A challenging macroeconomic environment coupled with a pandemic have weighed heavily on property fundamentals.Once the best-performing asset class on the JSE, listed property has undergone a significant rerating in recent years, last year posting a negative return of 35%. The impact of Covid-19 has forced property companies to preserve capital, reset the earnings base through rental reversions and cost interventions and focus on key balance sheet repair, according to Stanlib.
Now, the sector is on the rise returning 6% to 8% to end March so far this year, says Keillen Ndlovu, head of listed property funds at Stanlib. Analyst sentiment too hints at the period of underperformance and negative returns coming to an end with upside potential in the stocks.
“The sector is beginning to attract some capital inflows post the sell-off in 2020 with the impact of Covid-19 in the base and as visibility improves and operational uncertainty reduces. Investors were attracted to companies with balance sheets that had low gearing and strong liquidity positions. While this remains in focus, we think investors are placing more emphasis on yield and the ability for companies to provide a return to shareholders,” Ridwaan Loonat, property analyst at Nedbank CIB, tells finweek.
In its heyday, property traded at 10% to 20% above net asset value (NAV). Now, Ndlovu believes the sector is largely undervalued and presents a good value proposition for investors. “The sector is trading at a discount to NAV of about 30%. Given some of the challenges, property is likely to continue to trade at a discount. We believe a discount of 10% to 20% is fair over the medium term (i.e. lower discount and therefore higher share prices over time). [The] discount is supported by the fact that property values are still likely to decline but at a lower rate than last year.”
He says the sector is offering a yield of about 8% to 9% based on distribution per share. Distribution per share assumes a lower pay-out ratio, the minimum being 75% per real estate investment trust (Reit) legislation. On a distributable income per share basis, property is trading at a yield of 11% to 12%. Ndlovu says property is likely to continue to trade at yields above bond yields. Thus, at a discount to bonds.
“We are looking at double-digit returns over the next year (from end March), which are coming off last year’s very low base. However, the forecast risk remains high due to uncertainty around Covid-19 and concerns around a third wave. Our bull case indicates 25% total returns compared to a base case of 15% and a bear case of 6% total returns (income and capital),” says Ndlovu.
Recalibrated property landscape
The pandemic has had a massive impact on earnings, asset values and vacancies. SA’s retail and office spaces are paying the price for oversupply. Even before the pandemic it was beginning to play out.
Capital growth and income returns have dropped sharply with retail posting the lowest returns in 2020.
Rentals are reverting downwards. Property is highly correlated to the underlying economy with a lack of growth weighing on tenants’ profitability and the ability for landlords to grow rentals.
“The sector has enjoyed above-inflation rental escalations, which resulted in leases being over-rented, thus we expect to see negative reversions [lower rental rates on renewed leases] across the board in the short term,” says Loonat.
The office sector has been worst hit by vacancies, the South African Property Owners’ Association (Sapoa) citing a national average of 13.3% in the fourth quarter of 2020, the highest in 16 years. Retail vacancies came in at 6.1% with regional and superregional malls most impacted by Covid-19.
“The property sector is struggling to contain vacancies but the overall increase in vacancy rates is still better than what was initially feared,” says Loonat.
Ndlovu says last year saw asset write-downs of around 15% in the listed property sector. But writedowns are slowing down into single-digit declines in 2021. Still, he believes bigger malls will feel more pain. “Some are oversized for the new environment we are now in. The market is concerned with large superregional shopping centres (above 100 000m2) in general. But it’s difficult to value the underlying assets. Most super-regional centre valuations are theoretical, as there’s been no transactional activity over the years.”
This challenging period has also revealed the importance of acquisition price. “If you don’t buy your assets at the right price, when you get into tough times revalues are going to come through and suddenly your loan-to-value (LTV) shoots through the roof,” says Darren Wilder, CEO of Fairvest Property Holdings.
Valuations continue to be in the spotlight as investors focus on LTV and the possibility of covenant breaches. “We initially saw an average decline of around 8% in the SA Reit sector, with those exposed to hospitality and super-regional centres harder hit,” says Loonat. He expects valuations to come off in the short term but believes the worst is over.
Ndlovu says 2021 is a year of reducing debt levels, driven mainly by reduction in pay-out ratios, asset disposals and to a far lesser extent, raising equity. “While there is also a need to focus on interest cover ratios (ICR) [higher is better], the market seems to be fixated with just LTV. The LTV ratio for the sector sits at about 42% and most Reits are doing their best to take it to below 40%.”
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