The listed property sector, an investment darling for many years, seems to be turning a corner after share prices were knocked quite severely in the past 18 months.
The quality of earnings is improving, mainly because of a clean-up following a period in which earnings were propped up in an attempt to “keep up with the Joneses”, says Kundayi Munzara, co-founder and executive director of Sesfikile Capital.
Speaking at the Allan Gray Investment Summit in Johannesburg, Munzara said from 2015 to 2017 companies were taking cash offshore and engaging in activities that would turn capital into income.
Many invested their cash in the UK and Eastern Europe. However, the UK is currently faced with the consequences of a possible hard exit from the European Union.
“The real issue in UK retail has been online shopping, which makes up 20% of retail sales,” says Munzara, adding that online shopping makes up 11% of retail sales in the US, 8% in Europe, 6% in Japan and only 2% in SA. “E-commerce has penetrated and decimated the [UK] market.”
Continued need for a physical presence
Although e-commerce has been growing rapidly, the rate of growth will start to decline. The main reason for this is the continued need for a physical presence or space, although perhaps not as much space as before.
Eastern Europe countries have experienced stronger economic growth than those in the West. South African companies that have invested in countries like Poland have done quite well.
“They have gone into markets where the macros [macro-economic environments] are super-supportive.” The penetration of e-commerce has not been as prolific in countries like Poland (at 5.5%) compared to the UK’s 20%.
Consumer patterns have also changed. People used to buy ‘stuff’ but now they are buying ‘experiences’. The shopping centre environment has evolved because of that.
SA sector affected by the three Es
In South Africa a lot of effort has gone into cleaning up earnings, but the sector is still faced with specific risks which Munzara calls the three Es – Edcon, Eskom and the election.
Edcon is one of the biggest retailers and tenants in SA and when it fell on hard times a lot of listed property companies were affected.
However, in the first quarter of this year it met with several of the largest landlords and negotiated a 41% reduction in rental rates for at least two years.
The sector took the view that it could not allow one of SA’s largest retailers to go under, and that it might as well take the 41% drop in rental income on the chin.
Munzara says it is inevitable that other large retailers may also push for reduced rates when the time to renegotiate their lease agreements comes.
South Africa is not, by a long shot, out of the woods in terms of its energy crisis. Load shedding and unpredictable energy supply from Eskom has had a severe impact on the country’s financial position, and has also affected the operational side of businesses.
Wait-and-see approach might be over?
Munzara says the election has been “largely market-friendly”. However, in the five months prior to the election in May everyone adopted a wait-and-see approach to investing, signing contracts, expanding and doing any upgrades.
The retail sector currently finds itself in a difficult position, with an oversupply of shopping malls – especially in Gauteng. Vacancies are set to rise and in addition to that some local retailers are starting to shrink their footprint.
“Some of the international retailers, which we expected to rescue us, pulled back because they have their own issues in their own backyards.”
The office sector has been in a recession for what feels like forever, with vacancies ranging between 10% and 13%.
Munzara says it is quite encouraging that many of the new office buildings are already pre-let and that there are few new developments on the horizon, which means that supply is starting to dissipate.
In the industrial sector vacancies are around 6.4%. A lot of companies have upgraded to A-grade logistics warehouses, which have a vacancy rate of between 2.5% and 3%.
“That is really the market you want to be in at this point, and it is a market that we are quite confident about,” says Munzara.