So far this reporting season three property companies - GPT Group (ASX:GPT), BWP Trust (ASX:BWP)and Mirvac (ASX:MGR) - have reported net profit growth of 39%, 48% and 69% respectively.
Those numbers sound impressive but distributable profit growth – a more accurate measure of operational profitability and one investors barely see quoted in the media - was just 8%, 6% and 7% respectively. Why the difference?
Stories about companies impressively lifting their bottom line get attention so it’s unsurprising to see net profit growth figures used in news headlines. But for investors trying to gauge real-life performance they’re meaningless.
Take Mirvac, for example and its 69% net profit increase from $447 million last year to just over $1 billion in 2016. That sharp increase is almost entirely explained by a $500 million gain in the value of its property portfolio, a one-off item that has a big effect on the company’s accounts but none on its bank account.
This has been the story of Australia’s listed property companies this reporting season. Low interest rates have driven property price appreciation and, with investors willing to accept lower yields, they’re prepared to pay higher prices for AREITs.
GPT’s results showed this phenomenon in action. Only 39% of its valuation gains were attributed to its properties generating higher income. The rest was down to investors prepared to pay higher prices for that income (resulting in lower yields).
Property valuations will vary from year to year, depending on the frequency of revaluations and economic conditions. They can even fall, would obviously lead to a reduction in net profit.
What’s more important is not the application of accounting rules or flavour-of-the-month investor behaviour but the rent being collected, the developments being sold, the fees the company is earning and the costs embedded in the business as a whole.
That’s why the net profit figure is best ignored. Instead, focus on the distributable profit which accounts for these operational factors. Not only will be more stable, it will reflect the true performance of the business. And it will be what company management uses to determine the dividend.