much of the fund's success lies not only in who the tenant is, but also in the kinds of buildings Delta has.
“As long as we continue to have big, bulky assets, and considering most of our assets range in value between R95 million and R100 million – which for us is a defensive strategy – means less management time of those assets,” Nomvete says. “If you've got 400 small assets everywhere, like one in Pofadder, getting there and having feet on the ground costs money and time. That dilutes the distribution one can achieve. If you're going to solidify all your resources in fewer but better buildings, you should be able to generate better returns.”
Delta owns, among others, the Randburg Sars building where it has sweetened the deal by adding value to the building.
“We spent time with our professional teams and we're going to add another 176 parking bays to the property as parking has always been an issue in the area,” says Corbett. “Sars agreed to renew the lease for another five years.”
It's though measures such as this, as well as transforming C and B grade buildings to A grade specs that has proved successful for Delta. “There is value in buying a C grade asset in Bloemfontein, taking it up to an A grade building and signing a 10-year lease where you can renegotiate rentals,” says Corbett. “We have managed to do that very well.” 
With Delta being an office fund, it has not experienced the same market depression the private listed sector has with 12% vacancies.
“Our vacancy rate is 4% and we've often been asked how we've managed this,” says Nomvete. “The fact is it's government and you cannot compare us to a traditional office fund nor its economic cycles due to the fact we have the sovereign underpin of government: our lease profile is sitting at seven years with escalations of between 7% and 9%.
“Delta offers investors 9% yield while the sector average sits at 6.2%.”
Due to its generous yields and distributions, it's unsurprising Delta has captured interest from foreign investors hungry for yield: Switzerland, Germany, Hong Kong, Namibia as well as huge interest from South African pension funds.
“Our third largest investor it the PIC and Stanlib has a 25% stake,” smiles Nomvete, explaining the good shareholder spread creates good liquidity for the fund. “This is especially important for property.”