The listed property or real estate investment trust [Reit] sector in South Africa is up around 25% year to date, according to the All Property Index or Alpi of the JSE. That’s from a total-return perspective.
From a market-cap position, the sector is up around 20% and its total market capitalisation around R393 billion. Between 2018 and Covid-hit 2020 the listed property sector was the worst-performing asset class. However, the strong recovery has seen Reits return as the top-performing asset class for 2021 year to date.
In this episode of The Property Pod, I speak to newly appointed fund manager and head of property at Stanlib, Nesi Chetty.
He gives us his insight on the sector’s performance this year, including the winners and losers and his hot stock picks.
Chetty has been covering the sector for over a decade. Prior to being head-hunted by Stanlib a few years ago, he was head of property at Momentum.
Highlights of his interview appear below. You can also listen to the full podcast above or download it from iono, Spotify or Apple Podcasts.
How would you describe the sector’s performance this year after the fallout of 2020 due to Covid-19 and the lockdowns?
“I think we should maybe contrast the recovery in property performance we have seen this year with the impact on the sector last year. The beginning of March last year was effectively when South Africa went into a very harsh Level 5 lockdown, and most global economies were partially closed for retail trade.”
“If I look at the South African market and especially the property companies, it was only essential retailers that were able to trade uninterrupted, while large parts of non-essential [ones], including big retail categories like liquor, were shut down. This had a negative impact on the property market going into lockdown owing to reduced footfalls and also putting tremendous special on the property tenant base.
“We saw a sharp drawdown in the market in 2020. If you look at the Alpi, it was down just in March alone some 37%.
“I guess in the second half of the year you did see some recovery in the property sector. I think if we look at the second half of last year, and even the first 10 months of this year, the property companies put [several] intervention measures in place to get them back to a position where they were not only profitable, but able to pay a lot more in terms of distributions.”
“If I look at the stocks, the response from the sector was very positive. A lot of the companies in the market used this opportunity to rebase rentals. Certainly where leases were looking over-rented and putting strain on the business, they went in and fixed some of that.
“The pressure on reversion and top line hasn’t gone away, I think, in certain segments like offices; but the property market [did] quite a bit in terms of tenant relief. The quantum of it was almost R3 billion over 2020.”
“They’ve also used this spirit to improve liquidity and I guess prop up the balance sheet. A lot of the focus last year was [on] LTVs [loans to value], interest cover and covenants. We’ve shifted away from that this year into an environment where I think capital raisings have improved, and certainly you’re seeing this distribution visibility pick up as well.”
Reit sector still down over three- and five-year periods …
“If you look at the last five years in the listed property sector, you’ve had two periods of maybe very extreme volatility. I think if you look at 2018 … we had the issues around Resilient and Viceroy. There was a big drawdown in the market.
“If I look at 2020 and the start of Covid and lockdown restrictions, we had another period of extreme volatility, I would say, in both the Sapi [SA Property Index Fund] and the Alpi.”
“However, I think if you look at the characteristics of property over time, investors have been attracted to the sector because of the income-yield characteristic – and that hasn’t gone away.”
“[We have] seen a reset in [the] earnings space for most companies and what you’ll tend to see, I guess, is a lot more stable performance on the listed-property counters. And that stability will come because a lot of them are still focusing on re-gearing for the remainder of 2021 and into next year.
“LTVs are still high but most companies, if I look across the larger- and the smaller-cap properties, they have a plan to get between 35% and 40% LTV. I think property companies will still look to recycle out of underperforming assets and specifically sectors where vacancies are high, [and] look to acquire other assets in either logistics or to externalise as well [offshore exposure].”
“We’ve seen companies like Resilient in 2021 look to acquire assets in France …
“But I think I must emphasise the volatility of property somewhere in between bonds and equity. If I look at our return expectations for property, even in a weak SA growth environment where the sector is recovering off a very low base, we think the sector on a one-year basis – and that’s our base case built on a 4-6% distribution growth and a bond yield closer to 9% – a one-year return is probably 13% or 14% total return.”
“On a four-year view, if we assume property maybe at a 3% spread relative to bonds, we can get a four-year compound growth in excess of 14%. So property is very attractive still on a yield basis, total return relative to bonds, equity, and cash as well.”
“I think it’s also important to mention that in an interest-rate hiking cycle it’s only late into the cycle that you see that outperformance of property relative to cash and bonds.”
Which have been the best-performing and worst-performing Reits this year?
“Some of the smaller and more illiquid shares were maybe sold off a lot more aggressively, even before Covid. So if I look at the year-to-date performance, the likes of Dipula’s B-share is up some 170%. Texton is up over 90%. Arrowhead is also up some 60%. Those are the ones that were sold off a lot [more] aggressively about a year or a year-and-a-half ago.
