Why have Property funds taken a knock?

The SA listed property sector has rallied over the last five years, averaging over 35% per annum. This reign has recently come to an end, with the index losing more than 20% year to date.On the bright side, this is an excellent buying opportunity to purchase real estate stocks at substantial discounts to their net asset values. But is this the right time to buy?

Dissecting the property market shows a slowdown in residential property developments with volumes falling dramatically in the last few months. This has been driven by a combination of approval delays (municipal), power issues (Eskom) and interest rates. High-end residential developments have been less affected on average despite an increasing number of vacant houses across the board. This points to affordability issues rather than a lack of demand. Large retail centres are taking less strain as most tenants are solid, national businesses which have the ability to ride out higher interest rates. Leases are typically long-term and often relate to turnover, which provides some protection to tenants should business activity fall with the general slowdown in consumption. Smaller retail centres are finding the environment much more challenging. The implication is that these centers house tenants that are less resilient to current conditions, which raises the possibility of increased credit impairments. Industrial property is in fact experiencing similar conditions to retail property, with good demand driving a positive outlook for larger industrial centres, but smaller centres are also struggling. Growth in office space has been slow over the past few years but its outlook has improved significantly in recent times. Good space is now sought after and with power shortages hindering new developments, a premium is being attached to existing space.

Listed property companies invest in all sectors but tend to avoid residential property as it is the most labour intensive as well as the most sensitive to declining economic conditions. High interest rates and unexpected inflation are by far the greatest worries for property companies. Higher bond yields have a negative impact on listed property pricing. Bond yields are currently at a 4 year high and by all accounts are rising. It's not just consumers who get knocked by rising interest rates, listed property companies are also affected because they take loans to finance their operations. Collateral is needed for this debt and can be anything in the region of 10%-50% of the value of the assets they own. Listed property companies can limit their interest rate risk by fixing the rate at which they borrow. Tenants however, don’t have this comfort and are adversely affected by rising interest rates. If you have invested in listed property, don't despair. The short-term picture looks scary because of uncertainty in the macroeconomic environment coupled with current corporate activity. Short term volatility in share prices should come to an end as listed property companies continue to record good distribution growth and commercial property fundamentals still remain favourable. In the medium term, investment sentiment will improve as inflation comes under control and rates are lowered. Investors will return to property stocks, creating demand and pushing up prices. Over the longer term, distribution growth will be the key driver of performance for the property sector and stocks will trade back close to their net asset values. The only uncertainty here is - when!