By Mabuse Moja
The month of November brings with it another round of property company results, with 14 companies releasing interim or final results. The expectation is for similar rhetoric from the various management teams, as was witnessed in the third quarter reporting period.
What we saw then was continued improvement in fundamentals; more so in the office sector where there continue to be tentative signs of the tenure on new leases lengthening and in-force escalations remaining in the 7-8% range. We do however acknowledge that vacancies remain above the long term average in some nodes and in certain grades of offices, and that rentals are still under pressure.
Offshore exposures have reaped some benefits for a select few companies, with the weaker rand proving beneficial to earnings. We expect this to remain the case over the foreseeable period, with a few funds playing it conservatively by implementing hedging strategies. Locally though, an inward-looking focus has become a key theme, as the pricing of existing assets makes it difficult to conclude transactions. Thus management teams are looking to extract any remaining “fat” from their standing portfolios. Redevelopment and extension opportunities are continually being explored as a means of boosting earnings. In a difficult economic environment these types of opportunities offer managements a relatively low risk method of growing earnings and they generally tend to be accretive to earnings.
The benign economic environment has also resulted in listed funds searching for additional growth through active portfolio management. However more important has been the gradual development of more active balance sheet management. The use of debt capital markets has increasingly become a feature across the listed property sector, with a great majority of the large and mid-cap companies having taken advantage of the cheaper debt available by going this route. Benefits to some are yet come, but plans are afoot to put in place debt capital funding programmes, in a bid to take advantage of the attractive pricing and also the diversification benefits these offer.
April 2013’s introduction of REIT legislation has created the platform for natural consolidation across the sector, with most of the regulatory uncertainty now out of the way. Redefine’s acquisition of the Fountainhead manco in 2012 was the first genuine sign of the consolidation cycle beginning to play itself out. Other potential mergers that immediately spring to mind are the Acucap and Sycom, along with Premium and Octodec, where management is made up of one team and portfolios are in essence run as single entities, with commonalities and synergies already in existence.
Since 2009 the listed property sector has seen 17 new listings, largely as a function of the entrance of new BEE players to the sector, larger funds selling off tail assets to smaller players and unlisted portfolios being brought to market to source capital in the search of growth. Investors responded positively to these new propositions which offered attractive yields and growth, with many of these new players aggressively pursuing acquisitions. However the May 2013 bond market weakness coincided with the de-rating of the sector and in turn resulted in a higher cost of capital and rising borrowing costs.
Given the ease with which companies could access capital prior to May’s de-rating, sellers’ expectations had in turn risen as the number of buyers for a limited amount of assets had risen significantly. In a liquid environment like the bond market, re-pricing can take place overnight, whereas in the direct property market perception and opinions take time to shift. This has created a scenario where appetite for paper of the smaller, less liquid funds with high gearing has diminished, making it difficult for these companies to conclude transactions. We have heard anecdotally that some management teams have placed a moratorium on acquisitions, as they wait for sellers’ expectations to come in line with their own.
Management teams need to meet distribution growth expectations and grow their funds, especially since the current constraints have, we believe, laid a platform for consolidation to begin to take place across the sector. The key to these transactions will be the ability of potential acquirers to find commonality with their targeted peers. External management companies are likely to be a stumbling block in terms of the speed with which transactions will happen.
However, from an investor point of view, the potential offering of larger, more liquid property counters will remain a draw card to supporting any potential transactions. The coming 12-18 months may yet prove eventful for the listed property sector, more so amongst the smaller members of the sector.
About the Author:
Mabuse Moja, Portfolio Manager at Investec Wealth & Investment
Mabuse has been an investment analyst within the Investec group since 2008, and is currently part of the wealth and investment team. His specific area of investment interest lies within the local listed property sector.
The views expressed in this article are the author’s own and do not necessarily represent the views of Property Wheel