The heated race by South African property companies to enter emerging countries in Central and Eastern Europe (CEE) over the past two years continues to raise concerns about overpaying for poor quality assets.
SA’s worrying state of the economy, heightened political uncertainty and deteriorating performance (rental growth and vacancy rates) of office, retail and office properties has prompted property counters to expand in offshore markets – mainly Poland, Romania, Serbia and Montenegro.
Market watchers expect the diversification trend to continue among SA-focused property companies as their home market continues to bite.
Mark Stevens, the CEO of Fortress Income Fund, said CEE regions are showing real economic growth compared with SA.
“It’s about growth at the end of the day and these markets are showing growth. A lot of SA investors know that they are going to get a return in offshore markets,” Stevens said at the South African Property Owners Association’s convention on Wednesday.
Fortress, which is a JSE-Top 40 property company, is exposed to Romania, Poland and the Czech Republic via its strategic shareholding in Rockcastle Global Real Estate and New Europe Property Investments.
In the first quarter of 2017, CEE regions collectively grew their Gross Domestic Product (GDP) by 3.9%, with Poland and Romania recording growth of more than 4%, according to FocusEconomics. SA’s GDP contracted by 0.7% in the first quarter of 2017 from a 0.3% contraction in the previous quarter – meaning the country is in a technical recession.
But taking advantage of positive economic growth in offshore markets comes with potentially bruising risks. Phil Barttram, the executive director at research firm MSCI said the big question is whether property companies are concluding the right deals at the right price.
“When we look at fundamentals of property deals, there is good growth but there are not many rental escalations that are built into the contracts. However, property companies are purchasing good assets and the economy of CEE regions is starting to look up,” said Barttram.
For Stephen Jennings, the founder and CEO of property development company Rendeavour, property companies are making investments out of SA because of push factors such as low economic growth, which can be problematic.
“When you are making an investment decision because of push factors, you have to be very careful about where you go. You can’t go somewhere because it is easier to go. A lot of SA businesses are going to have to modify their business models as they diversify,” said Jennings.
The big drawcard for South African property companies in CEE regions is that acquisition yields on properties are typically higher (6.5% to 8.5%) than debt funding costs (2.5% to 3%), which boosts dividend payouts in year one. In South Africa, debt funding costs are higher than acquisition yields, making it difficult to finance acquisitions.
Also, property prices are lower in many CEE regions and leases on properties are about seven to ten years, which is driven by the demand for rental space by global corporates. Due to the oversupply of properties in some areas, lease terms of three to four years in SA are the new norm compared with a minimum of five years in 2013.
South African property companies that have recently invested in CEE regions include sector heavyweights Redefine Properties and Growthpoint Properties, Hyprop Investments, Tower Property Fund and Accelerate Property Fund.
Ten years ago, the JSE’s more than R650 billion real estate sector had no exposure to offshore markets and now nearly 40% of earnings are derived from markets outside of SA.
To lure property investments back in to SA, Stevens argued that “politicians should stay out of the important parts of running the economy”. He said investors will continue seeking yields in offshore markets as interest rates in SA will reduce in the next three years, while they will rise in the US and Europe.
The writer was a guest of the South African Property Owners Association at its convention in Cape Town.
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