Has property hit the wall?

The property sector, South Africa’s best performing asset class over the past 20-odd years, hit a wobble in May retreating, along with equities, from highs resulted in the property index falling 10% in weeks.

The property sector, South Africa’s best performing asset class over the past 20-odd years, hit a wobble in May retreating, along with equities, from highs resulted in the property index falling 10% in weeks. Have macro factors turned against property, or are these buying opportunities for the brave?

Bond warnings

“This correction was not unexpected, we had been warning that the sector valuations were looking steamy the last few months,” says Mohamed Kalla, portfolio manager at property specialists Sesfikile Capital.

Earlier this year, low bond yields started to increase but property kept on going – a warning sign. “This may have had something to do with the inclusion of companies like Hyprop, Resilient, Attaq in global indices,” says Keillen Ndlovu, head: listed property funds, Stanlib. “This attracted index trackers into the market between February and May and helped drive demand – even in an environment that was starting to look volatile.”

Volatility, they say, is to be expected. Some investors believe listed property is not volatile, says Evan Robins, manager of the Old Mutual SA Quoted Property Fund.

“The primary driver in the latest selloff was not property issues, but the macroeconomically determined increase in bond yields, off which property is valued.” So is it time to get out of property?

“A 20% return is not the norm. Past returns were a result of all the stars being aligned. These included positive property fundamentals and supportive capital markets,” says Paul Duncan, investment manager with specialist real estate investor Catalyst. “The stars have come out of alignment and we may see further correction, but it does not mean the sector will not do well. Investors could expect returns of 10% to 12% a year on a five-year view.” Has the correction generated buying opportunities?

Prices are coming in at healthier levels, says Robins, but they are not cheap. Bond yields could rise to 8.5% or 9% at year-end and the market could still pull back another 5% to 10% as a function of bond yields rising, but now is not the time to panic, says Kalla. “The lower prices allow investors to pick up higher yields; there are good quality stocks offering 8% to 9% distribution yields that are still growing ahead of inflation.”

In SA, property fundamentals are tough and distribution growth is expected to slow, thus SA-based property companies like Vukile, Emira, SA Corporate and Redefine pulled back harder in the correction. That said, difficult local conditions are encouraging investors to look at companies with offshore investments.

“The valuations are more attractive and the fundamentals are strong [declining vacancies, good rental growth, and improving economic growth in US and UK],” says Ndlovu. He adds offshore property offers more diversification, not only across regions but across sectors.

Know market

Duncan says: “The SA listed property index one year forward consensus distribution growth is 9%. If you unpack this, SA-centric portfolios are delivering mid-single digit distribution growth but what is driving the average closer to 9% are those funds with offshore assets benefitting from stronger offshore property fundamentals and rand weakness.”

Yet the Catalyst team is not a big fan of SA firms going offshore. “You need to know the market. … I fear that in three to five years some of these companies may find they have bought a lemon.”

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