Why invest in SA Reits rather than an offshore Reit or fund for dollar diversification?

‘It comes down to the value that there is in the Reits in South Africa’: OrbVest operations director Justin Clarke.

SIMON BROWN: I’m chatting with Justin Clarke, operations director at OrbVest. Justin, I appreciate your time today. We’ve had a couple of interviews – myself, MoneywebNOW [and] Ryk van Niekerk, of course, with various partners from OrbVest: [co-founder] Hennie Bezuidenhout, executives out of the US, and most notably Martin Freeman, your CEO.

It’s actually quite a fascinating tale of South Africans heading off to the US in a specialised segment of the economy, in healthcare – 18% of GDP [is spent on healthcare] in the US. That’s a $4 trillion economy.

In the stats you sent me, the value of the buildings in healthcare on their own is a trillion dollars. It is a giant space. Give us some of the background on how a group of South Africans thought they could become, and ultimately did become, a major player in this market.

JUSTIN CLARKE: Thanks, Simon. Always good to be online with you. I must say we were on last Tuesday with that very interesting fireside chat. So, yeah, good to be on again.

As you said, you have managed to have a few of us online, so you’ve had the story, specifically from our chairman Hennie Bezuidenhout, and I’ll start the story there.

Hennie is a very interesting character. He likes to stay below the radar and, quietly over the last 30 years, he’s built up this significant portfolio of medical office buildings and hospitals in South Africa. In his own right it’s a benchmark group. He’s built up this expertise in the medical office space. Like with a lot of us in South Africa, he was looking to diversify, get some of his wealth offshore, and he eventually ended up finding the US and discovering much to his amazement that the US actually works quite similarly to South Africa.

I think you said on the webinar the other day it’s more than 80% – I think he actually quoted 92% – of Americans are covered by private healthcare insurance, whereas in South Africa it’s probably closer to 20%. But it’s very similar in the fact that in most of Europe and the First World, the government provides healthcare. There’s a form of national healthcare in which case you become the price-taker. If you own a medical building, the chances are, if you don’t let it out to government, it’s a very, very small market.

So it’s very attractive in the US and, when he started getting involved in looking at the US and acquiring the first buildings in the US, it was almost not a segment on its own. It was sort of lumped under ‘office’. They didn’t even consider it to be [a segment on its own]. It was hospitals and then there were offices; they weren’t medical offices. But medical offices on their own make up sort of $500 billion of that trillion-dollar asset. So it’s a massive market, with some 36 000-odd buildings in the medical office space – and super-attractive. I think that’s really the beginning of the story.

The rest of us sort of got involved a little bit later on. Martin Freeman was one of the ex-founders of Bayport Financial Services in South Africa. He fell in love with the US, moved to New York and started to dabble in real estate there. And of course met Hennie and fell in love with medical offices, and realised the benefits. For the rest of us the story is similar.

I think I mentioned in our last chat that many years ago I actually developed a medical office building in Durban, South Africa. I went past there 30 years later just to go and have a look and the same tenants were there. It’s quite remarkable.

SIMON BROWN: And that is part of the attraction. You guys always talk to the statement: Your doctor doesn’t move; you might move, but your doctors don’t.

You mentioned that fireside chat – one of the things Bharat Mehta [Hectomark Investments MD] mentioned is that there is value in local Reits (real estate investment trusts), and that there is some opportunity in this local market. Of course that avoids the hassle of going offshore. But what is [it about] the OrbVest offer that makes it attractive for those looking for other opportunities?

JUSTIN CLARKE: I think it comes down to the value that there is in the Reits in South Africa. So I think we’ve got to put it in perspective. While obviously Bharat is heavily invested in Reits, he has got a deep understanding from the inside.

I think if you were to bet on real estate in South Africa, consider that real estate is driven by two fundamentals. One, if you want to make sure of the wave behind you, you want to make sure that there is growing GDP, that there’s growing demand for your buildings and the fact that the economy is growing, and that the type of buildings that you’ve got are going to be in more demand tomorrow than they were yesterday. We know that Reits and the funds in South Africa are highly stocked with retail and with office that have been the stars of the past. But I think you need to consider [whether] that is where you would put your hard-earned cash.

Another thing that came on that webinar the other night – we often talk about it – is if you were to fly up to the moon and look down, and take your hard-earned cash with you, and then think about where you would put your money in this market at the moment, how high would South Africa feature in your priority list? The chances are probably not – even if you look at equities. The JSE hasn’t done well over the last few decades. Sure, there’ve been a few opportunities where there’ve been little lumps and bumps. But there you have to be a trader; you’ve got to be on the inside – you’ve got to know what’s going on.

Ultimately what would you look at? You’d choose stable economies. You’d choose an asset perhaps that’s a bit more stable, where you understand that there’s some future growth potential in it.

That’s how you would think, looking at it from the moon.

So when we are sitting in South Africa we’ve got a very biased view. We think, ‘oh, we’ve driven past the building, we like it, we can see it, it’s concrete – and we’ll put our money in there’. But I think it’s very different if you just pull yourself away from the situation and look at it from above – you would make very different decisions from what you’re making at the moment.

