Time to cherry-pick?
The dismal performance of the listed property sector yearto-date — the SA listed property index (Sapy) is down more than 20% in the seven months ending July — has no doubt prompted property punters to reassess their investment strategies.
This year has been the listed real estate sector’s worst in terms of share price performance in 20 years. While the sharp sell-off was initially triggered by concerns around the corporate structure and allegations of insider-related trading against the Resilient group of companies (Resilient Reit, Fortress Income Fund, Nepi Rockcastle and Greenbay Properties), investor sentiment has also been dented by SA’s weak economic growth outlook, a deteriorating operational performance, slower dividend growth, and uncertainty created by the expropriation of land without compensation debate.
Latest figures from Catalyst Fund Managers show listed property was the worst performing asset class by far with a total return of -22%. That compares to a -2% total return for general equities and 4.2% and 6.6% for cash and bonds respectively.
However, industry players believe the correction has been overdone: property stocks are now trading at record high yields, with as many as 20 out of the sector’s 50-odd counters offering income chasers yields of between 10% and 18%. That offers value relative to longterm SA government bond yields, which are sitting at around 8.8% (mid-August). Offshore companies are similarly trading at forward yields ahead of their respective long-term government bond yields.
Craig Smith, head of research at Anchor Stockbrokers, says listed property looks attractively priced compared to other asset classes. But he believes property investors should moderate their longterm growth (and long-term total return) expectations.
Anchor Stockbrokers is forecasting an annual total return for listed property of 12%-14% (compounded annually) over the next three to five years, which Smith notes is lower than the average 18%/year total return delivered by the sector over the past 15 years (ending June). He expects distribution (or dividend) growth for the sector to slow to 6% over the next 12 months, down from 9%-10% in 2017.
A number of factors that supported the sector’s outperformance are no longer present or are less significant than 1015 years ago, says Smith. One is the increased weight of capital that has been allocated to listed property in recent years, which aided the sector’s rerating versus bonds.
“Due to the size of the listed sector, this tailwind, with a few others, will be less important in future,” says Smith. He believes the sector’s growth will also be curtailed because there are fewer “undermanaged” institutional-grade quality assets available for purchase from institutions and conglomerates.
However, Smith says a total return of 12%-14% a year is a more realistic and acceptable return for listed property. “Listed property is a hybrid between an equity and a bond, so investors should be comfortable with a return profile lower than equities but higher than bonds given that listed property cash flows are more predictable and secure than equities but less so than bonds.”
Nevertheless, he stresses that though investor sentiment towards real estate stocks in general may take time to recover, listed property is a separate asset class providing much needed diversification in any balanced portfolio. “As such, investors should remain invested in listed property over the long term, while acknowledging that relative exposure can and should vary over time based on the sector’s growth outlook and stage of the property cycle,” says Smith.
Kelly Ward, investment analyst at Metope Investment Managers, agrees there is now value to be had in property stocks. While dividend growth has certainly tapered off from some of the high double-digits of 2015 and 2016, she still expects the sector to deliver inflation-beating growth of an average 7% for 2018 and 2019. “And given the high yields on offer, we believe the sector is poised to deliver a total return of about 16% over the next 12 months,” says Ward.
The key question for investors is: which individual stocks offer the best buying opportunities? SA-focused property counters with partial offshore exposure appear to dominate fund managers’ stock-pick lists, including the Vukile Property Fund, Emira Property Fund, Investec Property Fund, Hyprop Investments and Attacq, as well as Fortress Income Fund and Resilient Reit. Offshore favourites include Central and Eastern European property play Nepi Rockcastle and Polish-focused EPP.
Investec Asset Management portfolio manager Peter Clark says investors should take a fresh look at Attacq now that the company is adopting a real estate investment trust (Reit) structure, which will convert it from a capital growth to an income fund. However, he says Attacq still offers an attractive development pipeline in one of SA’s most prominent growth nodes — Waterfall near Midrand, one of the largest
mixed-use developments in SA and anchored by the Mall of Africa.
