It appears property stocks’ four-month rally has lost steam, most likely on the back of less-than-exuberant earnings growth numbers released by several real estate investment trusts (Reits) in recent weeks.
Between October 27 and March 8, the South Africa listed property index rebounded by 27% to four-year highs. The sector’s long-awaited comeback, after going nowhere for most of the preceding five years, meant listed property trumped other asset classes for 2023.
Though property stocks were down nearly 8% by end-October, the sharp uptick in November and December saw the sector end 2023 with a total return of 10.1%, pipping general equities at 9.3%, and bonds and cash at 9.7% and 8% respectively.
It was the first time since 2017 that listed property was South Africa’s best-performing asset class. Analysts say the rally was supported by the US Federal Reserve late last year signalling the end of the interest rate hiking cycle, which led to a repricing of rate-sensitive assets such as real estate.
However, property share prices have come under renewed pressure in recent weeks amid rising prospects that central banks across the globe could potentially delay rate cuts due to lingering inflation worries.
Head of listed property and portfolio manager at Merchant West Investments Ian Anderson says the positive momentum already began to evaporate in February, as the Reit sector followed the broader equity market lower.
Anderson, who compiles the monthly performance chart book for the SA Reit Association, notes that only four out of 23 local Reits still delivered a positive total return in February.
That was led by Fortress Real Estate Investments, after the successful collapse of its dual share structure in January. Apart from Fortress, only Accelerate (7.7%) and Octodec Investments (0.1%) produced positive returns for shareholders in February, while Burstone (-10.9%) and Equites Property Fund (-9%) were the biggest underperformers.
Share price losses accelerated in March after several Reits released December results and trading updates. Over the past four weeks, sector heavyweights such as Growthpoint Properties, Hyprop Investments, Resilient Property Income Fund and Fortress all shed 10%-12%.
In fact, latest figures from Anchor Stockbrokers show the total return gap between the best- and worst-performing property stocks for the first three months of 2023 has widened to nearly 55%: Attacq topped the charts with 15.7%, while Delta Property Fund was at the bottom with -39.1% (see graph).
Independent property analyst Keillen Ndlovu ascribes the recent sell-down to a few “negative surprises” on the earnings growth front.
“The sector’s earnings growth outlook appears worse now than it did 12 months ago as higher interest rates start to fully reflect in the numbers,” he says.
Ndlovu tells the FM that the market may have underestimated the extent to which rates would erode Reit profits. That’s despite an overall improvement in the operational performance of underlying property portfolios.
“Rental growth and vacancies are improving, but most of the numbers do not reflect this.”
Ndlovu says three Reits notably downgraded growth estimates for the 2024 financial year. Hyprop, which surprised shareholders by withholding an interim dividend, adjusted its earnings outlook for the 12 months to June from a 10%-15% decline to a 15%-20% decline.
That comes on the back of higher rates and the devaluation of the naira in Nigeria, where Hyprop owns a large shopping centre. Management also cited potential Pick n Pay store closures, and economic and political uncertainty amid the upcoming general elections as concerns.
Growthpoint — which expects earnings to drop by 12%-15% for the year to June — and logistics play Equites also downgraded growth estimates. In fact, former market darling Equites now sits at the bottom of the pile with earnings expected to drop by up to 23.3% for the 12 months to February.
Equites has in recent years aggressively expanded its South African logistics footprint to the UK and is under pressure due largely to the termination of cross-currency interest rate swaps, in addition to higher debt funding costs.
Ndlovu says there is now a big divergence in the earnings growth outlook for individual Reits. Among the 20-odd individual stocks that have released results or trading updates year-to-date, Waterfall City owner Attacq leads the pack with management guiding growth of up to 12.5% for the year to June.
The only other positive outlier is Vukile Property Fund, with growth expectations of 6%. The retail-focused Reit’s portfolio is split about 50/50 between South Africa and Spain.
The sector’s earnings growth outlook appears worse now than it did 12 months ago as higher interest rates start to fully reflect in the numbers
— Keillen Ndlovu
SA Corporate Real Estate, Nepi Rockcastle and Octodec are likely to deliver muted earnings growth in the 3%-5% range, while Fairvest, MAS Real Estate, Stor-Age Property Reit, Burstone and Spear Reit have guided for zero to low single digit growth.
In addition, at least nine counters have forecast zero to negative earnings growth. Besides Equites, they include Exemplar, Emira Property Fund, Safari Investments, Dipula Income Fund, Redefine Properties and Resilient Reit.
The bad news is that even if rates start to ease in May or July, it will take some time to translate into improved earnings. Ndlovu points to rate hikes of almost 500 basis points since end-2021. “Debt could still be rolled over at higher rates, unless rates fall sharply in a short time.”
The unfortunate upshot for income-chasing investors is that dividends are likely to come under pressure this year. Ndlovu expects payouts to drop by a weighted average of between 1% and 4% in 2024, before stabilising somewhat next year.
Changing dividend payout policies is another factor property investors need to consider, as more Reits are likely to focus on shoring up cash reserves to strengthen balance sheets and fund growth opportunities.
Six years ago, most Reits paid out 100% of their distributable income by way of twice-yearly dividends to shareholders. Ndlovu’s research shows that only seven out of a sample of 23 property stocks are still paying out 100% of profits to shareholders.
These are Resilient, Equites, Fairvest, Fortress, Stor-Age, Exemplar and Safari. Three are paying zero dividends — MAS, Accelerate and Delta — while the payout ratios of the rest vary between 75% and 98%.
Looking ahead, Ndlovu says it’s difficult to predict capital growth given the uncertainty around how the elections will play out, escalating geopolitical tensions and when rates will eventually be cut.
Other factors that could dampen returns from property owners include rising water supply issues, load-shedding (though this has improved) and excessive municipal rate increases.
But it’s not all doom and gloom. Portfolio manager & head of research at Sesfikile Capital Naeem Tilly still expects listed property to deliver a total return of a decent 13% over the next 12 months (9% income and 4% capital growth).
“Our earnings growth and total return expectations have remained largely unchanged,” he says. “Despite higher-for-longer rates being a drag on bottom-line growth, the recovery in rental growth and other fundamentals across all property sectors remains on track.”
Besides, the sector still appears cheap — despite the recent rally. Tilly points out that property stocks are trading at a sizeable 35% discount to NAV with average distributable income yields, a key measure of cash flow generation, at just short of 11%.
That’s not too shabby, considering that cash in the bank will earn interest of no more than 7%-9% and give you zero capital growth.
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