Income chasers are starting to bet on bricks and mortar again, judging by the 27% rally in property share prices since late October, when the sector hit a three-year low.
In fact, for the 12 months to the end of January the South African listed property index (Sapy) outperformed the JSE’s top 40 index by a substantial 20% on a total return basis.
Property stocks notched up 14%, vs the top 40’s –6% over the same period.
It’s the first time in six years that listed property has pipped general equities to the post. However, it hasn’t been a blanket recovery.
The sector’s outperformance has been skewed by its large exposure to rand hedge stocks and local property companies’ growing footprints in offshore markets. Close to 45% of the JSE’s real estate sector’s earnings were generated in hard currencies last year, according to Stanlib figures.
Craig Smith, head of equity research at Anchor Stockbrokers, says the Sapy’s rebound has been driven largely by UK- and Europe-focused stocks.
These counters were hammered in 2022 due to the outbreak of the Russia-Ukraine war and surging oil and energy prices. Back then energy prices caused a spike in property operating costs, which have since been reduced.
In addition, European property companies’ rental increases are linked to inflation, which underpinned earnings growth.
The weak rand further supported offshore property stocks’ outperformance.
The sector’s outperformance has been skewed by its large exposure to rand hedge stocks and local property companies’ growing footprints in offshore markets
The top contenders include London-focused Shaftesbury Capital, German business park owner Sirius and European retail property companies such as Nepi Rockcastle, Lighthouse Properties and Hammerson.
All have delivered total returns of 30%-50% in the 12 months to the end of January.
According to Anchor Stockbrokers’ latest listed property report, there were only two local stocks that had shone in the past year: Fortress and Attacq.
Both were buoyed by corporate action. Fortress at last collapsed its unpopular dual share structure, while Attacq sold 30% of its flagship property, Waterfall City in Midrand, to the Government Employees Pension Fund for R2.7bn.
In contrast, real estate investment trusts (Reits) that generate the bulk of their earnings in rand, especially smaller, illiquid counters and those with a large exposure to the office market, mostly derated over the past year.
The worst performers include Fourways Mall owner Accelerate, Delta, which has a large government-tenanted office portfolio, Emira and Burstone (formerly Investec Property Fund).
Smith says the upshot of weaker share prices among local Reits is that several are now trading at higher distribution yields than a year ago. “South African property valuations are now particularly attractive,’’ he says.
Local Reits, most of which offer juicy dividend yields of 10%-12% vs an average 5%-8% from offshore stocks, certainly seem cheap, especially considering the huge discount to NAV at which they trade.
Catalyst Fund Managers’ figures show that South Africa-centric companies trade at an average discount to NAV of 38%, while their offshore counterparts are at only 16%.
Mvula Seroto, director and portfolio manager at Catalyst Fund Managers, says the good news is that local Reits are starting to report an encouraging improvement in underlying performance metrics.
For example, the negative impact felt from load-shedding earlier in 2023 has subsided, vacancies across subsectors appear to have stabilised, rental reversions continue to improve and valuation writedowns have bottomed out.
Most mall owners are also reporting surprisingly strong growth in trading density (sales per square metre). All of these factors should aid the recovery of local Reits.
“There is cause for optimism that the South African property cycle has bottomed out and that 2024 could be the turning point, should interest rates begin to ease,’’ says Seroto.
Still, the earnings of most South Africa-focused property stocks will remain under pressure in 2024 given that rate cuts will take time to translate into lower debt funding costs. Offshore companies, on the other hand, such as Nepi Rockcastle, MAS and Sirius, are expected to report positive earnings growth this year already.
However, Seroto expects “strong” earnings growth for South Africa-centric companies in the 2025 financial year.
That raises the question: should investors increase exposure to local property stocks while they are still trading at significantly higher yields than their offshore counterparts?
Anchor Capital, for one, is more bullish on local than on offshore real estate. The investment firm last month upgraded its stance on South African listed property from neutral to positive, while retaining a neutral stance on global Reits.
According to Anchor chief investment officers Nolan Wapenaar and Peter Armitage, domestic listed property is looking appealing “for the first time in years’’.
Anchor is projecting a higher total return for South African listed property (12%) than domestic equity (10%) and bonds (10%) for 2024.
There is cause for optimism that the South African property cycle has bottomed out and that 2024 could be the turning point, should interest rates begin to ease
— Mvula Seroto
The Navigator, Anchor’s quarterly asset allocation report, reads: “There is already much negativity in the price of domestic assets, and we have shifted domestic listed property to a positive stance, as this asset class is relatively cheap and earnings should benefit from interest rate cuts over this year.’’
Despite uncertainty about the outcome of the election, Wapenaar and Armitage expect domestic factors to improve this year.
They note that while local property fundamentals remain challenging, lease reversions (when rentals drop on lease renewals), even in the unloved office sector, have declined sharply. “So, net portfolio growth is returning, and the interest cost will start to decline towards the second half of 2024. South African Reits trade at an attractive forward dividend yield compared with five years ago, even though dividend payout ratios are now lower.’’
Anchor is forecasting the rand to weaken by a marginal 3% in the year ahead.
However, not everyone is convinced that now is a good time to buy local Reits. Research by independent property analyst Keillen Ndlovu shows that asset allocators are mostly still bearish on the sector.
A survey he completed in February among 25 local institutions — pension funds and wealth managers that typically dictate strategic asset allocation choices — revealed that 80% have an underweight or neutral stance on listed property.
Only 12% of fund allocators are now in favour of going overweight on listed property.
Speaking at the SA Reit Association’s annual conference in Joburg recently, Ndlovu said exposure to South African listed property has shrunk steadily over the past six years and is now at a record low.
He referred to the value of investment flows into domestic property-focused unit trusts, which has dropped from R87.4bn in 2017 to R37bn in 2023 — or from 4% to 1% as a percentage of total assets managed by South Africa-focused unit trust funds.
Ndlovu said the number of JSE-listed property stocks has also declined, from a peak of 67 in 2016 to 48 in 2023 — “and most are small and illiquid”.
In fact, there are only about 20 “investable” stocks left on the JSE, with a combined market cap of about R320bn. “That’s roughly on a par with FirstRand,” said Ndlovu.
Looking ahead, Ndlovu said most asset allocators still prefer bonds to property. Many believe Reits are expensive vs bonds on an absolute and a property-to-bond yield basis.
“Listed property is in a weird spot. The market doesn’t price it on NAV, it prices it on yield. In addition, South African property stocks’ earnings are still declining,’’ he said.
In terms of the outlook for local vs global Reits, the general view is that offshore is the less risky bet. Ndlovu ascribed that to the lack of diversification among local Reits given the exposure to mostly a mix of offices, retail and industrial buildings.
In contrast, global Reits offer specialisation in a myriad nontraditional sectors such as call centres, health care, family rental housing, leisure resorts, telecommunications, infrastructure and even farmland.
Still, Ndlovu said there is a contrarian view. Those who are going overweight into local Reits cite the value proposition as a key driver. The Sapy is, after all, still trading 51% below its peak of early 2018.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.