SA REIT returns likely to outperform cash, bonds in the long-term

SA REIT Association Chairman and CEO of Growthpoint Properties SA, Estienne de Klerk.

SA’s REITs are likely to outperform cash and government bonds in the long-term with Covid-19 in the rearview mirror, the increased interest rate cycle nearing its end, and landlords finding power generation solutions, says SA REIT Association Chairman and CEO of Growthpoint Properties, Estienne de Klerk.

De Klerk says that while returns for SA’s REITs listed on the JSE have been negative for the past five years, their performance was not unique, as global real estate faced similar challenges.

We need to contextualise the performance of SA REITs because, unlike other sectors of the economy, the sector faced headwinds in the form of floods, Covid-19, riots, inflation, and higher interest rates, negatively impacting the sector,” he says.

He explains that the good news is that the increasing interest rate cycle is nearing its end, and this will improve investment in real estate, further supported by the improved property fundamentals as evidenced by improved industrial and retail property’s stronger returns.

We are noticing a strong demand for industrial real estate and growth in this sector, and strong letting in Cape Town and Durban where vacancies are falling, and retail, office and industrial sectors performance have come back strongly.”

The Gauteng economy remains under pressure, but supply and demand dynamics are expected to improve as businesses start to return to their office spaces as most corporates preference of their place of work.”

The irony is that load shedding has resulted in more people returning to their offices. Therefore, it is reasonable to expect improved demand over time which could result in positive rental growth over the long run, particularly in offices with high green credentials.”

Indeed, the inflationary pressure on the development cost has raised the required rentals of new developments substantially, which will support increased rentals on existing properties. Therefore, landlords will have room to raise rents and actual returns.”

According to De Klerk, there is a 40% differential between the rentals required on new industrial properties compared to the in-force rentals on existing properties.

They always say you make money when you buy, not sell. SA REITs are beneficial to investors in that they have an effective tax structure, low transaction costs at acquisition, liquidity, transparent reporting, and diversified portfolios, often with exposure to the offshore real estate markets.”

In every challenge, there’s an opportunity. Landlords are rolling out solar power in their properties, and there’s an increase in environmental, social, and governance (ESG) reporting and green-building portfolios. Real estate companies can take advantage of this opportunity, and in the future, the deregulation of the electricity industry will create more avenues to improve returns,” De Klerk says.

Most landlords have been proactive in supplying generators and looking into other generation solutions like gas and solar. All will contribute to an improvement in electricity supply in the long run.”

De Klerk remains optimistic about the asset class.

No doubt real estate property remains an attractive asset class with cash, bonds, and equities. It is because property investment is more of a long-term game, and investors such as pension funds favour the asset in their allocation of investable funds.”

The past five years have been a mixed bag for the SA REIT industry, not least because of their investment strategies but because of the macro-environment where the sector has been at the mercy of the low growth economy, load shedding and high interest rates, which have affected the appetite for the asset class.

During the period under review, the sector has also had to contend with the Covid-19 pandemic. The pandemic, in particular, resulted in softer demand for commercial and industrial property as companies issued work-from-home mandates.

Counterpoint Asset Management Portfolio Manager Ian Anderson, who has collaborated with the SA REIT Association on its sector analysis, says that when one looks at the structure of the SA REIT market, it is mainly characterised by above-average exposure to large malls and offices. It is why returns were affected, especially during the pandemic.

There is a silver lining in the next two to three years, but the performance of the sector and returns will largely depend on the resolution of the power crisis and uptick in economic growth. It will improve investor confidence and, over time, demand in commercial and industrial property,” he explains.

Undoubtedly, load shedding poses a significant challenge for all South African businesses, but the property sector is likely to be the most negatively impacted, especially in the short-term, given the need to spend large amounts of capital when the cost of capital has risen sharply in the last twelve months.”

However, he points out that many REITs are already ahead of the curve and have done a lot already. Still, the market is concerned about the need for significantly increased capex spend at a time when the demand for space is still weak in several markets.

High interest rates and economic growth may not improve property fundamentals. However, worst news has been priced into many SA REITs, which are trading at a deep discount to net asset value (not too dissimilar to twenty years ago).

Anderson says most REIT management teams have spent a considerable amount of time and energy improving the quality and relevance of their property portfolios while at the same time strengthening the balance sheets.

Therefore, the industry should be able to cope relatively well with higher interest rates and produce moderate growth in profits and dividends over the medium term. However, they are unlikely to exceed inflation which is expected to remain between 4% and 6% over the forecast period.

Investors should expect the income yield plus 3% to 5% per annum as a total return (between 9% and 12% per annum).

Anderson ends by explaining that if sentiment towards the sector improves due to reduced load shedding or interest rates or an improvement in the economic outlook, then the large discounts to net asset value will unwind, adding a further 10% to 20% to returns over a three-year period.

Originally published on SA REIT Association’s website