The internationalisation of the listed property sector has been nothing short of spectacular. There are currently twelve ‘pure play ‘international listed companies, which account for about 40% of the entire market capitalisation of the listed sector.
When taking into account the international exposure of domestically orientated funds, effective exposure of investors to international assets accounts for more than 50% of market capitalisation. Excluding factors such as market capitalisation, gearing, free float factor, and index inclusion and only looking at the rand value of the physical assets that South Africans have access to through the JSE, that figure increases to 60-65% across more than twenty-five different countries. The large 32% component of UK is attributed to the likes of Intu, Capital & Counties, Hammerson and Capital & Regional which all have listings on the JSE.
Furthermore, externalization of investment has also taken the form of inward listings. In reality, they are South African companies listed on an international stock exchange, often a tax friendly one, that then lists on the JSE and raises virtually all of its equity from South African investors. Examples of these include Nepi, Rockcastle,Greenbay, Delta Mara, MAS Real Estate and a few others.
Why jump the fence?
A combination of push and pull factors are behind the externalization of investment capital:
- Positive yield spreads – Companies are able to acquire properties at yields of 5.5 – 8% which is higher than the cost of debt (1.75 – 3%) depending on the region. Compare this to South Africa where unhedged funding costs are c.9% and above 10% after hedging interest rate risk, and quality assets trade at 8 – 8.5%, and even lower. Investors are in a positive cash flow position on day one in European countries as opposed to only after a few years in South Africa. There is a massive incentive to do initially yield accretive deals in international markets that add to short-term growth, but achieving medium to longer-term growth is a challenge in low inflation environments.
- Higher GDP growth areas – The Central and Eastern European region offers higher economic growth, lower (and falling) unemployment levels, rising per capita income, a well educated population, cheaper debt and historic under-investment in real estate(although the last factor is changing).
- Investment opportunities – The quality of listed South African companies’ portfolios has improved over the years and the challenge is where to acquire quality assets. Globalisation and diversification are natural phenomena when economic growth is low and most local property markets are mature – as is the case in South Africa. Going international has given investors access to a wider range of return types and assets with different risk and return profiles as well as hard currency earnings.
- Tough trading conditions in South Africa with a worrisome outlook – South Africa’s GDP growth rate has been is forecast to be lower than most of the regions in which South African listed property companies have invested. Furthermore,investors are keenly aware of the local risks posed by political uncertainty, policy volatility and credit downgrades.
- The weaker Rand – The weaker Rand as a consequence of the above factors has no doubt played a part in this externalization. The Rand has a long-term track record of weakening despite bouts of strength and foreign exchange gains are a powerful incentive to opt for hard currency investments. However, investing in foreign assets that do not offer growth in their local currency amounts to little more than currency speculation.
Green grass can be slippery
There are a number of risks that can trip up investors in foreign countries.
- Political volatility in South Africa (events perceived as positive and negative) and the consequent Rand volatility is the largest and least-predictable risk that investors presently face in international property counters. Although political risk during the course of 2016 starting with ’Nenegate’ at the end of 2015 tended to be negative, some positive developments have seen the Rand find support. Investors into the UK saw the Rand scale R24.00 to the UK Pound before sliding to under R16.00 after the Brexit referendum which had a negative impact on their earnings.
Although some foreign regions have higher GDP growth than South Africa, often there is little to no rental growth. Unlike in South Africa, contractual annual rental escalations are uncommon or are indexed to low inflation rates of c1%.Rentals can remain unchanged for five years before reverting up by 8% to market – essentially one escalation every five years as opposed to one every year in South Africa. It is only through active asset management that investors will be able to make a meaningful difference to earnings growth. Passive long-term triple net leases leave little else to offer other than currency movements (up or down) to provide a change in earnings.
Distance and local management – finding the right in-country partners and building local knowledge provides many opportunities to gain experience. A lack of knowledge about the tenant market and local market dynamics can lead companies to acquire properties in the belief that they offer secure income only to be disappointed. Some smaller locations offer higher yields but lack investor market depth and could prove challenging to sell.
By Len van Niekerk, Senior Property Analyst, Nedbank CIB.