Zoolander was released in September 2001. Yes, 24 years ago. As old as that might make you feel, at least you can smile as you think back to Will Ferrell’s memorable line as the character Mugatu: “That Hansel — he’s so hot right now.”
The film was utterly ridiculous and I’m too afraid to watch it again for fear of how badly it may have aged (I made this mistake with Dodgeball). But one thing we shouldn’t be afraid to do is to go back in history and look at how sector cycles have played out, as there’s always something to learn. And when a sector is getting hot enough to remind us of Zoolander, it’s time to be cautious.
The words “accelerated bookbuild” have found their way back onto the JSE — in a big way. In the past week, there were a few examples of property funds coming to market and raising hundreds of millions of rand in the time it takes to get the kids to school and read your morning e-mails.
This is the power of listed markets and I love to see it, because it’s a reminder that the JSE isn’t just a sleepy hollow of small-cap delistings, largely bereft of IPOs. But it also points to a risk that shouldn’t be ignored: the sheer extent to which institutional capital will throw money at real estate investment trusts (Reits) in South Africa.
There’s one big reason that institutional investors such as pension funds absolutely love Reits: tax-efficient yield. Aside from other benefits that we will dig into shortly, the biggest win in these structures is the lack of tax leakage as a result of the design of Reit legislation. The South African Revenue Service is actively incentivising institutional investors to participate in this sector.
There’s clearly no shortage of reasons for institutional investors to love the Reit sector. This creates a dangerous situation, though
You see, Reit distributions are taxed as income, not dividends. This means that if, like a pension fund, you’re exempt from paying income tax, there’s no tax leakage at all in the process of a Reit collecting rent at one end of the value chain and paying it as a distribution to the pension funds at the other.
Pro tip for retail investors: if you have a tax-free savings account and you buy local property ETFs, you’re putting yourself in much the same position as those pension funds. This is an approach I use extensively in my own portfolio, banking substantial yields from Reits without any tax leakage.
In addition to the tax-efficient nature of the structure, there’s also the dependability of the cash flows. Leaving aside black swan events such as Covid, these funds enjoy contractual cash flows with multiyear leases and anchor tenants that include the biggest names in local retail. Sure, there are risks — urban decay, high-profile retail failures and changes in preferences (just look at the pressure in office property) — but these cash flows are still more reliable than those of most operating companies.
Another important element is the inflation protection inherent in Reits. Lease escalations protect Reits from highly sensitive costs such as energy, utilities and security. The escalations are in excess of CPI as many of those underlying costs are particularly inflationary. Provided that there’s enough economic activity to make the numbers work for tenants, landlords can secure these escalations and give investors arguably the best inflation protection available on the JSE.
This inflation protection also drives capital gains over time. The replacement cost of buildings will increase with inflation and the scarcity of land will put a premium on the best sites. This creates an attractive total return picture (distributions plus capital growth).
There’s clearly no shortage of reasons for institutional investors to love the Reit sector. This creates a dangerous situation, though, as it means management teams can execute accelerated bookbuilds and raise capital without a clear use for the funds. Loose rationales are becoming a feature of the sector once more, with oversubscribed bookbuilds and, in some cases, capital being raised at a premium to the NAV per share.
As appealing as the sector is, the valuation still matters. A decade ago, the proliferation of bookbuilds on the JSE led to disappointing returns and aged about as well as Dodgeball and probably Zoolander. And unlike those old movies, you can’t just avoid the pain by not watching them. You are stuck with the hangover of bad capital allocation decisions.
If the 2025 curtain call is anything to go by, 2026 is going to be a year of extensive capital raising in the local property sector. Tread with extreme caution here, especially around mediocre funds taking advantage of a strong market.
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