The South African Listed Property Index has pulled back by 17% since the start of 2018 – surprising many after the asset class returned over 20% annually for the past 15 years. At Sanlam Private Wealth we’ve held the view that listed property has looked expensive on a risk-adjusted basis – but what has caused this rapid decline after it quietly outperformed other asset classes for so long?
The recent decline in the SA Listed Property Index is in our view partly a function of the composition of the index, the strengthening of the rand, rising global bond yields and recent developments in the Resilient stable.
The composition of the SA Listed Property Index has changed drastically over the past few years. From having little to no offshore exposure, the index now derives around 40% of its earnings from abroad. This internationalisation was driven by a lack of local investment opportunities, the existence of a positive spread between the cost of funding and property yields abroad, and the continuously depreciating rand.
Local counters saw rand hedge opportunities, while offshore counters looked to list on our local exchange to raise capital efficiently. Given the deteriorating macroeconomic environment and growing political concerns, South African investors had an insatiable appetite for increasing their exposure to offshore property. Rand hedges were the order of the day.
After a period of weakness, our currency has recovered significantly against the US dollar. In November 2017, it was trading at R14.46 to the dollar, but has since strengthened by almost 20% and is currently trading at around R11.60 to the dollar.
The rand has also firmed up against other major currencies. The result is that counters with offshore exposure are now reporting lower earnings from offshore operations, which has put pressure on overall earnings growth. This is of course a simplified explanation that hasn’t taken into account the effects of exchange-rate hedges.
RISING GLOBAL BOND YIELDS
Another macroeconomic factor that needs to be considered is the movement in bond yields, both locally and, since the increased internationalisation, offshore. It’s important to note that listed property has an inverse relationship with bond yields, as bonds are used as a proxy for when interest rates will rise. The knock-on effect is that it becomes more expensive for property counters to gear up their balance sheets, which in turn affects the yield of investment opportunities.
The movement in global bond yields is important. Across the board, yields are rising, placing increasing pressure on global listed property. In reaction, the FTSE EPRA/NAREIT Global REITs Total Return Index – a barometer for global listed property prices – has declined by 5.9% in US dollars since the start of the year.
Locally, the South African bond yield has come off from recent highs of over 9% in November to just over 8% now, which has in turn seen some of our local counters appreciate. However, the local counters weren’t immune to the global sell-off.
SCRUTINY OF RESILIENT
Recent developments within the Resilient stable have compounded the impact on the SA Listed Property Index’s performance. The Resilient group of companies has come under severe scrutiny of late. The sell-off started when, following its Steinhoff exposé, Viceroy Research stated that the next target could be in the listed property space, and the market assumed it would be the Resilient stable, which includes Resilient, Fortress, Nepi Rockcastle and Greenbay.
Shortly after the sell-off, rumours emerged that more hedge fund managers were about to release negative reports on the group. The reports, once made public, focused on accusations of share price manipulation by management teams, concerns and conflicts of interest over the cross-holdings between the various firms, and the independence of its broad-based black economic empowerment (B-BBEE) partner. The Resilient board has ordered an independent review alongside a probe by the JSE into possible market manipulation by both the stable and the hedge funds involved.
It’s important to note that on 31 December 2017, the Resilient stable constituted just over 40% of the index. The group experienced significant declines in share prices despite management’s best efforts to respond to the released reports. Fortress’s B share is down over 55%, Resilient and Nepi Rockcastle are down 49%, with Greenbay declining 48% and Fortress’s A share down 13% since the start of the year. The sell-off contributed significantly to the index’s negative returns year-to-date.
At Sanlam Private Wealth we had exposure to Nepi Rockcastle and Resilient in our property portfolio, but reduced this before the large corrections in the market due to valuation concerns. The portfolio currently carries an underweight position in the Resilient stable.
Listed property remains an important asset class, as it allows investors to beat inflation via capital investment growth, and regular or contractual rental income distribution. It also provides good diversification within a portfolio. While the pull-back and the volatility of the index may provide short-term discomfort, we’ve taken the opportunity – in line with our investment philosophy – to add to some of our preferred positions as valuations have opened up.
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