A sector on the rebound? | Fin24

A sector on the rebound?

Feb 18 2020 14:44
Schalk Louw

I have made reference to the phrase “swimming upstream” before, and mentioned how it always reminds me of the joke about the man who was travelling on the N1 highway when he got a phone call from his panicked wife. 

She had heard on the radio that on the same highway, a vehicle was travelling in the wrong direction, causing havoc with oncoming traffic.

Frustrated, the man answered his wife that it wasn’t just one vehicle travelling in the wrong direction, but all of them!

When we look at South African listed property shares, one-way traffic definitely comes to mind, and not in an investor-friendly way. 

Investors had to watch this sector decline by 27% since the beginning of 2018 (between 31 December 2017 and 4 February 2020). 

Some of the main reasons for this decline in listed property shares:

1. A total collapse of the SA economy over the same period.

SA GDP growth shrank from 3% to nearly zero between 2014 and 2019, and this placed massive pressure on local companies’ growth. Most of them had no choice but to implement cost cutting, which in turn placed pressure on (among other things) property rentals. 

2. This sector came from a place of inflated pricing.

Over the past 20-year period, the FTSE/JSE SA Listed Property Index (SAPY) delivered an average of 1.5% better returns when compared with the SA All Bond Index (ALBI). 

The reason for this is simply because there is greater potential for capital growth in an investment in properties than an investment in bonds.

This difference in income, however, had grown to upwards of 4% up until the end of 2015, which clearly shows us the scope of this bubble. 

3. Ongoing investigations related to certain local listed property companies’ valuation methods created even more pressure around general valuations.

4. Local political environment. 

Uncertainty surrounding topics like land expropriation without compensation has definitely not made life any easier for property investments. The big question now is whether this reaction over the last two years is an overreaction, or whether it can be justified. 

You don’t want to rush out and buy, only to realise that, like the man on the N1, you are the only one travelling in the opposite direction towards oncoming traffic. 

We made a few statistical calculations based on this sector and the results were quite surprising:

- The correlation between the SAPY’s returns (yield) and the SA prime rate over the last 20 years was an amazing 84.5%. The SAPY’s returns also have a correlation of 76.8% with the ALBI’s returns. 

Such high correlations show us that there is a close relationship between these return rates. Do I expect this correlation to disengage going forward? 

Definitely not. 

- When we take a closer look at the decline in local interest rates, you will see that the SA prime rate and SAPY returns narrowly declined together. However, the Reserve Bank announced two interest rate cuts recently, one at the end of 2019 and the other in January 2020. 

The SAPY has not reacted to these interest rate cuts just yet (see graph 2). On the contrary, the SAPY declined even further and returns are now trading even higher. 

Schalk Graph 2

- It is interesting to note that the SAPY’s returns are now trading higher than the ALBI’s yields for the first time since the beginning of 2004. I’m not saying that history will repeat itself, but there is no denying that the beginning of 2004 was one of the best times to buy into something like the SAPY.

- If the difference between ALBI and SAPY returns normalise from the current negative to the 20-year average of 1.5% higher, there is great upside potential in the SAPY of about 29% (see graph 1). 

Schalk Graph 1

Even if you discount this upside potential by half due to current uncertainty in this sector, you’re still looking at around 15%.I do feel that value is starting to emerge in the local property sector. Were these aggressive declines justified? 

Absolutely.But is this the time to start buying slowly but surely? I tend to think so...

Schalk Louw is a portfolio manager at PSG Wealth.

This article originally appeared in the 20 February edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

sa economy

19 March issue
Subscribe to finweek