After three years of going nowhere, the real estate investment trust (Reit) sector has staged a surprise comeback in recent months.
In fact, the mini rally in property share prices late last year meant that the sector pipped other major asset classes to the post in 2023 with a total return of 10.1% (see table).
That may only be marginally ahead of bonds at 9.7%, equities at 9.3% and cash at 8%, but it’s the first time in six years that listed property has reclaimed its status as South Africa’s best-performing asset class.
But over five years the picture remains grim: listed property delivered a mere 0.2% total annualised return for the five years to end-2023 vs 11.9% for equities, 8.2% for bonds and 5.9% for cash.
Analysts say the recent uptick in property share prices, which are highly sensitive to interest rate movements, comes primarily on the back of the US Federal Reserve finally signalling an end to rate hikes late last year.
Given the growing likelihood that rates across the globe will start to ease in the coming months, the question arises where the Reit sector is heading in 2024 — and how much upside, if any, is left.
It all depends on the pace of rate cuts, says Craig Smith, head of research at Anchor Stockbrokers. “While rates have no doubt reached their peak, it’s not certain exactly when cuts will come. It may be later than what the market anticipated.”
Still, Smith says the underlying metrics that drive the performance of property portfolios such as vacancy rates and rental reversions are mostly moving in the right direction, which should start to support earnings growth.
“So the outlook for the sector compared to a year ago is certainly more favourable,” he says.
Independent property analyst Keillen Ndlovu says that though the South African listed property index (Sapy) has already rebounded 20% since early November in expectation of rate cuts, the sector still trades at a big discount to NAV of about 30%.
In addition, the index has clawed back only 60% of the losses suffered since late 2019. So there’s further rebound potential, says Ndlovu.
Importantly, most Reits have used the downturn to strengthen their balance sheets by selling noncore assets and paying off debt.
The index has clawed back only 60% of the losses suffered since late 2019
Ndlovu refers to the average loan-to-value (LTV) ratio for the sector of 38%, which is well below most banks’ debt covenant levels of 50%.
The average interest cover ratio (ICR) of the sector is at about 2.7 times, which Ndlovu notes is comfortably above the two times level that will signal a breach of most banks’ covenants.
He says once interest rates come down, both ratios are likely to improve. The positive upshot is that there will be reduced risk of banks having to call in mortgage loans or repossess properties.
Ndlovu adds: “Lower rates will be good for market sentiment and share prices, as we’ve already seen over the past month or two.”
However, he warns the negative impact of higher-for-longer rates on Reit earnings is still likely to be felt for the next two years — unless the Reserve Bank cuts rates aggressively this year.
Ndlovu says investors should expect a large divergence in income growth among individual Reits for their 2024 reporting periods.
Lower rates will be good for market sentiment and share prices, as we’ve already seen over the past month or two
— Keillen Ndlovu
For instance, Vukile Property Fund and Attacq both expect earnings growth of 8%-10%, vs Growthpoint and Hyprop, which have forecast a 10%-15% decline.
There will be an equally large divergence in dividend payout policies. Among the JSE’s 22 largest property stocks, four are unlikely to pay any dividends in 2024: Fortress, MAS Real Estate, Accelerate and Delta.
Only five companies are expected to return 100% of distributable income to shareholders in the form of a dividend (Resilient, Equites, Fairvest, Safari and Exemplar) while the payout ratio of the rest will vary between 75% and 95%.
Liliane Barnard, CEO of the Metope group, agrees that the Reit rebound still has legs given that the discount to NAV should continue to close on the back of lower rates and bond yields.
She expects 4%-5% capital growth this year, which together with an average dividend yield of 9% translates into a decent total return of 13%-14%.
Barnard says: “We see this as the start of a sustained recovery due to improved appetite from global investors as well as local balanced fund managers, who will find the high dividend yields in the sector attractive in a declining bond yield environment.”
There’s also good news on the rental growth front, particularly in the convenience retail and logistics sectors, which she argues could see dividend growth start to return in line with inflation over the next few years.
However, Barnard warns that escalation in the wars in the Middle East or Ukraine or social unrest after elections in several countries this year, including South Africa, could depress property share prices.
“Such events could lead to inflationary spikes which would delay any anticipated rate cuts and generally lead to increased volatility and share price weakness.”
The recovery in underlying earnings growth of local Reits could be curtailed by landlords dealing with additional diesel costs due to load-shedding
Barnard says the recovery in underlying earnings growth of local Reits could be curtailed by landlords dealing with additional diesel costs due to load-shedding.
Ahmed Motara, property analyst and portfolio manager at Stanlib, believes that while the gains made by the Sapy in the fourth quarter have set the base for further share price upside, it will be at a steadier pace than that seen late last year.
Motara expects a total return of 13% for the Sapy over the next 12 months, with concerns around load-shedding and a weak local economy already factored into his forecast.
He says offshore stocks that report in hard currency, which make up about 45% of the JSE’s property sector, are likely to lead the way in earnings growth in 2024, with local Reits catching up in 2025.
Motara adds: “Given the large component of offshore earnings in the property sector, rand weakness would be positive for the sector’s income growth.”
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