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Cape Town - Market capitalisation of the real estate investment trust (REIT) sector surged in recent years, rising from under R80bn in 2008 to around R400bn today, according to Overberg Asset Management (OAM) in its weekly economic and market overview.
"The REIT sector has provided consistently strong investment returns. REITs have been the top performing asset class in South Africa in six of the past fourteen years," said OAM.
"The number of REITs listed on the JSE has increased over the period from less than 30 to over 50."
Despite this, OAM notes that over the past year the SAPY REIT index has suffered from a substantial derating in the Resilient stable of companies, which includes Resilient, Fortress, NEPI Rockcastle and Greenbay.
South Africa economic review
• Moody’s credit rating agency maintained South Africa’s investment grade sovereign debt rating, citing a halt in the deterioration of the country’s institutions, improved actual and expected economic growth, and a stabilisation in the fiscal outlook. Moody’s cited “a sharp recovery in business and consumer confidence, illustrated both in surveys and by other indicators such as the recent recovery in the value of the rand”.
Moody’s signalled the potential for a credit rating upgrade at its next policy review in October by shifting its outlook from “negative” to “stable”. Moody’s stated that “the successful implementation of structural reforms to raise potential growth as well as stabilise and eventually reduce the debt burden, including through reforms to the State-Owned Enterprise sector which reduce contingent liabilities, would put upward pressure on the rating”.
• The current account deficit widened to -2.9% of GDP in the fourth quarter (Q4) from -2.1% in Q3 due to the moderation in the trade surplus and a further deterioration in the services, income and current transfers account. The trade surplus narrowed from R92bn in Q3 to R74bn in Q4 as imports increased faster than exports attributed to increased purchases of manufactured goods.
The deficit in the services, income and current transfers account increased for the fourth straight quarter to R211bn, exacerbated by an increase in dividend payments to non-resident investors.
The current account deficit may widen further in coming quarters as imports recover in line with improving business and consumer confidence and dividend payments to non-resident investors rise in response to improving corporate earnings. However, any widening in the current account deficit will likely be tempered by strong export demand, keeping the deficit contained at under -4% of GDP over a 1-2 year horizon.
• Consumer price inflation (CPI) fell more than expected in February to 4.0% year-on-year from 4.4% in January, well below the 4.2% consensus forecast and closer to the lower end of the Reserve Bank’s 3-6% target range. The decline is attributed to lower fuel and food prices and the base effect of high year-ago comparative data. Core CPI, excluding food and energy prices, remained unchanged at 4.1%.
On a month-on-month basis, CPI increased by 0.8% and 1.1% at the headline and core level, respectively due to a 0.6 percentage point contribution from miscellaneous goods and services. This category includes insurance and financial services, which tend to implement annual price increases during February. The current 4% CPI reading is expected to mark the low point in the inflation cycle.
Inflation is likely to rise in coming months in response to the VAT increase from 14% to 15%, which will add an estimated 0.5 percentage points to the year-on-year inflation rate over the rest of 2018. A fading beneficial base effect, moderation in fuel and food price declines as well as increased taxes on fuel, alcohol, tobacco and sugar will also apply upward inflationary pressure.
Nonetheless, the Reserve Bank emboldened by the benign inflation report, a reprieve from Moody’s credit rating agency and a stable rand, is expected to cut its benchmark interest rate, the repo rate, by 25 basis-points at its policy meeting this week.
• Retail sales growth slowed in January to 3.1% year-on-year from 5.1% in December and 7.9% in November. However, retail sales traditionally dip in January as consumers consolidate after the festive season. January’s reading was higher than the 2.8% average for 2017 and the 1.7% contraction in the same month last year.
By retail category, textiles, clothing, footwear and leather goods, stood out with growth of 6.5% on the year, contributing 1.1 percentage points to headline growth. The household furniture, appliances and equipment category grew 9.2% on the year contributing 0.4 percentage points to headline growth.
The outlook for retail sales for 2018, while constrained by an increased tax burden in particular from the VAT increase, should benefit from rising consumer confidence, lower inflation and faster real wage growth.
The BER retail business confidence index, which measures the outlook for the retail, wholesale and motor trade sectors, increased sharply in the first quarter from 29 to 42, signalling a substantial improvement in retail trading conditions.
The week ahead
• Reserve Bank Monetary Policy Meeting: The Reserve Bank is widely expected to announce a 25 basis-point cut in the repo rate, from 6.75% to 6.5%.
