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Where to find a solid property investment

South Africa’s listed property space has seen robust activity over the past year, with eight new listings amid the threat of higher interest rates.

The outlook for these stocks remains solid as investors bank on the dual growth nature of listed property: capital growth and income, or distribution, growth.

Some of the largest property companies have diversified their income streams offshore in a bid to limit country-specific risk in SA.

Others, especially the smaller property companies, have opted to provide investors with steady distribution growth from their local property portfolios.

Several factors impact the income outlook of listed property companies. Those with a large exposure towards retail space, especially shopping centres, depend on the strength of the local consumer to flock to these centres’ retailers and bolster sales.

Property companies with a large exposure to office space depend more on the general economic situation, where growing corporates demand more space as they grow their operations.

Property companies with a large industrial real estate offering are at the mercy of manufacturing growth and all that impedes this economic sector – notably a shortage of electricity, demand (or lack thereof) from offshore customers and interest rate levels, among others.

With economic growth in SA at a lacklustre 0.6% quarter-on-quarter annualised in the last three months of last year, it is hard to see how local conditions will result in a large boom in property development.

Given stiff competition in the retail property space, with about 400 000m2 coming to the market over the past two years, and a similar amount expected for the next two years, according to Estienne de Klerk, managing director at Growthpoint Properties, local funds would be hard-pressed to optimise efficiencies in their portfolios.

Growing capital or income?

One of the first factors a potential investor should take into account when deciding to invest in the listed property sector is whether they have a preference for capital growth or income yield and the growth of this income, according to Malcolm Holmes, fund manager at Stanlib Multi-Manager, who manages two property funds with R5.4bn under management.

“The more SA-specific property shares tend to yield higher income growth,” says Holmes.

Rental lease agreements include automatic annual escalations, which underpin income growth, explains Amanda de Wet, a fund manager at Plexus Wealth Property Fund.

This translates into a constant growing income stream for most of the property companies, she says.

In addition, not all leases expire at the same time, which means that the companies can negotiate future income on an ongoing basis, De Wet explains.

Those looking for capital growth opportunities in the property sector would probably opt for the larger shares with an offshore presence, says Holmes.

These funds have followed in the footsteps of large South African companies – such as SABMiller, Naspers*, Steinhoff and Mondi, among others – to engage opportunities offshore and de-risk their income-generating capacity away from the local economy.

“We’re very happy to put money into those funds,” says De Wet. These property funds acted partly as a rand hedge during the market turmoil of December, following the axing of former finance minister Nhlanhla Nene and the subsequent run on the rand.

Externalised or not?

Growthpoint, the largest listed property fund, ventured into Australia when a lucrative opportunity presented itself a couple of years ago, says De Klerk.

“There was an element of opportunism when we bought into our Australian company,” he adds.

Growthpoint now expects its GOZ unit in Australia to bolster the company’s growth this year, according to its financial results for the six months to end December.

“The externalisation of the property market is a positive from a diversification perspective and has driven capital returns as the rand has weakened,” says Holmes.

The interest-rate sensitive nature of the property market – due to the fact that debt is used to fund property development – makes it susceptible to current rising interest rates, and this could be a drag on income prospects.

The blowout of bond yields, when investors sold off government debt following Nenegate, saw the listed property sector also take a hit on worries that the higher cost of borrowing would hurt profitability.

The situation was cushioned by the near-parallel slump in the rand, which bolstered property shares with offshore exposure, as income earned in foreign currency would now be repatriated to SA at a higher rand value.

As most of the property funds’ local debt is linked to a margin above, or in rare instances below, the Johannesburg Interbank Acceptance Rate (also called Jibar), a higher repurchase rate would bode ill for finance costs.

*finweek is a publication of Media24, a subsidiary of Naspers.

This is an excerpt from an article which originally appeared in the 19 May 2016 edition of finweek. Buy and download the magazine here

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