PSG Wealth: Summer Investment Research and Strategy Report

One of PSG’s equity analysts, Bianca Haywood, says the South African Listed Property Index (SAPY) was the second best performer of the four traditional asset classes for the fourth quarter of 2016. The SAPY returned 1.26%, wiping out losses in the previous two quarters. Her analysis further found that all sub sectors in the property arena have fundamentally deteriorated, with the office sector the worst hit. Here is PSG Wealth’s position on this asset class.

Local cash was the best performer, returning 1.69% for the fourth quarter. The SAPY returned 1.26%, wiping out losses in the previous two quarters. South African bonds only returned 0.32% for the quarter, however, on a year-to- date (YTD) basis bonds returned a solid 15.42%.

Domestic equities ended the quarter in the red, down 2.09%. In October, the performance of income generating assets like cash (+0.57%), the SAPY (+0.5%) and bonds (+0.64%) were in line with each other. The equity market struggled with declines across the board and ended in the red, down 2.5%. The outcome of the US presidential election had a profound impact on bond markets in November.

Trump’s policies concerning fiscal stimulus sent the yield of 10-year US treasuries up by more than 50 basis points. Uncertainty about the outlook for emerging markets weakened the rand by 4.4%, with bond yields rising more than 30 basis points.

The SAPY followed the bond market lower and reversed its earlier gains, declining by 3.34% in November. In December, the US Federal Open Market Committee (FOMC) approved the Fed’s first interest rate hike in a year. However, the FOMC also surprised saying they foresee three more rate increases in 2017. All four major asset classes ended December in the green, led by the SAPY with a return of 4.24%, followed by local bonds with a return of 1.54%.

Reporting season

The reporting season and year came to an end with most companies reporting either half or full-year results. Here are some of the highlights:

  • Accelerate: 6964.52 (Market Cap R mil); Interim (Reporting Period); 8.1% (DPS Growth); 7% – 8% (DPS Forecast).
  • Arrowhead: 9029.87 (Market Cap R mil); Full Year (Reporting Period); 9.9% (DPS Growth); 6% – 8% (DPS Forecast).
  • Investec Australia Property Fund (IAPF): 4386.34 (Market Cap R mil); Interim (Reporting Period); 6.0% (DPS Growth); 6% – 8% (DPS Forecast).
  • Investec Property Fund: 10846.5. (Market Cap R mil); Interim (Reporting Period); 2.2% (DPS Growth); Flat (DPS Forecast).
  • Rebosis: 6869.98 (Market Cap R mil); Full Year (Reporting Period); 8.2% (DPS Growth); 7% – 9% (DPS Forecast).
  • Redefine: 57207.51 (Market Cap R mil); Full Year (Reporting Period); 7.5% (DPS Growth); 7.5% – 8.5% (DPS Forecast).
  • Sirius: 6642.08 (Market Cap R mil); Interim (Reporting Period); 51.1% (DPS Growth).
  • Stenprop: 5303.61 (Market Cap R mil); Interim (Reporting Period); 7.1% (DPS Growth); 1% (DPS Forecast).
  • Vukile: 13111.22 (Market Cap R mil); Interim (Reporting Period); 7.0% (DPS Growth); 7% (DPS Forecast).

(Source: Bloomberg, Catalyst Fund Managers)

PSG found that all sub sectors in the property arena have fundamentally deteriorated, with the office sector the worst hit. 

Generally there is an oversupply of office space in an environment of low GDP growth. Given the low growth environment in the South African economy, demand for vacant space will remain muted, placing further pressure on rentals. Retaining tenants in general has become a difficult task, and those with improving tenant retention rates, have done so at the expense of lower escalations on the renewal of rentals (rental reversions).

New lease escalations across all sub sectors are also trending lower. The shortage of residential space, particularly student housing, will create some opportunities. Despite sluggish local fundamentals, South African focused funds have outperformed foreign-focused funds. Locally listed companies with exposure to the United Kingdom (UK) and the rest of Europe were among the worst performers. The historically strong correlation between bonds and domestic property has been somewhat diluted by the increasing number of offshore companies on the SAPY.

The lack of growth in the local environment led to investors looking for opportunities offshore

Growthpoint was the latest company to venture out into Central Eastern Europe (CEE), through its 26.88% stake in Globalworth Real Estate. Globalworth has agreed to issue Growthpoint with 23.3 million subscription shares and one million fully-paid up fee shares. This gives Growthpoint an initial stake of 24.3 million shares for a total purchase consideration of €186.4 million. This represents less than 5% of Growthpoint’s market capitalization.

Hyprop also concluded the acquisition of the Else Macedonian Mall and Skopje City Mall for €92 million. This is the group’s third purchase in South Eastern Europe, through its UK subsidiary, Hystead Limited. Earlier in the quarter, MAS Real Estate entered into proceedings to expand into central and Eastern Europe with a focus on acquiring a leading regional shopping centre.

