Property share prices have come under renewed pressure in recent months as higher interest rates, a fragile economy and load-shedding start to eat into bricks-and-mortar profits again.
The JSE’s South African listed property index (Sapy) is down about 9% year to date, wiping out most of the gains achieved in the fourth quarter.
The mini-rally late last year was supported by a post-Covid recovery in earnings, which led to a welcome resumption of dividend payments after most real estate investment trusts (Reits) had to cut or suspend payouts during the pandemic.
The only company in the Sapy still not paying dividends is Fortress Real Estate, but that has to do with its inability to collapse its complicated dual share structure rather than its earnings performance.
However, the sector’s improved fortunes have turned out to be short-lived. Financial results and trading updates released by several Reits in recent weeks clearly reflect a deteriorating earnings outlook.
Many have opted not to provide guidance for their next reporting periods, underscoring just how difficult it has become to make predictable growth forecasts.
Research by Imdaad Nana, analyst and portfolio manager at Catalyst Fund Managers, shows that 23.4% of the companies in the all property index (Alpi) have forecast a drop in earnings for their upcoming full-year reporting periods — financial year 2023 or 2024.
Another 17% expect earnings to remain flat while 18.3% have given no guidance. Nana’s calculations are based on the benchmark weighting of the individual constituents of the Alpi.
The Alpi represents the JSE’s 35 largest property stocks in terms of free float market cap. Nana says the good news is that the remaining 41.3% still expect earnings to increase for the 2023/ 2024 financial years.
Companies that have forecast an uptick in distributable income include Nepi Rockcastle, MAS Real Estate, Fortress, Vukile Property Fund, Investec Property Fund, Attacq and Liberty Two Degrees (L2D).
A common thread is exposure to offshore real estate markets, with the only exception being South Africa-focused L2D. Eastern Europe-focused Nepi Rockcastle and MAS Real Estate generate 100% of their earnings in hard currency while Fortress and Attacq have stakes in Nepi Rockcastle and MAS respectively.
In Vukile’s case, more than 50% of its portfolio consists of retail centres in Spain. Investec Property Fund’s offshore interests include a large stake in a Western Europe-based logistics platform.
Though L2D is a 100% South Africa-based Reit, its positive earnings outlook has seemingly been supported by a “flight to quality” among retail tenants and shoppers.
Its mall portfolio includes super-regional centres Sandton City and Eastgate. The company has also seen a strong recovery in occupancies and revenues in its Sandton-based hotel portfolio including Sandton Sun, Garden Court and Sandton Towers.
But distributable income growth guidance doesn’t necessarily determine whether dividends go up, go down or stay flat.
Nana refers to the recent introduction of payout ratios, which has resulted in a divergence between the earnings yield and what companies ultimately pay out to shareholders.
Historically, Reits paid out 100% of earnings as dividends. Most are now retaining a portion of earnings (up to 25% in terms of the JSE’s Reit regulations) to reinvest in existing assets or cut debt levels.
Unsurprisingly, the list of the top 10 property stocks in terms of share price growth year to date is dominated by rand hedge companies and South Africa-based ones that have sizeable offshore footprints.
According to Anchor Stockbrokers, Sirius Real Estate (German and UK business parks), Shaftesbury Capital (central London properties), Hammerson (UK and West European malls), Nepi Rockcastle and MAS are among the Alpi’s best-performing counters for the six months to end-June (see table).
Over 12 months, South Africa-based Waterfall City developer Attacq pipped its rand hedge counterparts to the post.
The 70 % rally was probably supported by corporate action. In Attacq’s case, the Government Employees Pension Fund bought a 30% stake of Waterfall City for R2.7bn.
The 10 worst performers in the year to date are all South Africa-based property stocks, with former market darling Equites Property Fund reporting the biggest loss with a total return of -27%.
The sell-off of Equites shares no doubt comes on the back of an unexpectedly large valuation writedown of its UK portfolio of logistics properties and a 20% forecast drop in earnings for the year to February 2024. The UK assets make up 25% of Equites’s total portfolio, worth R27bn.
He refers to South Africa-focused Reits trading at a much larger discount to NAV than their offshore counterparts — about 42% vs 26%. That implies local shares offer a better value proposition than pure rand hedge stocks, so they shouldn’t be overlooked.
Chetty says South African and offshore Reits alike offer distinct risk-reward profiles that cater to different types of investors. “Given the high yields and large discount to NAV that South African Reits are trading at, the sector offers recovery potential when local economic conditions improve.”
On the other hand, as Chetty points out, global Reits offer portfolio diversification benefits, access to niche subsectors and the potential for currency gains.
“So investors should include both in their investment portfolios as part of their wider asset allocation,’’ he says.
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