“If I look at the more maybe established companies in the sector, like a Vukile, it has seen a very strong performance since the beginning of the year, up some 70%. MAS Real Estate, which has assets in Romania, is up some 55%.”
“It’s interesting that a company like Resilient, which went into Covid with probably one of the better balance sheets and very low gearing, is up some 46%.”
“If I look at the underperformers in the sector. Fortress B came under a lot of pressure, and I think there was a lot of uncertainty regarding the potential prospect for dividends being paid out to Fortress B shareholders. Balwin came under pressure as well, down some 18%, and then Capital & Regional, which is an asset in the UK that Growthpoint bought, was down some 22%.”
“I think what you’ll still see in the property market into next year are really wide divergences in performance as the different companies pursue various strategies in terms of local and offshore.
“But I also think what’s important is that the secular trend will start to emerge where active management will be important in terms of stock-picking. You are certainly seeing that in terms of how companies are recycling assets.
What would you say are the hot stocks in the sector to watch going forward?
“In terms of stock picks there are two companies we continue to like because of not just the portfolio characteristics, but what they offer to the fund. One is Irongate, which is the old Investec Australia [property] business – operationally a very good portfolio.
“They are mostly in metropolitan offices and industrial. They’ve successfully internalised the management company and it’s a tenant base. If I look at the top of the spread, it’s spread across government, technology and industrials, which are holding up in that Australian market.”
“We like the lease terms in Irongate, with very attractive yields of about 5% and strong portfolio occupancy at 98% …
“The other one we like also is Nepi Rockcastle. If we think about where we can pick up cheap offshore exposure into an environment where the rand might weaken, we like the dominant retail characteristics of Nepi.
“The management team have really been very cautious the last 18 months – low liquidity, low LTV with very high levels of liquidity. So it’s almost €1.2 billion that they are building up. Trading restrictions have been easing in those economies [in which Nepi operates], so they are probably back to 99/100%, let’s call it, operational GLA [gross lettable area] …
“On the local [SA Reit] side we still like Vukile. It’s one that has been strong year-to-date, but if I look at the portfolio over time, it’s one where the South African portfolio is still very defensive.”
“We think the low end of the market, particularly food-anchored smaller centres … will still continue to outperform the super regionals. We think, over time, this [Vukile] is one where there is certainly a strong balance sheet recovery that’s happening.”
“We also like Equites [Property Fund] … [it has] a very healthy development pipeline. We think there’s potential for cap-rate compression in the offshore portfolio, but I think the ability for Equites to go in and take up 10- to 15-year leases at very attractive yields, like they’ve done with the recent acquisition at about 7.3% and 7.4%…
“There is no problem raising equity, I guess, in any of those companies that I’ve mentioned now.”
How has the July riots and looting, largely in KwaZulu-Natal and Gauteng, affected some of the retail and logistics landlords in particular?
“The big funds that have been affected include SA Corporate [Real Estate], where the damage was about R550 million-plus. It’s only about 3.5% GLA, and they’ve got claims cover up to a billion …
“Fortress is another fund that has retail and logistics exposure. Certainly some of their logistics assets in Cornubia down in Durban were impacted; the estimated damage is anywhere between R400-R500 million-plus. They’ve got adequate cover up to R1.5 billion. If I look at their portfolio, it’s Cornubia and Biyela [shopping centre], which were the worst impacted …”
“The market hasn’t priced in any of these events, as the market impact was very muted, the distribution impact very muted.”
“I think longer term what you would see is things like insurance premiums increasing in the sector and maybe companies looking to employ more sophisticated security in retail and potentially in warehouses as well.”
From a Stanlib perspective, how much weight are you putting into ESG (environment, social and governance) considerations when it comes to investments into various Reit stocks?
“We as a business believe that ESG is a material consideration for us in delivering [long-term] returns to our clients. I guess as active owners, we have the ability to influence corporates in the property sector and the entities we invest in to incorporate ESG factors.”
“If you look at our business, we are signatories of the PRI [UN Principles for Responsible Investment] …
“If I look at the property companies over the last couple of years, the historic focus in the sector used to be particularly just on governance and management … Things like cross-shareholdings and maybe suboptimal board-check structures.”
“I think the focus has maybe shifted away from that. If I look at a property company now, a lot of emphasis and analysis is being spent on looking at how much they are spending on solar, their capex and water initiatives, and their overall investment in renewables.
“So I think each company in the property sector has a plan and is committed to maybe a net-zero carbon footprint by 2030. But property companies are in maybe a better position than in some other sectors, because they’ve been doing green buildings and contributing to that in the space.”
“These companies are also issuing sustainable bonds as well on the financing side, which is becoming a bigger portion of the sector. In terms of how we rate and risk them, we explicitly build a risk premium for ESG into our models, our risk discount rate as a inclusion for this, and we are able to relatively rank the companies based on a quantitative framework which looks at each of those inputs as well.”