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The SA listed property sector - migrating for growth

Posted On Wednesday, 20 April 2016 13:01 Published by
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The argument has often been made that the reason the SA listed property sector has delivered good returns over time, apart from a declining yield environment, is primarily due to its predictable and growing income stream.


The sector has achieved distribution growth of 7.8% per annum since 2002.

This is also the reason the sector’s dividend yield has consistently traded below the long-term bond yield. This is however not consistent with conventional investment theory which predicates that all risky assets should trade at a risk premium to government bonds which are normally considered to be risk-free assets.

The income growth element is simply a function of a number of factors which include rental growth achieved through revised rental levels at the time of lease renewals, on-going annual rental escalations built into lease agreements, cost control to protect margins and balance sheet gearing. 

Today, the reality is that the local economic landscape is deteriorating. SA GDP growth in 2015 averaged 1.4%.  For the year ahead GDP growth is expected to average 0.5%. This is not supportive of rental growth which has previously been responsible for above inflation distribution growth.

Additionally, operating margins have also come under pressure due to above-inflation cost increases in administered services, which are beyond a property manager’s control. These increases in costs are normally passed on to the tenants; however, given the current economic environment, some of the increases have had to be absorbed by the property companies. Gearing, which has also been a tool to further accelerate distribution growth, has its challenges going forward, as the cost of funding is edging higher.

However a mitigating factor is the local listed property counters’ gearing of about 29% on average and funding cost hedging of about 94%. These metrics are considered conservative.
Given the lacklustre local fundamental backdrop, listed property funds are increasingly looking elsewhere to generate good returns.

The sector has seen the advent of relatively newly established funds like New European Property Investment, Redefine International, Stenprop, New Frontier and Rockcastle which have made forays into Eastern Europe, United Kingdom, and Continental Europe.

Furthermore, Hyprop and Redefine have recently announced acquisitions in South Eastern Europe and Central Eastern Europe. The SA listed property index’s offshore exposure is estimated to be 36%, with Eastern Europe being the largest offshore exposure at 17% (see chart below). Other offshore funds which recently listed on the local bourse, although not included in the SA listed property index, include Capital and Regional and Schroeder Real Estate Investment Trust. 

Apart from offering local investors currency diversification, these offshore regions have better economic growth prospects than South Africa in the short to medium term. According to the World Bank, 2016 GDP growth for the United Kingdom and Romania is expected at 2.4% and 3.9% respectively.

Better economic prospects and property fundamentals will continue to attract investment flows into these regions. The Central Eastern Europe region in particular, has been a beneficiary of about €9bn in real estate investment transactions during 2015 with Poland receiving the largest share. 

Currently the low hanging fruit in the property sector is the positive spread between acquisition and development yields relative to funding costs. Funding costs are close to historic lows in most developed market offshore regions. Given this spread, deals done offshore are accretive to local listed property funds. These acquisitions will continue to boost income growth, barring adverse foreign exchange and funding cost moves. Offshore property yields are also likely to compress, although marginally, if this gap continues to widen due to declining funding costs.

The challenge however is that due to the low inflationary environment, on-going rental escalations will also be very low. The better economic environment should be supportive of rentals if economic conditions do not deteriorate.

The property sector’s offshore exposure is expected to increase beyond current levels as more offshore investments are made. Even though South African property fundaments remain relatively weak, the overall sector could still generate good income growth due to the benefit of recent offshore investments.

The sector is forecast to deliver distribution growth of 10% over the next 12 month, but is likely to surprise on the upside if more acquisitions are made. In simple terms, the SA listed property sector is importing growth through offshore acquisitions.

Source: Avior research

Last modified on Wednesday, 20 April 2016 13:41
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