An improvement in South African consumer and business sentiment in early 2018 contributed to real estate investment trust (Reit) Tower Property Fund’s vacancies reducing to 5% at the end of its financial year to May 31, after having reached a high of 12% in January.

However, in order to secure new tenancies, Tower has had to offer lower-than-anticipated rentals and longer beneficial occupation periods, dubbing it “a clear sign of the times”.

This, the company said on Tuesday, is particularly evident in Gauteng, with its properties in Cape Town, on average, achieving strong rental growth.

Revenue in the period decreased by 7% to R416-million as a result of certain, noncore properties being sold.

Similarly, operating profit decreased by 18% to R377-million, as a result of properties being sold, as well as the reduction in the unrealised gains compared with the prior period owing to the strengthening of the rand.

Distributable earnings for the period totalled R265-million, while distributions grew by 5% to R275-million for the year, which was slightly lower than the guidance of 6%.

This is reasonable, Tower said, given the rental "headwinds" experienced recently, adding that the pressures on securing tenancies are partially offset by "tailwinds", including the receipt of a portion of Agrokor arrears rentals, rates credits received at certain properties and tenant penalties paid for early lease terminations.

Meanwhile, Tower's strategy of extracting maximum value from its portfolio by adding additional lettable areas, refurbishing the properties to attract higher rentals and amending the use where appropriate, is starting to bear fruit, the company said on Tuesday.

This, Tower added, is evident with the Cape Quarter Precinct, one of the flagship properties, where new lettable area, additional parking and new residential apartments have been added. This has resulted in the net value of the precinct increasing from about R650-million in 2013 when the properties were bought, to about R1-billion as at May 31.

This equates to a total return of 15.6% yearly, Tower said.

Other examples of the success of this strategy include Sunclare Office Building, in Claremont, where the valuation has increased from R193-million in 2015, to R277-million as at May 31, equating to a total return of 26.2% yearly.

The De Ville Shopping Centre's total return yearly is 15.4%, with the property valued at R246-million, up from the purchase price in 2014 of R226-million.

However, most asset management interventions that drive value in a property result in

properties experiencing a "J-curve", where rentals decrease in the short-term, sometimes significantly, before increasing sustainability in the long-term.

As a result, the Reit can only take full advantage of the value creating opportunities in its portfolio if it has sufficient balance sheet capacity to fund these interventions, and has the appetite to absorb short-term declines in rental income, and the resultant impact of these reductions on distributions.

In KwaZulu-Natal, Link Hills Shopping Centre is at the start of its "J-curve" journey and the company anticipates changes in the future.

Office properties in Johannesburg undergoing refurbishments include 382 Jan Smuts avenue, which has had a vacancy for some time.

Outside of South Africa, Tower's Croatian portfolio is performing well, with increasing rentals in the office property, VMD Block B.

Tower in February secured a very important back-up lease to its anchor retail tenant, Konzum. The back-up lease agreement with Spar Hrvatska adds to the security of the retail portfolio and demonstrates the demand for the Croatian properties, Tower averred.

Through significant effort and negotiation, Konzum is up to date with its current rental

payments and is committed to continuing with the 12-year head leases of Tower’s properties.

Further, Tower agreed to reduce the rental at its Vukovarska property by 20% from June 1, as this had grown in excess of market rentals. This, the company explained, has resulted

in a 20% reduction in the May 31 Vukovarska valuation.

Additionally, the strategic intention of "ring fencing" the Croatian properties, to allow for growth and the strengthening of Tower's balance sheet, has occurred and TPF International has been established in Mauritius for this purpose.

Tower announced on March 1 that Namibian property fund Oryx Properties would buy shares in TPF International, resulting in Tower realising R300-million.

Of this, Tower will use R100-million to re-invest in TPF International, R120-million to reduce euro debt with Standard Bank and re-invest the balance in South Africa.

Meanwhile, progress on value-add opportunities includes R300-million from Oryx for the investment in TPF International, as well as about R25-million, which is expected from Napier Street, in profits for residential sales by about November 2018.

Other projects, including the addition of 54 residential apartments to Cape Quarter Piazza are under way.