Volatility in property share prices may make it near-impossible to call the bottom of the market. However, investors are seemingly starting to re-enter the real estate sector on the back of what looks like dirt-cheap levels.
The South African listed property index is up about 10% month to date, clawing back a large portion of its 2022 losses. That follows what has been a rather rocky recovery since the index hit Covid-induced 10-year lows two years ago.
The index is nevertheless still languishing more than 30% below pre-Covid levels and nearly 60% below late 2017 peaks.
Imdaad Nana, analyst and portfolio manager at Catalyst Fund Managers, says JSE-listed property stocks are still trading at an average 36% discount to net asset value.
He notes that South Africa-centric companies are sitting at a discount to NAV of as much as 39%, against 29% for the JSE’s offshore counters.
The 36% average discount offered by JSE-listed property stocks is significant, considering it is well ahead of the sector’s historical five-year average of about 18%.
The 36% average discount offered by JSE-listed property stocks is significant, considering it is well ahead of the sector’s historical five-year average of about 18%
The value proposition appears more pronounced if compared with the 25%-35% premium to NAV at which the property sector used to trade during the 2015-2017 heydays.
Not one of the sector’s 20 largest stocks is trading at a premium to NAV, which underscores the extent that real estate investment trusts (Reits) have been sold down.
The gap between the highest and lowest rated stocks is, however, significant. It ranges from a discount of 6%-10% for Stor-Age Reit, Lighthouse Properties and Equites Property Fund to a hefty 60%-70% for Hammerson, Attacq and Octodec.
Though analysts agree the large discounts to NAV at which Reits are trading imply in theory there’s plenty of value to be had, it doesn’t necessarily mean property share prices are poised for a sharp and quick rebound.
Nana expects share prices to remain volatile given ongoing global and local economic conditions. But even if investors get zero capital growth in the short term, the sector still offers an attractive dividend yield of 10%-12%.
Nana expects income payouts to grow in line with inflation over the short term on the back of a rebound in earnings growth.
That follows a dip in property company earnings over the past two years due to pandemic-related rental discounts granted to struggling tenants, higher vacancies, negative rental reversions and lower income from offshore investments.
Catalyst expects a total return of 12%-15% for listed property over the next year. Anchor Capital has pencilled in a similar 12-month total return of 13% for South African listed property.
That compares to Anchor Capital’s total return forecast for general equities, bonds and cash of 16%, 12% and 7%, respectively.
Chief investment officer Peter Armitage writes in The Navigator, Anchor Capital’s quarterly strategy and asset allocation report, that all asset classes have felt pain during what has been a “dreadful” year.
He adds: “Now is the time for cool heads and uncomfortable patience with markets.” Armitage says while volatility remains unnerving, there’s a sliver of optimism starting to appear.
“Analysts who were the most bearish a year ago are starting to talk about positive returns as markets inevitably bottom, inflation subsides, central banks reach peak interest rates, and hikes become a thing of the past.’’
Referring to listed property in particular, Armitage says rising bond yields have dented the attractiveness of the sector as an income investment, which is clearly reflected in the sector’s weak share prices. Over the past year, South African 10-year bond yields are up from around 8.5% to 11%.
He doesn’t expect listed property to deliver material capital growth over the next 12 months — or at least not until bond yields decline, which should trigger a Reit rerating. The bulk of Anchor’s 13% total return forecast (11%) for listed property will be in the form of dividends.
Downside risks include the inability of landlords to pass on rising utility and other property operating costs to tenants in the current environment. The prospects for filling more empty office space are also limited.
However, Craig Smith, head of research at Anchor Stockbrokers, says there is also upside potential if pension funds allocate more money to listed property as opposed to bonds or general equities over the coming months.
That follows an outflow of pension fund allocations to Reits in recent years. “The sector is looking attractively priced, so perhaps the reallocation starts to happen in the near term,” he says.
Of course, it’s not only the South African Reit sector that’s looking cheap. Property share prices in other parts of the world have come under huge pressure year to date on the back of the Russia-Ukraine war, global inflation and interest rate spikes and rising recessionary fears.
European listed property has slumped nearly 42% year to date while UK and US Reit markets have lost more than 30%
For instance, European listed property has slumped nearly 42% year to date while UK and US Reit markets have lost more than 30% (see graph).
But Garreth Elston, independent property analyst, says global Reit markets were trading at much higher valuations relative to South African Reits from 2019-2021, given that local listed property prices had already rerated sharply downwards in 2018.
He says it could be argued that higher interest rates, lower economic growth prospects and geopolitical factors caused by the Russia-Ukraine war are not yet fully reflected in global Reit markets.
So there’s still a lot of risk and it’s probably not time to go “all in” yet, he argues. However, Elston says “green shoot’’ sectors worth considering if you’re a risk-accepting investor with a longer time horizon include European residential, US health care, US malls, and, for the very brave and patient, US offices.
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