Entrepreneurs keep home fires lit until market revives
Middle-income flats go up as residential funds foresee upturn
● Strong demand for middle-income rental housing is prompting private entrepreneurs to build residential property portfolios that they can list when economic and market conditions improve and fund managers become less wary of risking new money in the listed property sector.
A residential-only fund may list as early as next year, according to analysts, who say that some funds have been able to get scale relatively quickly compared with other property types.
Such a fund would become the fourth residential-focused fund on the JSE, following on from Indluplace Properties, which has about R4.5-billion worth of rental flats; Transcend, which owns R1.2-billion worth of flats; and Balwin, which develops and sells sectional-title housing.
There is a disconnect between developers who see housing demand on the ground and fund managers who put their money into listed property companies and try to diversify against risk.
Some fund managers say residential property has historically been perceived as more risky because it has monthly as opposed to annual leases, and escalations are not built in.
Yet residential property is enjoying interest from investors because it faces fewer challenges than offices and retail. While economic growth is subdued across South Africa and consumers’ disposable income is growing slower than inflation, urbanisation is on an upward trend — which is driving rental housing demand.
This means residential landlords can fill vacancies more easily. Further, if a tenant defaults, the effect is not as negative as when a large tenant can’t pay their rent at an office or shopping centre.
In addition, demand for housing is mostly in the rental part of the market.
More people are scaling down where they live and young families are choosing to rent instead of buy as they wait for an uptick in the economy, according to research by economist Erwin Rode. Paying rent remains the priority expense for many South Africans.
Meanwhile, office landlords are struggling to fill vacancies because there are not enough medium-sized businesses that need space and are prepared to move into buildings vacated by large companies.
“There is a musical chairs kind of effect,” said Evan Robins, listed property manager of Old Mutual Investment's MacroSolutions boutique.
Retail landlords are also feeling the pinch as rapid growth in the number of shopping centres in South Africa in the past few years means they are competing for a pool of customers that is growing very slowly.
Resilient
The best-performing malls in the country seldom changed hands as owners were cash flush and didn’t need to sell assets, said Brian Azizollahoff, MD at Propertiq. “They don’t need to rotate capital that much, so I think people who put together new funds have to look to other asset classes,” he said.
Many suburbs in South Africa’s major cities had an undersupply of middle-class housing, and funds were prepared to develop apartment blocks that may take a few years but would see constant demand when they’re finished, said Azizollahoff.
“I think people will create portfolios of residential properties and then some will be listed when scale is reached. This could be next year for some or during a few years after that. Residential is the most resilient property type in my opinion. Economic growth may be slow, but people need somewhere to live and urbanisation is a strong driver of housing demand. Over the past 10 years, we’ve seen a strong shift from rural to urban,” he said.
According to the World Bank, in 1960 53% of South Africa’s population was rural. By 2017 this had fallen to 35% of the population.
Justin Blend, CEO of Africrest Properties, said the rental band of R4 000 to R7 000 was the sweet spot for the residential market in terms of sustainable demand where people tended to meet rent payments. His company has decided to focus half of its business on housing in this segment, while the other half is focused on commercial.
The TPN Credit Bureau’s rental monitor showed that at the end of the first quarter of 2018, 54.8% of tenants who rented in South Africa paid between R3 000 and R7 000 a month. The average vacancy rate across this category is only 5% and 84.02% of rent payers are in good standing.
Rent payers of less than R3 000 a month had 20% of rental market share, have an average vacancy of about 7%, and 72.87% of them are in good standing. This is while the average national office vacancy was 11.5% at the end of March, according to the South African Property Owners’ Association.
National residential rental escalations appear to be under pressure, but this is partly because of a strong drop in Cape Town rentals, down from double-digit numbers. The national level was at about 5% at the end of 2016 and at the end of March it was 3.75%. Gauteng escalations have been sustained at around 6% since the end of 2016, while Western Cape escalations have gone from almost 13% at the end of 2016 to 7.5% at the end of the first quarter of 2018.
Some fund managers still think bringing new residential assets into listed property funds is risky and they don’t think those residential assets already in the sector have had a run good enough to change their minds.
Naeem Tilly, a portfolio manager at Catalyst Fund Managers, said: “Recent performance from Octodec, SA Corporate and Indluplace residential portfolio has shown that the asset class is under strain given the pressure on household disposable income. Vacancies are increasing and low single-digit rental growth is common.”
But on the positive side, bad debts remained low and residential demand had an element of necessity spend, said Tilly.
Octodec opened its largest residential development, Sharon’s Place, in Tshwane this year. It consists of 400 residential units, 5 660m² of ground floor retail anchored by Shoprite and Clicks, and 289 parking bays. It lies adjacent to the new Tshwane House municipal development in the Pretoria CBD and was named after a nonexecutive director at the company, Sharon Wapnick, whose brother, Jeffrey Wapnick, is Octodec’s MD.