This would be the first rate cut in the current easing cycle since July 2007, helped by an easing in political and credit risk, lower inflation and a strengthening rand.
• Private sector credit extension: Private sector credit extension is likely to have picked up slightly in February from January’s subdued year-on-year growth rate of 5.5% to around 6.0%, boosted by a lift in business and consumer confidence.
• Producer price inflation: Producer price inflation is likely to have eased in February to 5.0% year-on-year from 5.1% in January according to consensus forecast, helped lower by a strengthening rand, and lower fuel and food prices.
• Trade balance: The trade balance is expected to have returned to a surplus in February following the larger than expected R27.7bn deficit in January. February traditionally marks an increase in export activity as shipments resume following the December-January festive season.
Technical analysis
• Having broken key resistance levels at R/$12.50 and R/$11.70, the rand has returned to its appreciating trend, targeting a break below R/$11.00 over coming months.
• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
• The British pound has broken above key resistance at £/$1.35 promoting further near-term currency gains to a target range of £/$1.40-1.50.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken decisively above key resistance at 2.5%, targeting the next key resistance level at 3.0%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.
• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 8.6%% indicating a new target trading range of 8.0-8.5%.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price has broken above key resistance at $60 and likely to remain in a trading range of $60-70 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• The break in the JSE All Share index above key resistance levels at 56 000 and 60 000 signal the early stages of a new bull market.
Bottom line
• The market capitalisation of the real estate investment trust (REIT) sector has surged in recent years, rising from under R80bn in 2008 to around R400bn today. The number of REITs listed on the JSE has increased over the period from less than 30 to over 50.
• The REIT sector has provided consistently strong investment returns. REITs have been the top performing asset class in South Africa in six of the past fourteen years. The SAPY REIT index beating equities, bonds and cash in each of those six years. In 2016 the SAPY REIT index returned 14.7% compared with the All Share return of 2.6%.
• Over the past year the SAPY REIT index has suffered from a substantial derating in the Resilient stable of companies, which includes Resilient, Fortress, NEPI Rockcastle and Greenbay. The derating of other rand hedge REITs such as MAS, Intu and Hammerson has also been evident due to a strengthening rand. The rand hedge component comprises around 45% of the SAPY REIT index contributing to its 21% decline since the start of the year compared with the 5% decline in the All Share index.
• How representative is the decline in the SAPY REIT index? Not very. The differential in returns between the best performer and worst performer in the SAPY index since the start of the year is around 80%. While the Resilient stable and rand hedge REITs have slumped, domestically focused REITs have provided amongst the best returns on the JSE with returns in the high teens.
• Domestically focused REITs are poised to deliver excellent returns. The fundamental outlook, which has been hindered in the most recent Zuma years by weak economic activity, high vacancy rates and poor rental growth, is set to show significant improvement. The shift in political leadership and increased policy certainty will boost business and consumer confidence and economic growth, putting REIT rentals on a firmer upward trajectory.
• The improved policy and economic outlook has had a strong positive effect on the rand and bond yields. Bond yields have a close correlation with REIT prices. As bond yields come down so too do the yields on REITs, which means REIT prices rise. So far REIT prices have been slow to respond to falling bond prices. Since the ANC elective conference in December the benchmark R186 government bond yield has dropped sharply from 9.50% to 8.0%.
Domestic REITs have not discounted the steep decline in bond yields. Furthermore, despite the strong performance by the rand and South African gilts over the past three months, they remain cheap on a relative basis. The R186 yield of 8% is still around 400 basis points above inflation (CPI at 4%), a much higher real yield than most emerging markets.
There is considerable scope for further tightening in yield spreads versus other emerging market bonds.
• Domestically focused REITs are extremely cheap when compared with bond yields. Historically, REITs yield less than the government bond yield as they provide an element of growth. Many of the smaller domestic REITs are yielding over 10%, a whole 200 basis points above the yield on the R186.
• Growthpoint, the elephant of the sector with a market capitalisation of around R80bn, is trading on an estimated forward yield of 7.3% just 70 basis points below the R186 yield of 8%. Growthpoint’s current estimated forward yield premium of 70 basis points compares with a long-term average yield premium of 107 basis points for the REIT SAPY index.
Growthpoint’s narrow yield premium compared with the R186 bond indicates significant value for Growthpoint and for the sector as a whole, in particular domestically focused REITs.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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