The local property sector loses
All good things come to an end
For the ten years to the end of December 2014, the average South African property unit trust produced an annualised return of 19.66%. It was a remarkable decade for the asset class, and investors benefited enormously.
Over the last three years, however, things have been far less rosy. The top-performing property fund over this period has returned just over 6.5% per annum.
It is inevitable that 20% returns per year could not continue forever, and some normalisation had to take place. However, quite a lot of the shine has come off listed property with asset managers in general being far less enthusiastic about its prospects.
After ten years of great returns, property returns have slowed down
Source: Profile Data
This is not just because of the concerns around Resilient and its associated companies. Some fundamental questions are being asked about the local property market.
“The operating environment remains tough,” says Mark Seymour, director of fixed income at Northstar Asset Management. “It has become more difficult for property companies to retain clients, the lack of business confidence has translated into shorter lease terms, supply has been exceeding demand across the retail, office and industrial sectors, and vacancies have been rising.”
Northstar is underweight property and has been for a while. Many asset managers have adopted a similar approach, even some that have been very bullish on property in the past.
This is despite the fact that business confidence is improving and the country's economic prospects are looking better under the Ramaphosa administration. As Seymour notes:
Mark Seymour says the operating environment remains tough.
Cyril Ramaphosa's presidency has given the country some reason to celebrate.
“Ramaphosa has implemented changes that will improve the chances of stronger growth going forward. He is putting in the correct structural reforms, has pledged to root out corruption, and begun a process of overhauling the boards of state-owned enterprises, all of which are steps in the right direction and which recently helped SA avoid a credit downgrade by Moody’s.
These factors are supportive of lower bond yields, a stronger rand and lower inflation, which are all important factors supportive of South African-focused property company valuations.”
However, the impacts are not immediate.
“Although we have seen the effects of 'Ramaphoria' and some South African assets have priced higher, we still haven't seen any improvement in fundamentals,” says Yusuf Mowlana, an analyst at Allan Gray. “Office rental growth in Sandton is probably zero in nominal terms, which is negative in real terms. In the retail sector we have had a number of years where large centres have been showing below-inflation trading density growth. It's unsustainable for trading density to be growing below rental escalations, so to my mind that means we should be seeing lower growth from retail as well.”
As for the industrial sector, what happens there is very much a factor of how the economy performs.
“We haven't yet seen growth, but what we do see is that assets that have been on ten-year leases have seen very strong negative reversions, and that makes us a bit cautious,” says Mowlana.
“Ramaphosa has implemented changes that will improve the chances of stronger growth going forward. He is putting in the correct structural reforms, has pledged to root out corruption, and begun a process of overhauling the boards of state-owned enterprises, all of which are steps in the right direction”
The retail conundrum
The majority of local listed property assets are however in the retail space, and questions have been asked for some time about over-capacity.
“South Africa has a very high retail space per capita ratio compared to other emerging markets,” Seymour points out. “To put this into context, the Constantia Village shopping mall in Cape Town should accommodate about 45 000 people. The same size shopping centre in an average emerging market would be servicing 150 000 people to remain economically viable.”
Constantia shopping mall accommodates 45 000 shoppers, far fewer than in your average emerging market.
The table below shows a comparison between South Africa and a selection of other countries in terms of retail space per capita measure.
Source: Northstar Asset Management
New builds are cannibalising existing malls.
Even at these levels, however, new malls are being built, and existing malls are being expanded and upgraded. “I think it is a very serious concern,” Mowlana says. “The issue is competition.”
If South Africa has reached retail capacity, new malls or upgraded malls are not attracting new customers. They are just drawing them away from somewhere else.
As an example, Mowlana cites the Glen Mall in Johannesburg, which suffered a severe knock to its trading density. Hyprop is now spending R90 million to refurbish it.
“What often happens is that landlords feel they are in for a penny, in for a pound,” says Mowlana. “When there is competition they either go backwards or they have to spend capex to update their malls and bring in more restaurants or entertainment and hope that things pick up and they can take share from another mall. But if there is lacklustre sales growth the pie isn't growing and you are spending money with no guarantee that you will earn a good return on it.”
The Glen Shopping Centre is an example of a mall that saw trading density fall as centres grew up around it.
Seymour agrees that this is an issue that has to be watched carefully.
“The growing issue is the pace of new supply,” he says. “In the retail space, there are 68 new shopping centres being added over the next four years. This represents 17 new malls a year, which is less than the 49 malls per year supplied between 2000 and 2010, however the new malls are on average twice the size. In area terms, the pace of new supply is therefore only marginally slower relative to a decade ago, which may be a problem given the lower demand growth currently as a result of lower GDP and the tangible signs of over-saturation in the retail space.”
For investors this means that they should tread warily when making new investments in the sector, and constantly re-evaluate current holdings.■