February 28 2024
Recently the first South African Real Estate Investment Trust (Reit) Conference of the year was held at the Houghton Hotel in Johannesburg. It was really well-attended and the overarching message was for real estate businesses to be optimistic despite uncertainty around the country’s upcoming national election and volatility in certain large geographic markets.
SA needs employment and wealth creation. Over the past 16 to 20 years this really hasn’t looked likely to come round. Nevertheless, as interest rates fall, investor confidence should improve including for real estate. Investors would then spend their capital on new developments as opposed to holding it in the bank.
Growthpoint Properties’ SA CEO Estienne de Klerk who is the chairperson of the SA Reit Association told the conference that interest rates and how they moved would remain a big question in 2024. The cost of capital was high. Listed funds battled to raise money at a high interest cost and many were having to manage large amounts of debt relative to their assets.
The consensus view among many of SA’s property analysts and fund managers is that interest are likely to enter a downward cycle later in 2024. A well-run free and fair election will also likely lead to better investor sentiment. Political analyst and journalist, Justice Malala said the best likely outcome could be the ANC going into a ruling coalition with a number of smaller parties, not including the EFF.
The South African Reserve Bank began its rate hiking cycle in November 2021 to combat high inflation. It raised its main lending rate at 10 consecutive meetings before holding at the current rate of 8.25% at its last four meetings. This is while some banks forecast a drop in interest rates from July 2024.
“If you look back on 2023, in particular the second half of last year, it does seem that that marked peak inflation in most economies in the world,” said Mike Brown, outgoing CEO of Nedbank.
Nedbank has the largest property lending book. Nedbank economists forecast three 25 basis point cuts in the US starting in June, with the local authorities likely to follow suit.
“We think we’re going to have 75 basis points of cuts here in South Africa as well: 25 in each of July, September, and November, so very much mirroring the behaviour of the Fed,” Brown said.
Property funds try to keep their average gearing level or loan-to-value below 40%. When interest rates are cut, the debt of a fund will reprice at new, lower rate. This will lead to higher dividend payouts and possibly concurrent share price gorwth.
Listed property which includes developers and mostly income-focussed real estate investment trusts (Reits) was the best performing asset class in 2023with the All Property Index (ALPI) returning 10.7% including capital share price growth and dividends. It outpaced equities which managed 9%, government bonds’ 9.7% and cash with 8%.
Keillen Ndlovu, an independent analyst said it was taking time for fund selectors to favour property stocks again. Many were not yet convinced that a turnaround was imminent. The number of property funds listed on the JSE had also fallen from 54 in 2013 when Reit dispensation had been adopted in SA to 48 in 2023. Ndlovu said consolidation was needed among Reits. Some needed to be taken private and leveraged buyouts might be on the cards. Unfortunately many private buyers did not necessarily have cash or access to means of raising enough to fund deals.
Listed property was in a weird spot as the market was not pricing it based on net asset value (NAV) but rather based on its yield. SA listed property was expensive compared with bonds, both on an absolute and property-to-bond yield ratio basis. In addition, earnings were declining. Listed property was beginning to look more like equities. It was possible that fund managers would clump listed property with equities in future analysis and allocation.
Meanwhile, the FTSE/JSE SA Listed Property Index (SAPY) which includes the 20 most liquid JSE listed property stocks of a certain size level was trading at 2010 levels, having peaked around 2018.
alistair@propertyflash.co.za
Keillen Ndlovu’s risks and opportunities for listed property (Used with permission)
RISKS FOR SA LISTED PROPERTY
- Infrastructure is in a dire state, and there are dysfunctional local governments
- Municipal costs – rates and taxes continue to run away
- Insurance and security costs continue to go up
- The private sector will need to step in to provide basic services, which increases the cost of doing business
- Water supply and management issues are more difficult for the private sector to solve and to step in compared with electricity
- Loadshedding, rail, and port inefficiencies
- Higher for longer interest rates
- Property investors can no longer rely on yield compression and readily available debt to drive returns
- Refinancing debt in Europe is likely to prove problematic, given high loan-to-value ratios and the low interest rates on maturing debt.
- Cross Currency Interest Rate Swaps – taken away most of the offshore diversification benefits
- Supply chain disruptions from the geopolitical tension could place pressure on retailer’s margins and, therefore, rental growth
- WFH and e-commerce
- Elections – Landlords and investors to be sitting on the fence in 1st half of 2024
- Lack of certainty around property rights
- Lack of interest by foreign investors could also stymie a re-rating in South African assets despite attractive valuations
- Increase in offshore exposure due to Regulation 28 changes
OPPORTUNITIES FOR SA LISTED PROPERTY
- Improved loadshedding, increased use of renewable energy and energy-efficient buildings
- Possibly at the start of a recovery in local property that will pick up speed into 2024
- Asset sales valuations are much closer to net asset value, suggesting potential undervaluation
- LTVs are down to acceptable levels
- Historically, listed property performs better after the interest rate cutting cycle
- Market returns to be driven by rand hedges and stronger fundamentals in Central and Eastern Europe
- Transparency, governance, standardisation of financial reporting are on the way to being resolved
- Use of Cross Currency Interest Rate Swaps (CCIRS) to synthetically manipulate a company’s cost of capital has materially reduced
- Employees returning to offices with the relaxation of WFH policies
- 5G growth, shifting demographics, and increased technology integration in real estate processes, the move towards allocating
more resources to data centres and warehouses seem viable - Extending technology integration to innovations like virtual reality for property tours, blockchain for transparent transactions, and
artificial intelligence for data analysis and decision-making might boost sector performance and processes - As soon as our conviction on the SA economy improves, possibly after elections and clarity on the Fed interest rate path, we will
probably go neutral on the sector
CONCLUSIONS
- There is a huge divergence in views
- More underweight than overweight views
- More neutral than underweight views
- Preference for Bonds to SA listed property
- Offshore investments are getting more attention – Regulation 28
- Different strategies on offshore property vs local property
- More comfort needed around SA direct property valuations
- Liquidity, volatility, and concentration risk a concern
- Rising rates and taxes, lack of service delivery, and collapsing infrastructure are worrying
- Positive election outcome, economic growth, and lower unemployment needed
- The listed property sector is banking mostly on yield compression when interest rates decline
- Investors need consistent, stable and positive returns for another year or two to bring back confidence in the asset class
