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There’s value in listed property, but risks remain

At a 10% yield, there is a margin of safety.
Local property companies have faced challenges in their home environment, which has spurred diversification offshore but this has raised concerns. Picture: Waldo Swiegers/Bloomberg

For most of the past 15 years listed property was the best performing local asset class. To the end of 2017, investors in leading property unit trusts had enjoyed annualised returns of over 15% for a decade.

More recently, however, returns from this sector have fallen heavily. According to figures from Morningstar, the three-year returns for the majority of funds in the South Africa real estate general category are currently negative. Only four have delivered positive performance over this period, with the best eking out just 2.48% per year.

Across the board, local real estate investment trusts (Reits) have struggled. As the table below shows, a handful have done well, but others – particularly some of the smaller cap Reits – have come off dramatically.

Performance of selected SA Reits
Counter 3-year annualised return
Equites 49.81%
Fortress A 27.3%
Vukile 14.59%
Growthpoint -5.33%
Redefine -21.28%
Delta -36.29%
Attacq -34.8%
Hyprop -42.47%
SA Corporate 45.42%
Resilient -53.64%
Arrowhead -55.6%
Rebosis -92.29%

Source: Profile Data

As a result, the fundamentals of the sector have also changed significantly over the last few years. Back in 2015, domestic Reits as a whole were offering a forward dividend yield of around 6.5%. Today, yields are over 10%.

The price-to-book-value multiple at which the sector is trading has also reversed substantially. In 2013, domestic Reits were commanding a multiple of as high as 2 times. That fell to around 1.1 times for most of 2015, 2016 and 2017, but has since fallen to 0.8 times.

In other words, local Reits can be bought at a 20% discount to their net asset value.

Cheap, but nasty?

As Evan Robbins, listed property manager within Old Mutual’s MacroSolutions boutique, points out, this makes the sector appear very cheap.

“It’s very much unloved,” Robbins notes. “A lot of bad news is priced in.”

There is no question that the environment is tough. The high and persistent growth in rentals that property companies enjoyed a few years ago are no longer available, and when rental agreements expire they are mostly having to offer the same space at lower prices.

Robbins acknowledges these risks, but nevertheless believes that there is value.

“If you think about it clinically, we are now talking about a market with 10% yield,” he points out. “Even with no growth, compare that to a few years ago when you had 7% yield. While that was growing, it would have to grow a lot to just catch up with the 10% you’re getting now.

“So you’re buying a sector where you can’t expect much growth for quite a few years, but you’re compensated with higher income.”

However, that doesn’t mean that local property is a screaming buy. It just means that there is some margin of safety for investors at these prices.

Risk remains

Robbins says that in that regard it is worth considering where concerns still lie.

Firstly, even though local Reits are trading at a 20% discount to their book value, he believes this is justifiable as direct property is overvalued. The market is therefore simply pricing in the fact that asset valuations are probably too high.

“And even if it’s in the price, it still means that if companies have to write down the value of their properties, their loan to values go up, which makes their balance sheets look much worse,” Robbins adds. “They may have to sell properties to get their loan to value down, and that’s very dilutive.”

There is also still excess supply in a low growth environment. The amount of new space being built has dropped noticeably, but it hasn’t disappeared and that means there is still an overhang, particularly in the retail market.

Robbins also believes that some earnings growth and therefore distribution growth has been due to non-sustainable drivers. In particular, many companies have bought international assets that have given them once-off improvements.

“They have bought property assets in Europe yielding 6% but that can be funded at 2%,” Robbins explains. “But they can only do that as long as they have balance sheet capacity. Eventually they won’t be able to do it anymore and growth will flatline.”

The lag

This preference for offshore assets also raises concerns around capital allocation.

“Almost all South African property companies are going offshore, not because they have expertise, but because they want to diversify away from South Africa,” Robbins says. “But local companies, across sectors, don’t have a great reputation in terms of success offshore.”

Read: Offshore markets: Where dreams die for SA retailers

There are always inherent risks in going into international markets where local companies have no obvious advantage.

“We have had a few disasters offshore already, although it has been among the smaller companies,” Robbins points out. “The larger companies have been more responsible. However they are buying in hot markets, where prices are high already, so disasters could happen.”

Finally, he notes that the performance of property stocks does lag the economic cycle. This has two potential consequences.

“What concerns me is that a lot of shops are struggling,” says Robbins. “Even if things recover, they may not recover in time for them to remain insolvent.”

Secondly, any recovery that does happen will take time to filter through to Reit performance. This is because long-term leases that are being signed now will reflect the current conditions. Rentals will therefore be lower, and with smaller annual increases.

“So even if things improve in a year or two, it is still going to take some time for the fundamentals to improve,” he says.

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Things are going to get quite a bit worse in this sector, especially among those REITS that are heavily invested in shopping malls – huge oversupply plus failing retail businesses are going to take quite some time to work through. De-industrialisation also going to take a toll on industrial properties unless Ramaphosa starts delivering on his promises soon.

Yep …. refer Intu.

The SA REITs are going to struggle to deliver dividend growth that matches SA’s inflation rate for some time to come. Then those beating a path to foreign shores are picking up the B & C grade discards – this does not look good.

With the way the ANC Secretary General( and his fellow clowns) is behaving we are likely to go on negative watch (at best) from Moodys so will need to have higher long term interest rates. Property prices are dependent on this. Why take tenant risk(other than escalations) if you get the same or a higher return “risk free” in government bonds?

“Almost all South African property companies are going offshore, not because they have expertise, but because they want to diversify away from South Africa,” Robbins says

The rich, educated graduates, capital etc. are looking to go across the oceans for greener pastures. Are we looking at a decaying infrastructure?

Am afraid to agree with you. Any (modern) economy NEEDS skills & new entrepreneurs to expand. SA is slowly losing critical skills (along with investment capital)….hence where is the growth going to come from, if the ANC does not (truly) reform?

“It’s very much unloved,” Robbins notes. “A lot of bad news is priced in.”

In total the JSE offers no value as investors are misreading the market…. Even good performing companies have a dramatic showing in their share price.

Price book value of 0.8 times is not a 20% discount! Their properties are not worth half of what they claim. Price book value of 0.5 is more accurate in this current economy. Attacq values Mall Of Africa at R45304 for one square metre, but they don’t even own the property, and erf 4261 JUKSKEI VIEW is owned by MOA 20 WUQF 1, MOA 15 WUQF 2, MOA 15 WUQF 3, MOA 25 WUQF 4. But auditors don’t check survey diagrams, leasehold contracts, and who actually owns the erf or holding company. Property companies re-value their properties higher every year because that “paper” re-valuation is booked as profit for the year on the financial statements. The higher they re-value, the more “profit” the company “earned” for the year, calling it a “fair value adjustment”, with various assumptions. And directors are rewarded for this non-existent “paper profit”, basically rewarding themselves bonuses by finding higher valuations every year. Conflict of interest. The valuations are not completely independent. They pay the people to do the valuation. Many ways to get the valuation you want.

End of comments.

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