SIMON BROWN: We already have that concentration via our Regulation 28 [of the Pension Fund Act]; but also our Reit industry in South Africa is quite narrow. We’ve got some offices, some retail, some industrial – not a heck of a lot for the investor who’s looking, who takes your story and says ‘One hundred percent, I’m interested in offshore; I’m interested in property’. They’re probably looking at a Reit-for-dollar diversification. Why OrbVest – as opposed to a typical Reit in the US?

JUSTIN CLARKE: That’s a great question. The first thing is, okay, I’m going to go offshore. I’m nervous about the markets, because I believe that there’s probably going to be some form of correction, interest-rate hikes, people moving their money out of the markets. I’m looking for something a bit more solid. Where do I go? I’m too far away, I can’t manage the asset myself. Why don’t I just go into a Reit?

I guess the concern there is similar to [that in] South Africa. The Reits generally are Reits that are focused on a spread of different assets, and again quite heavily invested in retail and office for the same reasons as in South Africa. It certainly is a solution for some investors.

But I think for most of us kind of simple folk we like to understand what we are investing in, and the benefit of what we put together is we strip out all the assets that are not related to the building that we are talking about.

In other words, you invest in a specific building. You can literally go to the building and kick the concrete. You can have a look at the tenants, look in their eyes, if you like. So it makes it very tangible. When you buy into or invest in a building, you know who the tenants are, how long they’re going to be there, what the wealth is, the average lease period, what sort of income you’re earning from those channels – everything about that thing. You’re equipped to make that decision. I think that’s the difference between an offshore Reit and what we are offering.

SIMON BROWN: You almost make your own fund, in the sense that I can buy a couple of your different buildings and create my own little US medical property fund.

JUSTIN CLARKE: Absolutely. You’ve heard Martin [Freeman] talk about [that]. Even though these things are very secure because they are stable assets, developments or anything like that, you should always spread your risk and build up a nice little portfolio; take a little bit of five buildings rather than put your whole life savings into one building.

SIMON BROWN: If investors are interested – and it’s as easy as going to the website orbvest.com – [in] the medical buildings and the like, what sort of returns are you getting from your medical offices and the like in the US?

JUSTIN CLARKE: Well, we have a sort of minimum target of a 7% cash on cash. How that works, Simon, is that we basically collect the rent in every quarter, and we distribute whatever’s left in that account, less a little bit of a buffer, every quarter.

So [it’s] roughly 2% a quarter we’ve managed to pay out over the last couple of years. Remember, it differs from building to building. We’ve three different risk profiles from an absolute core asset, which is as good as a government bond. [Chuckle] Maybe I’m stepping over the land there, but it’s a very, very secure asset.

And then there’s something that has a little bit of excitement, a slightly higher IRR (internal rate of return), a sort of 15% to 18/17% IRR. But then there’s a little bit of risk that you might not get your full dividend if there’s a disruption – a Covid or something like that.

So in between there, as I say, 8% is what you can rely on as far as a cash-on-cash annual income. Compare that to a Reit in South Africa, where you might get a similar return but it’s in South African rands.

Once again, go back to that moon position and consider: should I be investing in South African rand assets, or should I be investing in US dollar assets? I think that becomes simple.

Quite simply, at the end of the five-year period, Simon, what we do is we sell the building off. That’s the mandate that we have. We take the capital appreciation. There’s always appreciation – why? Because the rentals have escalation. And then of course that capital growth we then share with the investor and that knocks your IRR up. So basically between 7% and 9% cash on cash, and a 10% to 17% IRR.

SIMON BROWN: A quick last question. [There are] lots of worries around China’s slowdown – Evergrande is the current one – [as well as] inflation, rising rates in the US. China’s slowing down and Evergrande really doesn’t impact someone in Florida and needing to go and see a specialist. That’s going to happen regardless. Inflation, rising rates – what sort of impact could that have, even if the rates in the US, in particular, may be still a year or two away?

JUSTIN CLARKE: Simon, I think your job’s going to get very interesting in the next couple of months. You’re going to have a lot to talk about.

Sometimes we talk about our assets as being slightly boring, and the reason for that is that these are brick-and-mortar assets. We sign long leases; our triple-net buildings – basically our wealth there is 12 years. That means there’s a lease from a credit tenant, someone who’s going to pay the rent regardless, for 12 years – and we are only in for five years.

It’s absolutely as secure as you can possibly get. Then we fix the interest rate.

So the risk there is contained, whereas if you’re in the stock market – what’s happening at the moment is people are starting to divest of some of these stocks and [are] putting that money into more secure investments: government bonds or of course specific niches of real estate, of which we are the honey at the moment.

SIMON BROWN: We’ll leave it there, but I take your point on ‘boring’. I always say markets should be boring. If you want fun, go to Van Stadens River and jump off the bridge, do a bungee jump.

We’ll leave it there. That’s Justin Clarke, operations director at OrbVest. Justin, I appreciate the time today.

JUSTIN CLARKE: Thank you, Simon.

Brought to you by OrbVest.

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