CAPE TOWN – Late last week, the listed property sector’s second biggest player, Redefine (JSE:RDF), announced that it would be acquiring the entire issued capital of Annuity. This added R2.1 billion worth of property to its portfolio, and included a R103 million payment for Annuity’s management companies.
Last year, the sector’s biggest counter, Growthpoint (JSE:GRT), concluded a R1.3 billion takeover of Abseq. That deal also included taking over the Equity Estates property management company that was responsible for Abseq’s assets.
The same trend played out in Arrowhead’s (JSE:AWB) purchase of a 31% stake in Vividend last year, which was followed by the purchase of the latter’s management company, Vividend Management Group. Arrowhead’s stated intention is to absorb Vividend completely.
Vukile (JSE:VKE) and Synergy (JSE:SGA) have also advised shareholders that they are in talks. The likely result is that Vukile will offer to effect a complete takeover, following its acquisition of 34% of Synergy last year. Any deal would presumably also include Capital Land Asset Management, which is the management company responsible for Synergy’s portfolio.
And now, one of the biggest stories currently playing out in the sector is the potential for a three-way merger between Rebosis (JSE:REB), Ascension (JSE:AIA) and Delta (JSE:DLT). This is an ongoing story that started with a bizarre disagreement in early February when both Rebosis and Delta claimed to have signed agreements to buy Ascension’s management company as a precursor to a full takeover.
Surge of corporate activity
For one thing, these deals highlight the unusually high levels of corporate activity in this sector. Recent research from SA Revealed showed that the JSE’s listed-property counters concluded transactions worth a total of R21.63 billion last year alone. This was up from R13.45 billion in 2012.
In one respect, this spate of corporate activity is to be expected in a sector coming to terms with a new reality after 15 years of exceptional growth. And it does make sense for larger companies with a lower cost of capital to be buying out smaller funds with higher capital costs.
“I think consolidation is a theme that we will see in the sector for the foreseeable future,” says Anton De Goedge, manager of the Coronation Property Equity Fund. “The reason for that is that many of the smaller funds listed in anticipation of potential portfolio growth and to increase their size, but the market never really gave them the yield that they thought they would get and that made growth more difficult.”
Neil Stuart-Findlay, manager of the Investec Property Equity Fund, agrees: “Generally a bull market like the one we have seen over the last decade is the kind of environment that encourages private funds to list so that they can raise capital and make acquisitions to grow their portfolio,” he says. “But when the market turned in May last year, the cost of funding increased so it became more challenging for the small funds in particular to make earnings-enhancing transactions.”
The flip side
But there is another side to all of this activity. And one that raises questions about who the biggest beneficiaries of all this to-ing and fro-ing really are.
“These acquisitions are all relatively new listings that came to market in the last few years and created external management companies to manage their portfolios,” says Evan Jankelowitz, a manager of the Sesfikile Capital SCI Property Fund. “And now all of these management teams have sold out for a profit. So what you are seeing is that those who took money from unitholders to set-up these management companies, are now leaving with a few hundred million rand having really achieved very little for those unitholders.”
It’s worth considering that, since September 2010, 17 new real estate listings came to the JSE. Most of these were smaller funds with market capitalisations under R2 billion. In the majority of cases, management was externalised. And this is not a situation that sits well with analysts.
“That often creates a disconnect between management incentives and unitholder incentives,” says Efficient Select’s, Nolan Wapenaar. “Take one recent listing as an example. They established themselves, set up a management company, and put in a break clause whereby the management company would be due a significant fee if management of the portfolio was ever moved away from them. While there are strong arguments that this is market standard and that the break fees are lower than most, it does create a financial asset worth quite a bit of value for your original founder shareholder at the expense of the other unitholders.”
Sesfikile’s Jankelowitz says that while the Ascension, Annuity and Vividend deals are essentially done, the market has to ask questions about what value their management companies really created while they were in operation: “Have they, in just two years, enhanced their portfolios to such a degree that those who want to acquire them only now see value in their assets?” he asks. “They pieced together a port of assets that the market didn’t really want, created value in a management company that unitholders didn’t really need, and have now sold out and we are paying their retirement packages.”
He emphasises that there is a fair amount of frustration at what is essentially money leaking out of the sector. “The fact that the bigger counters have had to pay for these management companies is not right,” he says. “Those who are selling made a profit, and good luck to them. But why are the companies who are buying them bailing out the management companies as well as those investors who supported the listings? If they hadn’t achieved what they wanted to achieve, they should be sold at a significant discount.”
Perhaps the most unsettling thing is that the market has seen this before. Just for example, the team behind Annuity is the same team that listed Primegro Properties in 1999 and CBS Properties in 2005. The former was sold to Growthpoint in 2003, and the latter to the PIC in 2007.
In a free market, one can argue that these individuals have found a way to turn a big profit, and they are not doing anything illegal. But these actions do cast the sector in an unfavourable light and call into question whether the tail is wagging the dog as far as investors are concerned.
“Why did the market support a lot of these listings?” Jankelowitz asks. “Why did many of these smaller funds really need to be listed if not to enrich the owners of the management companies?”
It raises important questions about both unitholder vigilance and self-regulation within the sector.
“I’m not sure that the individual unitholder is aware of these mixed incentives,” Efficient Select’s Wapenaar says. “And I’m not sure that the industry is as self-regulating as it could be. Certainly there is pressure from asset management companies to do the right thing, but the market has been reluctant to act. You still see a lot of externalised management companies and that definitely isn’t first prize from our perspective.”
One could argue that unitholders have been lulled into a false sense of security by how well their real estate investments have performed over the last decade. But that doesn’t excuse any ongoing silence.
“Over the last five or ten years property markets returned 20% to 25%, so if there is a bit of leakage in that environment there is less concern about it,” Wapenaar says. “But people tend to scrutinise things more when things get tough. That’s when investors sit up and ask whether they are getting all they can from their investment.
“Previously anything you bought in property was a winner and that made life very easy. But that’s not likely to be the case in the near term. So we need to scrutinise the sector and see who is acting in unitholder interest and who is acting in their own self-interest. And it will take the good asset managers to know the difference.”