Financial Mail - Investors Monthly - - Contents - Joan Muller

JSE in­vestors who own shares in prop­erty stocks that are ex­posed to the UK must have had a few sleep­less nights since Bri­tain’s de­ci­sion to exit the Euro­pean Union on June 23.

Cur­rently, no fewer than 16 of the JSE’s prop­erty coun­ters own real es­tate in the UK, ei­ther di­rectly or in­di­rectly via other listed ve­hi­cles. Some are 100% in­vested in the UK while others only have par­tial ex­po­sure. Ei­ther way, most of th­ese coun­ters lost at least 10%-20% of their value on the day Brexit was announced.

Lon­don-fo­cused Cap­i­tal & Coun­ties Prop­er­ties (Capco) was pun­ished more harshly than any other rand hedge counter on the JSE. The share price dived 33% in the first two weeks af­ter Brexit, bring­ing the to­tal drop to nearly 45% from its December record high of just more than R100. That trans­lated into value de­struc­tion of some R48bn in terms of mar­ket cap wiped out in the year to date (to July 8).

What makes Capco’s ex­ten­sive share price losses par­tic­u­larly hard for South African in­vestors to swal­low is that the counter has been one of the most pop­u­lar rand hedges in re­cent years, de­liv­er­ing an im­pres­sive 50% cap­i­tal re­turn last year. That ex­cluded div­i­dends, al­beit a small one, as Capco is pri­mar­ily a cap­i­tal growth play and trades at a div­i­dend yield of less than 1%.

An­a­lysts as­cribe Capco’s big­ger share price losses (rel­a­tive to other UK-fo­cused prop­erty stocks) to the fact that its en­tire port­fo­lio is lo­cated in Lon­don. This be­ing the UK’s fi­nan­cial cap­i­tal, the gen­eral view is that Lon­don’s prop­erty mar­ket is likely to be hard­est hit by cor­po­rates and re­tail­ers cut­ting back on ex­pan­sion plans as well as wan­ing in­vestor ap­petite for res­i­den­tial prop­erty. Also, the weaker pound will put pres­sure on re­tail­ers’ mar­gins and may af­fect their abil­ity to pay rentals.

Capco owns Covent Gar­den (a trendy leisure and shopping precinct) and Earls Court, a large tract of un­de­vel­oped land which the com­pany plans to turn into one of the largest new res­i­den­tial sub­urbs in Lon­don. The first phase of off-plan apart­ment sales kicked off last year.

The big­gest worry is the im­pact that Brexit will have on Lon­don house prices and the knock-on ef­fect on land and prop­erty val­ues at Earls Court.

In re­cent weeks, a num­ber of in­sti­tu­tional open-ended prop­erty funds, in­clud­ing those of Standard Life, Aviva, Hen­der­son and M&G, have sus­pended trad­ing to stem po­ten­tial losses from in­vestors look­ing to cash out. “That’s an ex­tremely wor­ry­ing first sign that there is a lot of pain ahead for the UK prop­erty mar­ket,” says Av­ior Cap­i­tal Mar­kets in­vest­ment an­a­lyst Adrian Jar­dine.

How­ever, times of dis­tress do of­fer buy­ing op­por­tu­ni­ties for the brave. And it seems that UK prop­erty stocks such as Capco have been over­sold in re­cent weeks, cre­at­ing what could be a cheap en­try point for South African in­vestors look­ing to in­crease their off­shore di­ver­si­fi­ca­tion. Af­ter all, Lon­don it­self is likely to re­tain its sta­tus as a world-class tourism and fi­nan­cial hub in the long term de­spite cur­rent jit­ters. At the R53-R56 level at which Capco was trad­ing ear­lier this month, the stock of­fered a dis­count to net as­set value of about 26%.

Anas Madhi, di­rec­tor of Meago As­set Man­agers, says while Earls Court may face some ad­verse con­di­tions, an in­vest­ment case can be made for Capco based on the mer­its of Covent Gar­den alone.

The lat­ter’s lo­ca­tion, which ex­poses it to the dy­nam­ics of the prime cen­tral Lon­don re­tail mar­ket, means it should re­main ro­bust, even dur­ing what could be an ex­tended pe­riod of uncertainty. In fact, Madhi says Covent Gar­den, be­ing a tourist land­mark, could even ben­e­fit from in­creased for­eign tourism spend­ing on the back of a weaker Bri­tish pound.

In ad­di­tion, suf­fi­cient as­set man­age­ment op­por­tu­ni­ties re­main in the precinct to sup­port medium-term rental growth. But Madhi cau­tions in­vestors to be pre­pared to bear with volatil­ity.

Stan­lib’s head of listed prop­erty funds, Keillen Ndlovu, has a sim­i­lar view. He be­lieves most of the down­side of a po­ten­tial de­cline in rentals and prop­erty val­ues is al­ready priced in at cur­rent share price lev­els. But he says in­vestors need to take at least a three-year view.

Av­ior Cap­i­tal Mar­kets’ Jar­dine is more bear­ish. “While it is tempt­ing to have a stab at Capco at th­ese lev­els, given the dis­count to net as­set value, it’s any­one's guess how deep cap­i­tal losses may go and how long the down­turn in the cy­cle will last.”

Jar­dine says while Covent Gar­den and the de­vel­op­ment pipe­line at Earls Court are truly prime, world-class real es­tate as­sets, the share prices of Capco and its peers should re­main de­pressed and volatile un­til there is at least some sign that the mar­ket has bot­tomed. “In­vestors would be wise to avoid mak­ing hasty al­lo­ca­tions un­til the out­look is clearer.”

It’s any­one’s guess how deep cap­i­tal losses may go and how long the down­turn in the cy­cle will last

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