HOW THE FUND MANAGERS BUILD THEIR PORTFOLIOS
south Africa’s listed property space has seen robust activity over the past year, with eight new listings amid the threat of higher interest rates. The outlook for these stocks remains solid as investors bank on the dual growth nature of listed property: capital growth and income, or distribution, growth.
Some of the largest property companies have diversified their income streams offshore in a bid to limit country-specific risk in SA. Others, especially the smaller property companies, have opted to provide investors with steady distribution growth from their local property portfolios.
Several factors impact the income outlook of listed property companies. Those with a large exposure towards retail space, especially shopping centres, depend on the strength of the local consumer to flock to these centres’ retailers and bolster sales. Property companies with a large exposure to office space depend more on the general economic situation, where growing corporates demand more space as they grow their operations.
Property companies with a large industrial real estate offering are at the mercy of manufacturing growth and all that impedes this economic sector – notably a shortage of electricity, demand (or lack thereof) from offshore customers and interest rate levels, among others.
With economic growth in SA at a lacklustre 0.6% quarter-on-quarter annualised in the last three months of last year, it is hard to see how local conditions will result in a large boom in property development. Given stiff competition in the retail property space, with about 400 000m2 coming to the market over the past two years, and a similar amount expected
The blowout of bond yields, when investors sold off government debt following Nenegate, saw the listed property sector take a hit. In March, inflation breached the Reserve Bank’s upper 6%target of for the third consecutive month as food prices spiked following the worst drought in decades in SA.
for the next two years, according to Estienne de Klerk, managing director at Growthpoint Properties, local funds would be hard-pressed to optimise efficiencies in their portfolios.
Growing capital or income?
One of the first factors a potential investor should take into account when deciding to invest in the listed property sector is whether they have a preference for capital growth or income yield and the growth of this income, according to Malcolm Holmes, fund manager at Stanlib Multi-Manager, who manages two property funds with R5.4bn under management.
“The more SA-specific property shares tend to yield higher income growth,” says Holmes.
Rental lease agreements include automatic annual escalations, which underpin income growth, explains Amanda de Wet, a fund manager at Plexus Wealth
Property Fund. This translates into a constant growing income stream for most of the property companies, she says.
In addition, not all leases expire at the same time, which means that the companies can negotiate future income on an ongoing basis, De Wet explains.
Those looking for capital growth opportunities in the property sector would probably opt for the larger shares with an offshore presence, says Holmes. These funds have followed in the footsteps of large South African companies – such as SABMiller, Naspers*, Steinhoff and Mondi, among others – to engage opportunities offshore and de-risk their income-generating capacity away from the local economy.
“We’re very happy to put money into those funds,” says De Wet. These property funds acted partly as a rand hedge during the market turmoil of December, following the axing of former finance minister Nhlanhla Nene and the subsequent run on the rand.
Externalised or not?
Growthpoint, the largest listed property fund, ventured into Australia when a lucrative opportunity presented itself a couple of years ago, says De Klerk.
“There was an element of opportunism when we bought into our Australian company,” he adds.
Growthpoint now expects its GOZ unit in Australia to bolster the company’s growth this year, according to its financial results for the six months to end December.
“The externalisation of the property market is a positive from a diversification perspective and has driven capital returns as the rand has weakened,” says Holmes.
The interest-rate sensitive nature of the property market – due to the fact that debt is used to fund property development – makes it susceptible to current rising interest rates, and this could be a drag on income prospects. The blowout of bond yields, when investors sold off government debt following Nenegate, saw the listed property sector also take a hit on worries that the higher cost of borrowing would hurt profitability.
The situation was cushioned by the near-parallel slump in the rand, which bolstered property shares with offshore exposure, as income earned in foreign currency would now be repatriated to SA at a higher rand value.
As most of the property funds’ local debt is linked to a margin above, or in rare instances below, the Johannesburg Interbank Acceptance Rate (also called Jibar), a higher repurchase rate would bode ill for finance costs.
At first glance, the recent opening of the Mall of Africa north of Johannesburg could be seen as a sign that South African consumers are keeping their spending intact, despite the various economic factors acting against them. In March, inflation breached the Reserve Bank’s upper target of 6% for the third consecutive month as food prices spiked following the worst drought in decades in SA. The weakening rand also fed through into imported prices, and unemployment remains at historically high rates. The Reserve Bank has increased its benchmark repurchase rate six times by a total three percentage points since January 2014 to bolster the rand and tame inflation expectations.
This hasn’t stopped SA consumers from continuing to spend, especially those that are economically more well off.
Large regional retail properties geared towards the more affluent, which constitute the majority of Growthpoint’s retail portfolio, have been performing well and continue to do so, says Growthpoint’s De Klerk. The company’s retail portfolio is valued at R29bn, he says.
“There is a healthy demand for retail space,” says Plexus’ De Wet. “The SA consumer is not scaling back much on fashion and the international retailers are looking for large box space, which is lessening the bargaining power of local retailers.”
The smart asset managers are working hard to ensure that the demand for retail space remains strong in their centres. After the demise of Ellerines we have seen some of these spaces filled by enhanced entertainment offerings, or by government agencies such as the SA Social Security Agency or day clinics, which boost centre trading densities.
Shopping centres in the country that are not doing well would be those servicing the lower end of the market, particularly those in the outlying areas like the mining towns, De Klerk says. One such example is the ironmining town of Kathu where layoffs by the resource companies led to a slump in spending and growth for Resilient’s Village Mall Kathu, according to its financial statements for the six months to end December.
With the impact of the slow economy, the office sector is the most challenging currently, according to De Klerk. Growthpoint has a R33bn office portfolio in SA, he says.
The latest vacancy rates among the largest property funds show that 7.6% of Growthpoint’s lettable offices stood empty by the end of December; 12.8% of Fortress Income Fund’s office space was vacant at the same time; 6.8% of Vukile Property Fund’s offices was vacant at the end of September; and 9.3% of Emira’s offices was not let by the end of December, according to their latest financial statements.
“We are seeing no inflation in office rentals,” says De Klerk. “Across the board this is a difficult space to be in.”
The industrial property sector, which includes logistics warehouses and factories among others, is at the behest of the manufacturing and other industrial sectors. Power infrastructure, which curtails growth in these sectors, also affects the industrial property sector. For this reason, development of industrial properties has been muted over the last couple of years.
“Nationally, vacancies in industrial are not very high,” explains De Klerk. “We do not see massive growth in rentals in this sector if the economy remains sluggish.”
De Wet from Plexus agrees that the sector is finding itself in a “volatile economic climate”, but good results are still seen from the warehouse and distribution sub-sector, driven by the centralisation of distribution facilities and increased online retail sales.