LISTED PROP­ERTY

HOW THE FUND MAN­AGERS BUILD THEIR PORT­FO­LIOS

Finweek English Edition - - FRONT PAGE - By Jaco Visser

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.

Re­tail sec­tor

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.

Of­fice space

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.”

In­dus­trial prop­erty

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.

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