Listed property investors should expect some volatility

While SA listed property is currently offering good value, backed by a very high dividend yield despite a negative sentiment on growth, investors would do well to take a long-term view of the sector and expect some volatility in the interim.

This is according to Evan Robins, Listed Property Portfolio Manager at Old Mutual Investment Group, who warns that the weak domestic economy suggests the asset class is unlikely to deliver the heady combination of inflation-beating dividend growth and stable income distributions to which South Africans have become accustomed over the last two decades.

Robins notes that the JSE’s South African Listed Property Index (SAPY), a measure of the 20 most liquid real estate investment trusts (REITs) by market value, was South Africa’s best-performing asset class over multiple periods, consistently outperforming inflation and delivering returns as high as 27% in 2014, 8% in 2015, 10% in 2016 and 17% in 2017. However, 2018 saw the SAPY index fall more than 25% due to a combination of weak domestic economic growth and a series of company specific issues at certain flagship REITS.

That said, Robins points out that one of the positive aspects of investing in listed property at the moment, in spite of the weak economic climate, is that the current low valuations are not a reflection of the quality of their underlying assets. “Much of the excessively poor performance of certain listed property counters has more to do with governance issues or internal corporate matters related to financial structuring, non-core/ unsustainable income or potentially risky overseas forays rather than the quality of their property portfolios. The irony is that if the local environment was thriving, it would have masked a lot of these issues,” he says. “The result is that South African portfolios appear to be performing worse than what they are in reality.”

Listed property has historically been perceived by South African investors as a relatively ‘safe’ investment as the tangible nature of fixed property assets afforded protection against permanent capital loss, while rental distributions provided steady income returns somewhat akin to bonds and cash. However, Robins cautions that investors should bear in mind that investments in the listed property sector are similar in nature to equities as valuations can be significantly affected by market sentiment, economic growth, the decisions of management and the ability of the listed entity to make a profit.

“Because listed property has performed so well over the last couple of decades some retail investors made fairly aggressive allocations to property relative to a prudent weighting to the asset class, which is a risky strategy to take,” says Robins. “In good times you can get strong performance from your portfolio even if your asset allocation is skewed but in bad times it can end up hurting you. In a weak economic environment like we are experiencing right now, tenants are under pressure which makes it very difficult to grow distributions because you have very little pricing power.”

He states that while the listed property sector is likely to experience a slowdown in new supply coming on to the market, as there simply isn’t enough growth in the economy to support new buildings, it doesn’t mean that all development will grind to a complete halt. Robins believes that some under-served areas, particularly rural areas and certain township markets, are still in need of further investment.

“Urbanisation remains a theme in South Africa so there will still be building developments, it’s just that the pace of that development will slow down, particularly in oversaturated segments like the urban retail market and office nodes such as Sandton,” he says. “In fact, what the sector really needs is a lot of supply to become available in order to regain pricing power.”

One possible solution to the current oversupply of office and retail space could be for investors in the residential sector to convert these properties for alternative use. Robins says the market is rife for greater consolidation in the sector as well as possible de-listings as a number of players, particularly those trading at significant discounts to net asset value, are probably more suited to private ownership rather than institutional shareholding.

“In the current environment it’s very difficult for listed REITs to raise capital and the market has a low appetite for gearing so we believe there is strong logic for taking certain companies private, either through a management buyout or private equity play,” he says. “There are no quick fixes for the sector so listed property investors need to take a long-term view. Based on current metrics investors are still likely to get good yields over a longer time horizon but there’s bound to be some short-term volatility.”