The property sector continued with the consolidation theme during the fourth quarter of 2016. The largest and most recent was the proposed merger of NEPI and Rockcastle. NEPI and Rockcastle concluded a framework agreement pursuant to which their respective businesses would effectively be merged in an entity named NEPI Rockcastle PLC, newly-incorporated in the Isle of Man. The merged entity is expected to become the largest listed real estate player in CEE.

Fortress made a general offer to acquire all Lodestone shares by exchange of one Fortress A ordinary share and one Fortress B ordinary share for every 6.66667 Lodestone shares held. The offer was accepted by the holders of 99.43% of all Lodestone shares in issue. Pivotal was recently delisted as a result of the acquisition of its entire issued share capital by Redefine. The acquisition concluded in an exchange for the issue of 460 million Redefine shares to scheme participants. This translates into an assumed swap ratio of 1.38537 Redefine shares per scheme share and 31.2 million Echo Polska shares, which equates into 0.09382 Eco Polska shares per scheme share.

Accelerate announced its intention to issue up to 125 million new Accelerate shares at an issue price of between 610 and 650 cents per share. The pricing range represents an estimated 7.1 to 12.9% discount to Accelerate’s NAV per share.

IAPF entered into a contract for sale with associated entities of Dexus Property Group and Brookfield to acquire a 50% share in the property located at 324 Queen Street, Brisbane, with Abacus Property Group for a total purchase consideration of 132 million Australian dollars. This represents attractive value and upside at an acquisition cost per m² of 6600 Australian dollars per square metre.

Rebosis entered into an agreement to acquire a 100% shareholding in Baywest City, Billion Property Developments, Billion Asset Managers and Billion Property Services. In terms of the transaction, the amount of R533.8 million, being a portion of the aggregate transaction amount, is payable in cash to Billion Group, Nedbank Corporate and Investment Bank. Rebosis will raise the R533.8 million from shareholders by way of a fully subscribed claw-back offer, at a price of 1 071 cents per ordinary share in Rebosis. Billion and Nedbank will therefore be issued with up to 41.8 million and 8 million Rebosis shares respectively.

Domestic-heavy property companies topped the charts in the UK fourth quarter

Focused real estate investment trusts (REITs) were among the worst performing counters, as fears over lower UK property prices continued, following the UK’s vote to leave the EU. Mas Real Estate was the top performing stock with a return of 22.9%. Investors reacted favorably to the group’s announcement to expand into the CEE region. Next on the list of top achievers was Investec Property Fund (+4.65%) and SA Corp (+3.12%). The continued devaluation of the sterling penalized those with UK asset exposure such as Capital & Regional (-15.97%), Redefine International (-10.7%) and Intu Properties (-9.3%).

The FTSE Capped Property Index ended the quarter in the red, down 0.82%

UK-focused REIT, Intu was the largest detractor for the last quarter of 2016 and contributed 106 basis points to the overall decline of the index. This was followed by Redefine International and Hyprop Investments, which contributed a further 43 basis points to the index’s decline. The largest South African-based real estate company, Growthpoint, added 31 basis points to the index. This was followed by Mas Real Estate and NEPI who contributed 20 and 16 basis points, respectively.

On the global front, the FTSE Epran/Nareit Developed Rental Index ended the quarter on a negative note, with a net total return of -5.92% (in USD)

Germany came in as the worst performing listed real estate market, with a double digit decline of 13.99%, followed by a subdued performance in Hong Kong with a total negative return of -12.62% (in USD). This was despite a strong performance in the Hong Kong Central CBD region, which showed a high demand for office space by Chinese firms, low vacancy rates and soaring rental prices.

Although luxury retail sales have declined significantly due to the pressures of a decline in tourism, restaurants and necessity-shopping focused retailers continued to deliver solid results. Greece ended the quarter with the best performance, recording a 6.71% return for the same period, while Israel achieved the second spot with a total return of -1.52%.

The Australian property market was led by large returns generated by steady demand and low supply for office space in Sydney. The retail sector saw a shift in performance from small neighbourhood grocery stores to upper-end shopping malls as consumers became more focused on the quality of shopping experiences and with e-commerce accounting for an increasing percentage of marginal sales

The effects of ‘Brexit’ impacted the London office space sector with a rise in supply, while occupancy levels declined due to the uncertain future of businesses in the region. The US reporting season saw results generally on par with market expectations with solid growth achieved by their REITs.

The effect of lacklustre local economy was reflected in the reported results and PSG anticipates this to persist across all sectors

This is especially likely as sluggish demand for vacant space continues to put pressure on rentals. Despite the recent under performance and an uncertain outlook for the UK-economy post Brexit, UK-focused REITs continue to experience a stable footfall, high occupancy rates, steady rental-renewals and property development in the UK remains robust. PSG will continue to monitor the risks of illiquidity in the South African listed property sector, which remains a general concern. They remain of the view that the interest rate cycle will impact domestic economic strength, affordability and sentiment.

Where PSG is required by mandate to hold listed property, they prefer to hold counters with the following characteristics:

• low price-to- book values

• low levels of debt/gearing and strong credit ratings

• using of structures that offer superior liquidity, like REITs

• superior distribution growth track records