“So though the fund appears to be low yielding, it will now provide investors with a combination of sustainable income and capital growth through a pipeline of local property development opportunities, something that is hard to come by in the current listed property market,” says Clark.
Attacq also holds a substantial stake in UK- and Central and Eastern Europe-focused MAS Real Estate, which provides growth in the short term but can also be used as an accretive funding structure to roll out the Waterfall development pipeline. After the Reit conversion, Attacq will exclude its deferred tax liability, which Clark says will lead to a substantial uplift in net asset value. “The NAV uplift combined with the newly realised income yield and extensive develop- ment pipeline creates a hybrid investment case that offers substantial share price upside.”
Clark also likes Investec Property Fund, which provides a solid income platform through the longer-weighted average lease profile the company has in its SA portfolio of offices, shopping centres and industrial buildings compared to its peers. Earnings growth is driven by various offshore businesses in which Investec Property Fund has interests, including Investec Property Australia, Argo JV in the UK and the recently launched Pan European logistics venture.
He expects Investec Property Fund to outperform its peers on the dividend growth front. The company’s balance sheet also remains within a reasonable comfort zone below the 40% loan-to-value gearing level. “At a valuation discount to both bonds and the sector, IPF now provides an attractive entry point,” says Clark.
Metope’s Ward believes Resilient and Fortress B — the JSE’s worst performing property stock with a drop of 63% year-to-date — both offer significant value given the sharp declines from their December 2017 highs.
While the two companies remain under investigation by the Financial Sector Conduct Authority for alleged market manipulation, Ward says both have rebased their earnings over the past six months following criticism from the market. “We are confident in Fortress and Resilient’s ability to deliver on earnings growth.”
Ward says the assets underlying Resilient’s performance are of a high quality — its directly held SA shopping centre portfolio is valued at R21bn and includes flagship centres such as The Galleria and Boardwalk Inkwazi in KwaZulu-Natal, Mall of the North in Limpopo and Highveld Mall and Secunda Mall in Mpumalanga. Resilient also has stakes in Nepi Rockcastle, the leading retail property investment and development group in Central and Eastern Europe with a portfolio worth €5bn (R77.5bn), and Greenbay, which owns a €184m (R2.8bn) port- folio of direct retail property and infrastructure investments and a further €800m (R12.8bn) in listed securities. Resilient is trading at a 10.3% historic yield versus the Sapy’s 8.67%.
Ward says Fortress B offers investors an 11.8% dividend yield with above-inflation growth of about 6% a year over the next three years. Fortress has a large portfolio of modern logistics facilities leased to national and international bluechip tenants, as well as retail centres located close to transport nodes or in CBDs, which typically cater to lower-income shoppers and generate strong demand from national retailers.
“We believe Fortress’s strategy of recycling capital from noncore offices into new industrial developments with better lease covenants and stronger capital growth prospects will deliver abovemarket dividend growth in future.”
Both Clark and Ward single out Vukile as another good buy. The company owns a quality portfolio of SA shopping centres including stakes in the East Rand Mall, Dobsonville Mall in Soweto and Gugulethu Square in Cape Town. It also has a stake in Fairvest, which owns a portfolio of shopping centres that cater mainly for lowerincome shoppers.
Ward says management’s offshore ventures have been very successful. The latter include an indirect investment in the UK through Atlantic Leaf Properties as well as a portfolio of retail centres bought in Spain, one of the highest economic growth regions in Western Europe. She believes Vukile’s Spanish foray will provide plenty of support for abovemarket distribution growth in the medium term. She notes that the company trades on an attractive forward yield of 9.4%, with dividend growth forecast at an average 7.3% a year for the next three years.
Listed property is a separate asset class providing much needed diversification in any balanced portfolio. As such, investors should remain invested over the long term