The current economic and operating environment in South Africa – characterised by sluggish GDP growth, rising operating costs, struggling consumers, low employment figures and depressed business confidence – is far from ideal for listed property to perform well locally.
The contractual nature of the landlord-tenant relationship also plays a role – as a result, listed property companies tend to lag behind the underlying operating environment by between 18 and 24 months, sometimes longer. We believe the operating environment has now caught up, however, and we’re likely to start seeing increasing vacancies, a pushback in rental escalations, and tenant churn. Coupled with an oversupply of office, retail and industrial space within specific nodes, this doesn’t bode well for future investment returns as distribution and net asset value growth slows.
The operating and economic environment offshore, however, has attracted the interest of local property stocks as it offers greater potential returns. In certain regions, economies are showing signs of early recovery, with an uplift in demand for space and an increase in consumer appetite. Infrastructure and operating costs are relatively more stable, which allows firms to act on longer-term investment views.
The two main drivers for the trend towards offshore exposure are:
- Property yields offshore are higher than current lending rates – also known as ‘positive spread’.
- The improved property fundamentals provide greater certainty.
In South Africa, property yields are lower than current lending rates, which is described as experiencing a ‘negative spread’ environment. To try and mitigate this, annual rental escalations tend to exceed inflation. When companies value potential developments or acquisitions, they assume tenants will be able to continue paying above-inflation escalations, which in turn makes the development or acquisition feasible at given yields and lending rates. The question of sustainability of course then arises, given that landlords are pushing already pressed tenants for higher escalations.
A big offshore drawcard for local property firms is that with the use of leverage, the investment is ‘in-the-money’ from the get-go and won’t be reliant on rental income growth. What we’re also seeing abroad is that tenants are willing and able to sign longer lease terms with inflation-indexed escalations – we attribute this to greater economic and political certainty in those countries.
It’s important to note that it’s not just been our local property stocks that have spotted these opportunities – a number of global firms are also following the trend. Competition has seen a compression of yield, but the spread remains due to the artificially low interest rate environment.
Some JSE-listed property funds have succeeded in identifying these trends early on and have captured significant value by acquiring and/or developing offshore exposure. Naturally, there will always be the opportunistic trend followers who are late to the party and end up paying for their investments.
At Sanlam Private Wealth (SPW), our view has been to invest with management teams who have experience abroad, are specialists in their given sectors, and have managed their balance sheets pragmatically. Management teams must be aware of the nature and quality of their assets and have a competitive understanding of the market in which they operate if they are to succeed.
It’s also important to note that all is not doom and gloom in the local property environment. Property is a cyclical business and the current weakness could provide us with opportunities to invest at attractive yields. Ultimately, what makes a good investment, whether offshore or local, is the price you pay.
