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It’s been a tough year for the country with even the resilient property sector beginning to show the effects of trying economic conditions.
Brexit and volatile bond yield movements have exacerbated local headwinds, the sector now underperforming bonds and relinquishing its top spot as the best- performing asset class, a position it held in the first two quarters.
But the property sector still managed to outperform both equities and cash year-to-date, producing between 8% and 9% dividend-per-share growth.
The SA listed property sector may be facing weak economic fundamentals, but it does provide an attractive, growing yield in a global low-yield environment, according to Absa’s 3rd Quarter Asset Management Investment report.
There’s another reason why pundits are more upbeat about the sector and it has to do with the close, positive correlation between listed property and bonds, the asset class expected to hold up in concert with bonds.
Declining economic growth has in particular seen softening in the office space, with vacancies rising and rental prices coming under pressure.
Reduced office space requirements as well as new developments coming on stream means competition between landlords is fierce.
For property funds looking to dispose of non-core B-grade office space, this could present a particular challenge.
“Office space is challenging because B-grade space is being displaced by new A-grade and P-grade space with cheaper cost of occupation, building efficiencies and in some instances better location where employees can work, play and live,” says Keillen Ndlovu, head of listed property funds at Stanlib.
“Consolidation of space by big corporates will also drive vacancies in the office space. At the moment we have a negative view on office [space] and prefer retail to all other asset classes.” In pursuit of a retail bias, the R15.6bn Vukile Property Fund recently exchanged 29 of its retail, office and industrial properties valued at R2.43bn for Synergy’s entire retail portfolio of 14 properties valued at R2.47bn.
“Retail specialist funds tend to trade at a premium on the JSE and hopefully the quality coming through from new Vukile [properties] will attract such premium,” says Ndlovu.
Size mattersIn spite of size, well-managed small caps can be very resilient. But in challenging conditions casualties in the sector are typically greater among these smaller funds. Size and diversity, like that of the country’s two largest real estate investment trusts (REITs), Growthpoint and Redefine, can make a fund strongly defensive, boding well for challenging times. Growthpoint Properties Limited, the country’s largest REIT with assets valued at R112.5bn, can boast of a portfolio of 526 properties, 467 local properties valued at R73.8bn, 58 in Australia through the company’s investment in GOZ valued at R30.9bn, as well as a 50% interest in the V&A Waterfront valued at R7.8bn.
The company delivered 6% full-year distribution growth to 30 June 2016, kept gearing conservative at 30.5%, debt fixed at 86.6% and decreased cost of debt from 9.3% to 8.5% through cross-currency interest rate swaps. Income from the SA portfolio contributed 75.9%, V&A 8.5% and GOZ
15.2%. During the year Growthpoint invested an additional R398m into GOZ by
electing to reinvest its distributions. It also invested R2.4bn in developments
and improvement to its local portfolio. The company acquired R840m of assets
and disposed of assets worth R1.1bn and has committed R1.7bn to future
developments. Market shifts and influences on investment criteria will see Growthpoint
also disposing of 13 non-core office properties, the company’s office portfolio
of R33bn reducing by over R1bn after disposal. Despite
a weak macroeconomic environment, Growthpoint expects stable property
fundamentals and anticipates achieving dividend growth for the coming year at a
similar level to the 2016 financial year also on the back of opportunity to
grow international distributable income. But economic headwinds are putting smaller development-focused funds
under pressure. Access to capital, currency flip-flops and six-month swaps are
added headwinds that restrict growth in the development arena. Capital is essential With no capital to execute, the
development pipeline suffers. It’s a position Pivotal Property Fund, a
development-income focused fund with a R12.9bn portfolio, found itself in.
Pivotal’s income-producing assets comprise eight retail properties, 10 offices
and three industrial sites, a number of development properties with four active
developments, and assets in Africa.
Even while the fund saw a 17.3% increase in net asset value (NAV) for
the 12 months to 31 August 2016, interest rate swaps, strengthening of the rand
and the fund’s exposure in Nigeria constrained growth, the fund trading at a
25% discount to NAV. Despite quality assets, financial instruments pulled it back, putting
significant pressure on Pivotal’s ability to generate satisfactory development
profits and investment returns. Management found itself caught between a rock
and a hard place. Pivotal could have plodded on, reducing its already diminishing
development pipeline. It could have even converted to a REIT. But both options
would have compromised value to shareholders and the latter would have put the
small fund at risk of a hostile takeover. Pivotal CEO Jackie van Niekerk took the brave but painful decision to
do what was best for shareholders – a merger with Redefine Properties.
“Redefine is the best fit. They are big enough to weather the storm and have
the same values and ethos as Pivotal,” she tellsfinweek. Says Ndlovu: “Pivotal has been a tightly held stock with low liquidity
and has been trading at below NAV while owning iconic assets such as the Alice
Lane precinct in Sandton. The proposed swap ratio seems more attractive for
Redefine. However, Pivotal shareholders will have to decide on giving up NAV
upside potential on future development profits for Redefine’s strong liquidity,
scale and diversification, REIT status and potentially a better NAV rating
inside Redefine while maintaining access to Pivotal assets.” Subject to the Competition Commission and shareholder vote end November,
the deal will go ahead with Pivotal delisting end January 2017. Redefine Properties – even during a period marked by unknowns
outweighing the known (see graph) – expanded its property base by R8.9bn (the
bulk of that a €1.2bn investment in Poland), maintained loan to value below 40%
and increased distribution per share by 7.5% for the full year to end August
2016. A savvy hedging policy ahead of Brexit affords the company added
protection in 2017, nor does its retail portfolio have any exposure to
Stuttafords, the fashion retailer applying for voluntary business rescue.
Significantly, the company is also protected against interest rate spikes with 82% of its debt fixed.
