Investment Insights: Disruption and evolution in the SA listed property sector

Ian Anderson CIO at Counterpoint Asset Management; portfolio manager of the Nedgroup Investments Property Fund, discusses the extreme levels of income and capital volatility that South Africa’s listed property sector has experienced.

Fund performance
The listed property sector has got us excited again. Significant opportunity is presenting itself in the listed property market particularly as businesses are taken private or experience merger and acquisition activity.
If we look at how the fund has performed relative to the sector, we see that by March 2020 the listed property market had halved in value. While the Nedgroup Investments Property Fund also declined, it was not to the same extent as the sector because we own different stocks to what is in the sector. This also resulted in us enjoying a significant recovery which started around October/ November of last year. And while the property sector is still down 20%, we anticipate that we will recover all of last year’s losses in time.

Top contributors/detractors
Taking a look at the past 12 months to end April 2021, we see that it has been some of the smaller business that have made the most impact, dominated by Fairvest and Safari (both of which invest in convenience retail).  Arrowhead and Indluplace have recently been targeted for corporate action which has resulted in substantial price action. Tower  is also under cautionary at the moment which has resulted in some significant price action.

The only detractors in the portfolio for the period were Grit and Delta. Delta spent a bit of time suspended and therefore didn’t enjoy the rally experienced by the rest of the sector, while Grit, our only non-South African holding in the portfolio, has underperformed as a result of the rand’s strength over the last 12 months.

Year-to-date performance has been dominated by businesses that have performed better than what the market has anticipated and/ or resumed dividend payments eg. Dipula B and Octodec.

Income recovery is likely to be slower
While we have seen a strong resurgence in prices, we haven’t seen a strong recovery in income levels and expect that income recovery is likely to take longer.  Price recovery has largely been due to the  prospect of corporate action and not necessarily because of an improvement in fundamentals.  We are going to see increased vacancies and lower market rentals particularly for office and mall landlords.  Despite a fairly strong recovery in retail sales in March (online and in malls) as consumers started spending the money they may have saved over the last while, we don’t believe this will be sustainable and office and mall landlords will continue to struggle.  Unfortunately, while vacancies are rising and market rentals are falling, costs in utilities, security, rates and cleaning are rising above inflation which is likely to accelerate in the second half of the year.

Some landlords are still providing rent relief although it has become less and less significant which will increase the risk of tenants failing to make rental payments.

Companies are also looking to preserve cash to strengthen balance sheets particularly around uncertainty of whether or not property valuations will fall further.  REITS have to pay out at least 75% of their distributable income every year in order to retain their REIT status.  While historical pay-out ratios have been 100% of earnings, they certainly have leeway to lower dividend pay-out ratios and delay/defer dividend payments while still maintaining their REIT status as long as those dividend payments are at least 75% of earnings. 

Then, there is the acceleration in trends that have disrupted real estate markets globally for some time now. Where we work, how we shop and how we are entertained continues to evolve and have a huge impact on global real estate markets.

Outlook for 2021 and beyond 
Despite the recent recovery in prices, discounts to NAV remain wide.  The large discounts are attracting prospective buyers and a number of smaller REITs have recently gone under cautionary. Discounts are likely to narrow in 2021 and 2022 as economic recovery gathers momentum and deals are announced.

We anticipate strong distribution growth in the portfolio of more than 50% in 2021 (albeit off a low base) and then 7% or 8% in 2022, moving back towards that inflation-hedged growth in income.

While pay-out ratios are difficult to predict, we believe they are likely to remain low (75% to 80%) for at least this year, and forecast risk remains high.