The listed property sector in South Africa has taken a big depreciation in 2018 and will likely not rebound in 2019, Eugene Visagie, portfolio specialist at Morningstar Investment Management, told Fin24.
The substantial volatility during the year was mainly caused by company specific issues combined with local economic concerns.
As an asset class, SA's listed property sector delivered -25.2% for the twelve months up to the end of December 2018, taking the three-year return to a mere -1.1%.
This is compared to a three-year return at the end of December 2017 that was at 11.7%.
At the same time, this will create opportunities for savvy investors, in Visagie's view.
In Visagie's view, the biggest risk for SA listed property companies mainly active in the country itself, is the uncertainty around the national election this year - whether President Cyril Ramaphosa could bring about stronger economic growth or not.
For overseas property companies listed on the JSE, the risks are mainly the rise in online retail and the need for their home market economies to grow too.
Visagie said almost a third of the foreign property companies listed on the JSE are only raising capital in SA and do not operate any SA based properties. Some of them have a lot of UK exposure.
Land reform impact
Asked about the impact of land reform on the SA listed property space, Visagie said Morningstar is of the opinion that this has created uncertainty in the sector and especially foreign investors are more skeptical to invest.
Although many of the properties owned by these listed property companies in SA are situated in central business districts which will likely not be impacted by expropriation, in his view, Visagie said offshore investors could, nevertheless, interpret expropriation talks as implying that commercial property will be affected too, thus scaring them off.
"Many foreign property investors were skeptical to invest in SA last year due to uncertainty created by land expropriation. We as South Africans realise it won't play out like that, but foreigners interpret it as negative," said Visagie.
"So, negative sentiment will definitely impact the appetite of foreign investors in the sector."
SA listed property sector
His message to investors is to be aware that the listed property sector in SA has changed and is not homogeneous anymore.
It is a relatively small sector by global standards, at about R540bn worth of assets under management (AUM) as at end December 2018. That is about 3% of the total assets listed on the JSE.
Visagie emphasised that it is important to be aware that different companies in the SA listed property space have exposure to different regions and risks.
"When evaluating unit trusts in the SA listed property space, be aware of the different bench marks (indices) available in terms of their composition - for instance, their concentration and offshore exposure," he said.
The SA Property Yield Index (SAPY) is very concentrated on the largest listed companies in the property space.
Historically the SAPY was used as the measure of performance in the local property sector, but, according to Visagie, this index has significant shortcomings. These include that only 21 companies are included in the calculation of the index.
It is also "disproportionate" in index weights, with heavyweights Growthpoint and Redefine comprising 37% of the index.
The newly created All Property Index (ALPI), on the other hand, caps its largest holding at about at 15%. This index was introduced in 2018 and incorporated dual listed property companies such as Capital and Counties, INTU and Hammerson.
Close to 50% of the earnings on the ALPI are derived from outside of SA. The sharp manner in which the rand experiences deviations can, therefore, have a material impact on the asset returns and income stream of these companies.
"It is argued that this index is more representative of the investable universe and reduces concentration risk," said Visagie.
"However, this index does have a higher exposure to offshore companies, specifically in the UK, which is likely to change the return profile of the sector that SA investors have historically had a love affair with."
"With the new All Property Index (ALPI) which includes more offshore listed stocks combined with the rand being as liquid as it is, it will introduce even more volatility into the SA property Index," said Visagie.
SA Reit Index
The third locally available listed property index, the SA Reit Index, has operating assets, but not developing assets.
"Last year was largely disappointing for investors with large allocations to the listed property sector. Despite this, investors are encouraged to remain calm and rational when making investment decisions," said Visagie.
Going forward, he said the SA listed property sector can be broadly broken down into three broad categories, each with its own risks, in his view.
The first category is the purely South African companies like Growthpoint and Redefine, which make up about 50% of the listed property sector in SA.
These would be property companies that generate most of their earnings in SA and are, therefore, reliant on growth in the SA economy.
They comprised roughly half of the ALPI as at the end of December 2018.
The second category is the offshore companies also listed on the property sector of the JSE. They account for about 25% of the listed property sector in SA.
These companies are merely listed in SA, with their operations and properties siting elsewhere in the world. As at the end of December 2018, the foreign listed companies equated to about 30% of the ALPI.
The third category is the remaining 25% of the sector which consist of the Resilient group of companies facing some regulatory challenges. Their risks are, therefore, different. Although the bulk of their income is derived from SA, they have their own unique risk in terms of further investigations from regulatory authorities.
Visagie said each of these three categories also face their own unique risks.
Setting the scene
For the locally focused stock it is the low-growth environment in the SA market combined with uncertainty created by land expropriation.
For the offshore listed stocks, it is the volatility of the rand affecting the return profile of the companies as well as global property markets facing uncertainty around Brexit, rising interest rates, especially in the US and an increase in online shopping impacting retail markets in developed countries.
"We want to highlight that we do not expect the property sector to be as smooth a ride as we have historically experienced. Because of the volatility due to the rand, one must keep in mind the impact of the massive fluctuations when pricing these offshore companies," said Visagie.
For the bulk of the SA listed property space - the local entities - the SA economy needs to grow so they can grow their earnings by pushing up rental income. But if there is not enough demand due to people not growing their businesses, then you will see a decline in income of these companies. A lot of large shopping centres are struggling to keep their malls full.
There is also the corporate space. Companies do not fill up all the space they have rented.
For the offshore property companies listed in SA investors must look at each area where they are active.
In the UK there is the Brexit uncertainty. Online retail is also a massive threat for growth in traditional retail overseas, especially in the US.