No longer an ideal hedge

After a stellar run over the past few years and rand hedge status, global property is looking a little less attractive than only a few months ago, writes Johann Barnard. This is due to Brexit putting the skids under the hugely popular UK property market, and rand strength, which has eroded the hedging opportunity.

According to global real estate firm CBRE, capital values for offices in the City of London dropped 6.1% in July from the previous month, following the Brexit decision. Values for the rest of the UK dropped by 4.1%.

With such early signs of distress emerging in one of South African investors’ most popular offshore property destinations, how do investment managers view the future?

Greg Hopkins, chief investment officer at PSG Asset Management, is sceptical about global property.

“We are generally cautious about both global and domestic property.

“We continue to think that underlying net asset values, which are struck at the estimated market values of the underlying properties, are high,” he says.

“Some of the rental assumptions and rental yields appear overly optimistic and the discount rate that the valuations are based on appear too low. Share prices are trading close to underlying net asset values, and as a result we feel the underlying shares don’t have a sufficient margin of safety for us to invest.”

Hopkins says this view is based on rental prices in certain segments in the market — particularly office rentals — starting to approach the historic highs of 2007. This is compounded by new supply coming into the market that could potentially lead to oversupply if vacancies rise from quite low levels.

The danger, Hopkins cautions, is compounded by the gearing levels of these properties — the debt incurred to buy or build them. The property counters are exposed to this debt and could be at greater downside risk if the trend of falling property values continues. There is the possibility then of the share valuations falling below the underlying property value.

“One of the reasons global property has been popular is that its dividend yields are often above local government bond yields.

“These bond yields are, however, at generational lows — and if bond yields normalise it could have a significant effect on property valuations and subsequent share prices,” Hopkins adds.

Investors should bear these warnings in mind; however, it is also true that there is no shortage of choice for South Africans.

Not only has the popularity of offshore property given rise to numerous funds playing in that market, but direct exposure is also possible through JSE listings of externally focused property counters. In the past month alone, the listing on the JSE of three new offshore property companies has been announced. These include Poland-focused GTC Group and Echo Polska Properties (EPP), and UK shopping mall developer Hammerson.

Stephen Meintjes of Momentum SP Reid Securities says that while the greater choice is good news for investors, caution is advised. This is due to the strong run that property has had, and despite the yield on Reits (real estate investment trusts) remaining attractive.

Dave Christie of Ashburton Investments says the investment house has also had a preference for Reits as a way to gain exposure to property, though to a limited degree.

“We do think they are a little overpriced at the moment, so we are also avoiding property as we think there is probably some dirty washing to come out and there are liquidity issues,” he says.

The decision for investors wanting to gain exposure to global property is, as in the case of other asset classes, not an easy one. There may be greater opportunity, as the rand is stronger, but returns and risk are not as favourable as they were a few short months ago.

Left: Office rentals are starting to approach the historic highs that were seen in 2007. Picture: iSTOCK Below: Greg Hopkins, chief investment officer at PSG Asset Management.