Resi Reits — something to write home about?

Unlike in South Africa, residential property has long been an established asset class across US and European stock markets.

Moreover, investors can typically choose between several different types of residential-focused real estate investment trusts (Reits), be it multifamily rental units, student accommodation or retirement housing.

In fact, recent Bloomberg figures show that residential property has the biggest weighting of all subsectors in the FTSE Nareit all equity index, the benchmark for US Reits, at just more than 16%. That’s followed by telecoms, health care, retail and data centres at between 12% and 16%.

In contrast, residential bricks and mortar represents less than 3% of the total asset value of the South African listed property sector.

Despite talk in recent years of bringing more specialist housing portfolios to the JSE, there is not a single 100% residential-focused Reit left on the bourse after the post-pandemic delisting and takeover of Indluplace by SA Corporate Real Estate, and of Transcend Property Fund by Emira Property Fund.

Still, SA Corporate and Emira are two of four Reits among the sector’s 40-odd counters that provide investors with access to rental housing income streams, albeit as part of larger diversified retail, office and industrial portfolios.

SA Corporate is the largest with a portfolio of more than 20,000 rental apartments and student beds (41% of total assets by value). Emira has a 13% exposure (by value), Octodec Investments 34% (by income) and Dipula Income Fund 4% (by value).

In addition, there’s a handful of small-cap non-Reits on the JSE that are active in the residential market, most notably sectional-title developer Balwin Properties and Trematon Capital Investments.

The good news is that the JSE’s pool of residential offerings is set to expand as investors regain their appetite for property stocks. After four years of underperformance, money flow to Reits rebounded strongly last year, pushing the sector’s total return to 29%.

JSE heavyweight Growthpoint Properties has already made impressive strides towards a purpose-built student housing fund, which is likely to gain further traction as interest rates drop and institutional interest in property picks up.

The unlisted fund, known as Growthpoint Student Accommodation Reit, was launched in December 2021, with assets of about R2bn, through Growthpoint’s third-party management business.

The fund’s student-bed portfolio has grown to nearly 9,000, worth about R4bn, most of which are located within a 10-minute walk of major universities in Pretoria, Joburg and Cape Town.

It’s a defensive sector and will likely remain resilient as demand for affordable accommodation continues to outstrip supply

—  Keillen Ndlovu

The plan is to take the student-bed tally to 22,000-25,000 by 2028 or an asset value of R12bn, whichever comes first, paving the way for a separate listing. 

In November, SA Corporate approved a R1.25bn equity investment in an unlisted residential fund that could similarly find its way to the JSE once it has scaled up.

The FM believes Burstone (formerly Investec Property Fund) is now also looking to expand into residential property for the first time.

But why should JSE investors increase their exposure to residential relative to the retail, offices and industrial sectors, and why now?

The lingering shortage of affordable housing alone provides compelling enough reason.

According to a recent report commissioned by the South African Multifamily Residential Rental Association, about 4.5-million households (23% of the population) rent the homes they live in. Yet there are only 685,000 of them that rent in a formally owned and managed block of flats.

That equates to an effective 3.5% of the total South African population. Kecia Rust of the Centre for Affordable Housing Finance in Africa, the author of the report, argues that these numbers underscore just how much potential there still is for “build to rent” developers, listed property players and institutional investors to increase their exposure to this asset class.

Meanwhile, returns on residential property have rebounded in recent years, making it an increasingly viable alternative to other property subsectors.

Independent property analyst Keillen Ndlovu says residential held up better during the pandemic than most other sectors, with vacancy rates in rental housing portfolios typically at less than 5%. 

The residential sector also tends to have different demand and growth drivers than office, retail and industrial buildings. “It’s a defensive sector and will likely remain resilient as demand for affordable accommodation continues to outstrip supply,” he says.

Ndlovu adds that residential property returns should benefit from further interest rate cuts, which will improve the ability of tenants to absorb rental and utility cost increases.

Latest figures from MSCI confirm there’s been a notable acceleration in residential property returns on the back of lower vacancies and higher rental growth.

In the six months to June 2024, the residential sector delivered a total return of 6.9%, the second-best performing subsector after industrial with 7.4%. Retail followed with 5.1% and offices with 4.1%.

This is the first time that residential comfortably pipped retail to the post since MSCI started tracking residential returns in 2017. Over a five-year period, residential lagged both the industrial and retail sectors (see graph).   

Naeem Tilly, portfolio manager and head of research at Sesfikile Capital, agrees that a further recovery in residential returns is likely on the back of lower interest rates and encouraging prospects for economic growth and employment.

The latter will boost household income and housing demand, which should further support rental growth.    

Another positive is that issues around the National Student Financial Aid Scheme allowances, which created uncertainty for student accommodation developers and operators in recent years, “appear to be behind us”, says Tilly.

He singles out Octodec as Sesfikile’s preferred entry point into the residential sector. Octodec, founded in 1956 by Alec Wapnick, is one of the most experienced residential property owners and operators in the Tshwane and Joburg inner cities. 

Octodec’s housing portfolio consists of 65 buildings and more than 9,000 residential apartments worth close to R4bn. The bulk of its rental units are aimed at low- to middle-income tenants who pay monthly rentals in the R3,000-R8,000 bracket.

Octodec also has a student housing portfolio in Hatfield, a stone’s throw from the University of Pretoria.

Tilly says City Property, which handles property management for Octodec, has a strong track record.

He adds that Octodec offers one of the highest dividend yields in the sector, so it ticks the value proposition boxes. “Octodec is trading at very attractive valuations with a distributable income yield of 15.4% and a 55% discount to NAV.”

In addition, the share price should benefit from its likely inclusion in the all property index (Alpi) from March. Octodec is one of four real estate stocks set to join the 20 existing Alpi counters if a JSE proposal to lower the market cap threshold for inclusion is implemented.