Property companies are among the JSE’s biggest winners in recent weeks on the back of improved investor sentiment, softer bond yields and a somewhat stronger rand, which has bolstered appetite for cheap South Africa Inc stocks.
Despite ongoing currency volatility and political uncertainty about how the newly constituted government of national unity (GNU) will play out, the South African listed property index (Sapy) has rebounded to four-year highs.
South Africa-based counters such as Redefine Properties, Hyprop Investments, Growthpoint Properties, Resilient Reit, Vukile Property Fund, Emira Property Fund and SA Corporate have topped the JSE’s leaderboards in recent weeks. Some have notched up double-digit increases in the past month.
On a year-to-date basis (January-June), top of the pops include small-cap Texton Property Fund with a 32% total return, no doubt boosted by recent corporate action; Emira Property Fund with 27%; Fortress Real Estate with 21%; and Waterfall City developer Attacq with 21%.
Retail supply has dropped to historically low levels on the back of a steady recovery in tenant demand. The upshot is that the sector experienced its first period of positive rental reversions in years as tenant sales recovered. That followed a prolonged period of downward rental adjustments.
Moreover, there are finally signs of life in the struggling office sector as employees return to their corporate desks. Tilly refers to the latest office vacancy survey of the South African Property Owners Association, which shows vacancies at 14.7% in the first quarter, down 200 basis points from their 2022 peak.
He says the rebound in investor sentiment and rerating of risk assets, coupled with improved electricity supply, has had a positive influence on production in the economy. “As a result, the bias has now shifted to higher economic growth, which is supportive of the property sector.”
Tilly adds that many generalist fund managers who are underweight to Reits are now using the opportunity to increase exposure to the sector on the back of the lower interest rate outlook.
The question is, will the mini rally in property share prices turn out to be a temporary correction or is it the start of a more sustainable recovery?
“Should the GNU remain intact, and we see a positive trajectory in GDP, we believe the sector could have another leg-up,” Tilly says.
He believes the eagerly awaited implementation of economic reforms can boost both earnings and sentiment. “We see the continued recovery in local Reits’ net operating income, potential for bond yields to decline further and lower funding costs as key drivers of returns into the second half of 2024.”
But Tilly warns that fragile local politics and a wait-and-see approach adopted by many South African-focused investors mean that Reits’ near-term performance will largely track “modestly positive”.
He says: “After the recent rally, we think the sector is now close to fair value. We see a 12%-14% total return over the rolling 12-month period.”
In a more measured response, Yusuf Mowlana, portfolio manager at M&G Investments, tells the FM that while sentiment towards South Africa Inc shares has been boosted by “a more market-friendly election outcome than initially feared”, property stocks aren’t necessarily out of the woods.
“What we’ve seen is Reits respond to a change in the discount rate applied to them because of the rally in bond yields and a lower South African risk premium.”
He believes a sustained recovery will ultimately depend on whether Reits can grow rentals in the medium term, which is what drives earnings and dividend growth.
Mowlana adds that though the recent operational improvements reported by most domestic Reits in underlying property portfolios suggest the sector is through the worst, these gains are still being offset by high interest rates.
Independent property analyst Keillen Ndlovu expresses a similar sentiment, saying most of the positive outcome from the election is probably already priced in.
He says though property share prices are now barely back to 2010 levels, the Sapy has already recovered about 30% since it hit a four-year low in late October.
Flows into property stocks were initially triggered late last year when the US Federal Reserve signalled an end to the rate hiking cycle, which was followed by institutional investors increasing their weighting to Reits, most notably the Public Investment Corp.
Still, the local sector’s earnings performance is not yet conducive to a sustained rally in property share prices. Though there’s been a gradual improvement in operational metrics in underlying portfolios, Ndlovu notes that most Reits are still reporting negative or low single-digit earnings growth this year.
There’s also a big divergence in dividend payouts. For example, Vukile leads the pack with 10.5% growth (for the year to March), while Hyprop decided to withhold dividends for its interim period to December.
Among those still to report results for the 2024 financial year, only a handful of outliers are expecting above-inflation earnings growth — these include Attacq, SA Corporate and Safari Investments.
Ndlovu estimates that earnings will stabilise “somewhat” next year as rates come down and the higher interest cost base is mostly in the numbers.
But he says a more positive picture across the sector will be reflected only in 2026, “unless the economy grows faster than expected and rate cuts are more aggressive”.
Several Reits have also recently adjusted dividend payout ratios downwards; others are planning to do the same. Ndlovu’s research shows there are only six counters among the JSE’s tally of 30-odd property stocks that are still paying out 100% of distributable income to shareholders — Resilient Reit, Stor-Age Property Reit, Exemplar, Equites Property Fund, Fairvest and Safari.
He adds: “If rate cuts happen sooner than expected, property shares could rally further, alongside most other sectors and asset classes. Otherwise, I believe we’ve probably seen most of the positive reaction from the election outcome.”
How much upside is left in the Reit recovery will also depend on what happens to the rand exchange rate. In a research note titled “SA Property Geared to an SA Inc Recovery”, Anchor Stockbrokers argues that the strong offshore expansion drive seen among local Reits in the past five to 10 years should support the sector’s rebound.
That’s because several local property companies funded offshore acquisitions by placing hard currency debt, cross-currency interest rate swaps and short euro positions (hedges) on their South African balance sheets.
Anchor Stockbrokers says: “While these positions were very damaging in times when the rand depreciated sharply, these instruments will have the opposite effect as the rand strengthens.”
Property counters with negative net hard currency exposure — where debt exceeds asset values — will likely benefit most from a strong rand.
The note reads: “Much of the deterioration in the loan-to-value (LTV) ratios of the larger Reits with offshore exposure seen during 2023 can be attributed to a weaker rand. Conversely, the recent strengthening in the rand should support LTVs, as a strong rand increases the weight of low South African LTVs and reduces the weight of the high hard currency LTVs.”
Should the GNU remain intact, and we see a positive trajectory in GDP, we believe the sector could have another leg-up
— Naeem Tilly
The only rand hedge property stock in the top eight is Iberia-focused Lighthouse Properties. Perennial underperformer Accelerate Property Fund, owner of Fourways Mall, delivered the worst year-to-date return at -7%.
Unsurprisingly, the bottom of the rankings is dominated by rand hedge stocks including Eastern Europe-focused MAS, Western Europe mall owner Hammerson and German business park owner Sirius Real Estate, according to Anchor Stockbrokers figures.
Analysts say the uptick in demand for South Africa-focused real estate investment trusts (Reits) is not unexpected given how much value the sector offers.
Most local counters have been trading at huge discounts to NAV in recent years — some up to 50% or more. In early June, dividend yields were at multiyear highs of between 10% and 14%.
In contrast, the JSE’s offshore property stocks have in recent months traded mostly at discounts below 10%, while yields typically ranged from 5% to 7%.
Sentiment towards local Reits had soured noticeably in recent years as local landlords were hit by a combination of pandemic-induced trading restrictions and work-from-home policies, a stumbling economy, a weak rand and soft demand for office and retail space.
Load-shedding and associated diesel costs, coupled with above-inflation increases in rates and taxes, further eroded profits. And then came aggressive interest rate hikes.
Naeem Tilly, portfolio manager and head of research at Sesfikile Capital, points out that while interest rate hikes have affected all sectors, it may have been felt most acutely in the real estate sector, where gearing typically sits at about 40%.
However, Tilly notes that the recent results released by South Africa-based Reits point to an encouraging improvement in the operational performance of underlying property portfolios.
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