The investment case for listed property

Uncertainty and volatility have been the hallmarks of recent times. Aside from global unpredictability, the downgrade of South Africa’s sovereign debt ratings by Standard & Poor’s and Fitch, local political shenanigans and a volatile rand have weighed on SA’s listed property sector.

Despite these challenges, the sector is expected to post total returns of between 8% and 10% this year, says Keillen Ndlovu, head of listed property funds at Stanlib.

It has long been an attractive sector for investors, outperforming other asset classes over the past 20 years. Over this period, listed property yielded an average return of 19% annually against the 16% delivered by equities, 12% by bonds and 9% from cash. In 2016, SA’s real estate investment trusts (REITs) returned 14.7% to investors, only marginally outperformed by bonds at 15.4%, and well ahead of cash at 7.4% and equities at 2.6%, according to SA REIT Association research.

At the time of writing on 16 May, the FTSE/JSE SA Listed Property Index (SAPY) was up 1.1% since the start of the year, underperforming the FTSE/JSE All Share Index, which was up 6.7%. In the first quarter of 2017, non-SA JSE-listed REIT stocks with UK or EU exposure like that of Capital & Counties, Nepi and Rockcastle, were mostly outperformed by SA REITs, with Rebosis and Delta topping the sector’s performance. Much of that had to do with the strengthening of the rand.

Predictably, there was a U-turn in that scenario after President Jacob Zuma’s firing of former finance minister Pravin Gordhan at the end of March, and the subsequent credit ratings downgrades.

“Post the country’s downgrading, 100% offshore-focused companies like Hammerson, Capital & Counties, and Intu did well mainly on the back of a weaker rand,” says Ndlovu.

“But larger [SA] REITs like Growthpoint Properties and Redefine Properties, despite their sizeable offshore exposure of over 25%, were sold off more after the downgrades.” This, explains Ndlovu, was mainly attributable to liquidity, the REITs not deriving the benefit of their offshore exposure when the rand weakened.

Yet the impact was a short-term one, the stocks starting to come back as the market normalised, he says. “It’s likely the market mostly expected the downgrade, because there has been no panic disinvesting.”

Junk status though is certainly not supportive of investment generally. It also reduces the potential horizon of foreign investors that have the mandates to invest in the SA REITs – a sector that represents nearly R400bn worth of real estate assets and boasts a market capitalisation of around R360bn.

“The downgrade affects the SA foreign currency debt rating, as well as that of Growthpoint or any other SA company/corporate or SOE [state-owned enterprise] that has foreign currency debt,” says Estienne de Klerk, managing director of Growthpoint Properties. The same holds true for those that might wish to issue such debt if they haven’t got any yet, such as Growthpoint.

“The rating downgrade is not likely to have any real impact on equity investors, as opposed to debt investors, safe to say that as the economy and growth prospects deteriorate, so will our ability to grow our earnings and that would be negative for equity investors, as opposed to the debt downgrade itself.”

Downgrading has brought with it a rise in bond yields and simultaneous rising property yields that have meant a fall in capital values. It also brings with it risks associated with higher funding costs and debt ratios.

Debt hedging will mitigate effects of the downgrade in the short term, but the REITs now face increased cost of capital over the medium and long term that will directly impact the valuation of direct property and the valuation of the REIT share prices.

The bulk of the REITs have hedged 80% to 90% of their debt for three to four years, and debt ratios are around 30% to 35%. “In fact, most REITs have been funding most of their acquisitions through equity compared to debt,” Ndlovu tells finweek.

“Generally the SA REITs have low LTV [loan-to-value] ratios and thus we don’t foresee this becoming a major issue,” says Growthpoint’s De Klerk. However, interest cover ratio covenants will be negatively impacted if the rental levels drop, he adds.

While the downgrade is not good news, likely to affect not only the property industry but also the economy as a whole, it came as no surprise, says Mark Stevens, CEO of Fortress Income Fund.

“Most property funds had prepared for an event like this. It’s been hanging over us for the last year and a bit. From an operational point of view, most expect that with junk status will come the inevitable interest rate increases and the majority are reasonably well-positioned from an interest rate hedging point of view.

“Those not hedged and with high gearing are going to be hit by interest rates,” Stevens says.


