The listed property sector has endured significant challenges since the fallout of the Covid-19 pandemic. Over the years, it faced strong headwinds from a sluggish economy, rising interest rates, and the ongoing impact of load shedding.
However, the outlook is now shifting in a more positive direction, driven by improved market sentiment following the formation of the Government of National Unity (GNU), reduced load shedding, and the onset of an interest rate-cutting cycle.
These factors are collectively providing a much-needed boost to the sector’s recovery.
Garreth Elston, managing director of Golden Section Capital, a specialist in listed property, provided key insights on the performance of the real estate sector for 2024 on the latest episode of Property Pod.
Elston noted that the SA Reit sector, as reflected in the SA Property Index (Sapy), reached a significant milestone in September 2024, surpassing R400 billion in market capitalization for the first time in over four years.
The last time the sector traded above this mark was in February 2020. This sharp rebound, he explained, signals a return to rationality for the sector rather than an overdone rally, with much of the recovery based on forward earnings.
Elston credited the recovery to a combination of factors, including the supportive policies of the GNU government and a favourable shift in the interest rate cycle, both of which provide stimulus for economic growth.
In a growing economy, consumers and tenants are less likely to experience financial strain, which bodes well for the property market.
The markets are expecting further interest rate cuts, and while the most recent cut may not have an immediate impact, it signals the start of a cycle shift, Elston said.
He stressed that sentiment plays a critical role in a sector that has been under pressure for an extended period, and a turning tide in rates can uplift investor confidence.
Looking ahead, Elston remains optimistic about Reits' performance as interest rates continue to decline. He anticipates a stronger position for consumers, especially as the Christmas season approaches, which could result in more discretionary spending.
Naeem Tilly, portfolio manager and head of research at Sesfikile Capital, a firm focused exclusively on listed property investments, recently noted in a report that South African listed property has delivered a remarkable 30.1% total return year-to-date.
This strong performance outpaces bonds (+15.9%) and equities (+10.6%) by a significant margin.
Understandably, such outperformance has led some investors to question whether the rally, which began in November 2023, is nearing its peak.
"Some are asking if it’s time to 'take profits'. In our view, the re-rating seen in the property sector is justified, and several tailwinds remain to support further upside," Tilly explained.
A key driver of this rally has been the positive outcome of the recent elections and the formation of the Government of National Unity (GNU), which reduced the country’s risk premium.
This shift has contributed to a 1.8% drop in the 10-year bond yield since May 2024, bringing it down to around 10%.
Local property market fundamentals are also improving, with retail rental reversions turning positive across most shopping centre categories, making leasing more affordable than it has been in a decade. This presents a strong potential for distributable income growth.
In the industrial sector, rental prices have surged due to rising building costs, while office vacancies have compressed by 1.9% over the past year, now standing at 13.6%, with prime-grade office vacancies even lower at 7.5%.
Notably, some regions, like Cape Town and Umhlanga, are experiencing strong demand, particularly from the call-centre industry, leaving limited available space for large users.
Tilly expects net operating income (NOI) growth to align with inflation over the next two years, with recent earnings reports exceeding consensus forecasts, potentially leading to upward revisions in growth estimates.
The improving electricity supply in South Africa is another growth catalyst for landlords and tenants alike. Historically, landlords recovered around 65% of diesel costs, with the remaining 35% affecting REIT operational costs directly.
With these costs declining, coupled with reduced generator maintenance expenses, earnings are set to benefit.
Additionally, investments in solar projects, which account for the bulk of capital expenditure and yield around 15%, are further enhancing bottom-line growth.
In terms of balance sheet strength, the debt-to-asset ratio in the sector has dropped to 37%, providing capacity for debt-funded acquisitions.
This comes at an opportune time, as the cost of funding has begun to decrease. Tilly pointed to recent activity in the capital markets as a positive sign.
Vukile Property Fund, through its Spanish subsidiary Castellana, acquired three malls in Portugal for €176 million at a 9% yield, followed by a successful R1.5 billion capital raise.
Other companies, such as Lighthouse and Spear REIT, have similarly tapped into capital markets, demonstrating that growth through acquisitions is returning to the sector.
"Lastly, we believe we are on the cusp of a protracted interest-rate-cutting cycle that could last 12-18 months."
The US Federal Reserve’s larger-than-expected 0.5% rate cut and signalling of further reductions paved the way for the South African Reserve Bank (SARB) to lower rates by 0.25% in September 2024. With inflation in South Africa falling below 4.5%, the market is currently pricing in an additional 1.25% in rate cuts over the next year.
Tilly also highlighted that the sector is trading at a 23% discount to net asset value (NAV), with a 9.1% distributable income yield and around an 8% dividend yield.
Distributable income growth is forecasted to be approximately 6% per year over the next two years, surpassing local inflation, which continues to trend downward.
"In our view, we have merely seen a normalisation in a sector that was oversold – we believe there is more ‘juice in the tank,’ with total returns of 13-14% per annum expected over the next 3-5 years," Tilly concluded.
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