Over the past three years, the property sector has found itself in a tough and volatile space. The past 12 months particularly, have been the most difficult. Still, this sector has demonstrated unimaginable resilience. While the asset class has declined from R600 billion market cap to R220 billion, it has also gone through massive re-pricing.
Investment case for local real estate investment trusts (Reits) in the current environment
Most credible industry players are forecasting forward funds available (FAD) yield of 10.7% for the sector, despite the weak property fundamentals in the short term and a four-year FAD growth of -0.54%. Some of the fund managers’ underlying assumptions remain conservative with no meaningful recovery expected in 2021. While factoring in a 2022 recovery, they do not anticipate earnings will reach 2019 earnings levels in the short to medium term.
On the positive side, recent company results have been encouraging with reported earnings and forward earnings guidance ahead of forecasts, albeit coming off a low base. The ALPI is still trading at a significant discount to the net asset value of 28.5%. Total returns for the sector in the short to medium term will be positive subject to economic conditions not worsening, and with the successful roll-out of Covid-19 vaccines, the fund managers are forecasting five-year annualised returns of between 14% and 17%. In addition, companies have built significant cash buffers to fund growth into the future and have thrown everything at rebasing earnings (buying opportunity) at the lowest point in the earnings cycle.
However, they remain cautious of risks facing the sector in the short term, including a possible third wave of Covid-19 infections in South Africa and have allowed for additional tenant relief and concessions in forecasts. Low interest rates will provide some respite for South African real estate investment trusts (SA Reits) in the short term, but it is anticipated that debt costs will move out over the longer term. What has been encouraging, is the resumption of dividends and improvements in Loan to Values (LTVs) due to the preservation of capital in the form of lowered payout ratios, increased disposal programmes and the introduction of reinvestment options by some REITs.
Future of SA property given the changes and acceleration of ‘new norms’
South Africa’s economy is under immense strain and will continue to be under pressure over the next few years. Loss of businesses due to the bad economy will have a deeper impact than working from home, so SA can’t really be compared to global markets. Ecommerce penetration in the country is still significantly lower than that evidenced in developed markets and due to structural challenges faced by the country, online sales do not make up a material percentage of total retail sales.
It is the common view that the new normal for retail will be omni-channel led, where bricks and mortar landlords work hand in hand with online and eCommerce platforms. It is important to highlight that we have allowed for a marked increase in online sales penetration in our SA retail sales forecasts as different retail categories and formats will be impacted differently by the acceleration of online sales. Traditional retail assets, notably smaller convenience, township-based malls and rural retailers continue to show resilient performance amid a subdued economy. This has been supported by a strong demand for essential goods and services, while omni-channel and eCommerce penetration levels remain limited in rural and township areas.
The omni-channel shift has been more prevalent in metropolitan nodes and has subsequently seen numerous larger format retail assets in these areas underperform. With that said, well-located, high-quality super regional shopping centres have recovered particularly well from the slowdown in sales during the second half of 2020.
Work from home (WFH) is a trend that is continuously evolving and difficult to extrapolate as to the actual impact on the office subsector over the long term. We are seeing tenants consolidating and reducing office space requirements. The current weak macro-environment and uncertainties related to when businesses will go back to the office, continues to put pressure on the subsector. The long-term expectations are that demand for offices will reduce and have a negative impact on any recovery in office market rentals. Generally, market rental growth assumptions for the office subsector are conservative and the subsector may take the longest to recover from the impact of the pandemic. One positive for the sector however, is that the sharp slowdown in development activity and an increase in the alternative use of office space has eased pressure of the oversupplied sector to some degree.
Is it time to bet the farm?
The SA Reits has a substantial discount to NAV and it is attractively priced relative to other classes. The sector offers an attractive yield and has potential for further re-rating once we revert to a normalised operating environment. The asset class provides diversification in a balanced portfolio context (volatility in between equities and bonds). Most asset allocators are neutral on the sector, whereas others are happy to move up the risk curve on selected companies.
Thabo Hlangwani, analyst: Absa Multi Management.