Given the greater uncertainty surrounding SA after junk status, SA’s REITs might be more circumspect when it comes to making local acquisitions and pursuing their development pipelines in SA. Disposal programmes too could be affected.

“Interest rates will go up. Acquisitions of property will be more difficult because it will be more expensive to gear,” says Stevens.

“There will be some impact on funding costs because bank funding base rates and spreads will rise. That means REIT funding base rates and margins will become higher too,” says Emira Property Fund CEO Geoff Jennett. “And, if there is a general tightening of credit conditions, then potential buyers will be affected, which will also slow down disposal programmes.”

A downgrade means less money coming into the country, and less money for spending and circulating. It exerts even more pressure on an already weakening economic environment that had already begun to impact property sectors like retail, where trading densities are down.

“While good and dominant assets continue to do well and deliver positive rental growth, a weakening economy has seen the local market becoming extremely competitive across most of the sectors, especially office and retail. This continues to put pressure on rental growth. Vacancies are also increasing in the industrial space but they are not out of control,” explains Stanlib’s Ndlovu. Says Growthpoint’s De Klerk: “A reduction in market confidence will result in a further weakening of demand which in turn is negative for rental levels.” He adds that a decline in retail spend is generally bad for the economy which the SA REITs trade in.

Junk status may also reduce the South African REITs’ competitiveness in the global markets and could have a marked impact on their foreign growth ambitions.

Even so, Ndlovu expects the trend of expansion to offshore markets to continue, albeit at a slower pace.

The silver lining

On the bright side for the sector, the rating downgrades were foreseen and factored in through offshore expansion, debt hedging and low gearing, mitigating its effe cts.

“From an offshore diversification perspective, the move to junk status certainly highlights why offshore diversification is so important and this is something that has been receiving much more attention recently,” says Emira’s Jennett.

SA REITs are somewhat cushioned from local events by offshore hedging. “Most SA REITs have some sort of offshore exposure. On average the REITs have about 30% of their investments offshore. So while there might be negatives locally, the REITs derive the concomitant positives from that offshore exposure,” says Fortress’s Stevens.

Despite income growth slowing down in the local markets, this too is being cushioned by offshore exposure or expansion.

In 2009, SA REIT offshore earnings were a paltry 1%. Today 40% of earnings come from outside SA, partially hedging the sector from local events.

SA’s REITs are attractive not only for their ability to identify assets that generate returns for shareholders and where sustainable growth on those returns can be made in the future, they are attractive for another reason, especially for international investors, and it has to do with compliance.

The REITs’ level of compliance, which includes auditing standards, REIT standards, stock exchange requirements and the King Code, surpasses that of even some countries within Europe.

It’s a big tick, and that, together with the sector’s inflation-beating returns, could prove to be a big carrot on the stick for investors willing to set aside downgrade risk in the chase for yields.

In 2016, SA REITs raised over R26bn in new equity, coming from new listings, dividend reinvestment plans, mergers and acquisitions, and secondary placements. A strong appetite for offshore exposure from local investors has also seen JSE listing proving attractive for offshore REITs, the likes of Eastern European property funds Global Trade Centre (GTC) and Echo Polska Properties, and UK-based Hammerson plc (now the largest listed property stock on the JSE) tapping into the local market and providing investors with access to hard currency income.

We may see more offshore companies coming to list in SA. “We continue to have frequent visits or enquiries from offshore companies looking at the prospects of listing in SA, or attracting SA investors,” Ndlovu tells finweek.

Despite the downgrade and a low-growth domestic environment, rating agency Moody’s expects the performance of rated SA REITs Growthpoint Properties, Redefine Properties, Fortress Income Fund and Hyprop Investments to remain resilient courtesy of quality properties in prime locations, broad sector/tenant diversification and offshore property exposures.

Property is a long-term game, with analysts often encouraging investors to hold a long-term view and to ride out volatility.

“Coming out of junk status and a return to normality can take as long as five to seven years. But REITs who have hedged their businesses, those who have offshore exposure, will weather the storm and go forward,” says Stevens.

This is a shortened version of the cover story that originally appeared in the 25 May edition of finweekBuy and download the magazine here.

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