Neil Stuart-Findlay, portfolio manager at Investec Asset Management, discusses what was behind 2014’s performance in the listed property sector, and gives his stock preferences for the coming year.
2014 proved to be an exceptional year for the South African listed real estate sector, with the SA Listed Property Index returning an impressive 26.6%. The year began with the expectation of a recovery in global growth, an easing of monetary stimulus and a rise in both interest rates and bond yields to more normalised levels. Higher yields would translate into a headwind for domestic real estate shares and hence more moderate sector returns.
Macroeconomics and plunging oil:
In reality, two major macro catalysts drove a significantly better outcome for the sector over the year.
Firstly, 2014 was headlined by many countries’ struggle with varying macroeconomic concerns including muted demand and disinflation. Most developed nations, with the notable exception of the US, experienced material growth downgrades. This drove divergent monetary policies – the US Federal Reserve moved towards raising interest rates post the conclusion of its quantitative easing programme in October, while on the other hand the European Central Bank (ECB) and Bank of Japan loosened monetary conditions in order to stimulate their respective flailing economies. Given the overall weak global growth backdrop, global yields fell sharply over the year, aiding local sector share prices.
Secondly, in the final quarter of the year, a plunging oil price (-40.2%) put a lid on domestic inflationary pressures, with the SA Reserve Bank (SARB) delaying any further rise in interest rates. Oil fell sharply, not only on the back of the previously highlighted weak demand, but also on growing supply from US shale gas and OPEC’s decision to maintain its oil production levels. Even though the SARB re-iterated its view that interest rates would need to normalise over time, the far more benign inflationary outlook supported bonds and property stocks into year-end, with the real estate sector delivering 11.1% over the final quarter.
The Investec Property Equity Fund’s relative return in 2014 was aided by a general preference for larger cap shares over their smaller cap counterparts given that, in general, the former are backed by higher quality assets and more sustainable income growth. In this regard, shares which contributed positively included retail-oriented Resilient and Hyprop. The fund’s preferred large-cap exposure, Redefine Properties, enjoyed a strong final quarter (after a sluggish performance earlier in 2014) on the back of a solid set of financials released in early November.
Arrowhead B Properties, one of the fund’s select smaller cap stocks, was amongst the largest contributors to fund performance both over the quarter as well as 2014 as a whole. The release of its impressive final results, which combined decent organic growth with earnings enhancing acquisitions, proved to be a catalyst for a share price rally into year-end.
In December the fund participated in the IPO of Pivotal Property fund, which has significant exposure to premium grade office in Sandton. Pivotal, through its extensive development pipeline, will have a capital growth focus rather than the typical yield orientation which characterises most of the domestic real estate sector. This was the only new listing in which the fund participated in 2014 – unlike other recent IPOs, Pivotal offers investors a differentiated strategy at a reasonable price.
What does 2015 hold?
This year global monetary policy developments, commodity prices and geopolitical issues are likely to continue to dominate the headlines. On the local front, power outages, public sector wage negotiations and possible labour disruptions could hamper growth. However, the sharp drop in oil not only provides the SARB with scope to avoid further policy tightening, but also gives local consumers some discretionary spending relief in the current challenging environment.
From a stock perspective, we continue to seek out those counters that show sustainable, above-average distribution growth at reasonable prices and which are backed by quality assets, strong balance sheets and experienced management teams. After underperforming last year, sector heavyweight Redefine looks attractive heading into 2015, whilst Hyprop can continue its strong run, backed by its high-quality regional shopping centre asset base.
We remain cautious on prospects for the rand given stubbornly high twin deficits and the volatile global risk environment. Hence we believe it prudent to continue to have exposure to offshore real estate counters including NEPI, Investec Australia Property Fund and Capital & Counties. All of these shares offer strong growth prospects in their respective geographies.
Overall, the benign inflation and interest rate outlook creates support for yield-oriented asset classes including bonds and listed real estate. The latter offers the additional benefit of a fairly predictable, growing income stream (through contractual lease escalations) which aids total returns over time. Whereas a part of 2014’s distribution growth was generated by debt restructuring and exchange rate gains, growth in the year ahead is likely to be slightly lower, but largely organically driven.
That said, distributions are still forecast to grow in excess of 8% in 2015 – well ahead of inflation – and when combined with a forward income yield of roughly 7%, real returns remain achievable from the sector in 2015, albeit well below the exceptional levels achieved over the past year.
*As at end September 2014