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Investors must be wary

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Listed property index fell by 28% late last year

The performance of the property sector in the past 18 months has been less than desirable, and investors are urged to tread carefully.

The FTSE/JSE SA listed property index fell by a whopping 28% late last year since peaking in April 2016, and investors should be careful, warns Kundayi Munzara, director and portfolio manager at Sesfikile Capital.

Listed property is likely to deliver a total return of between 11% and 13% in the medium term.

“The sector’s outlook is being impaired by weakening growth prospects coupled with a lack of confidence with respect to corporate governance concerns. Considering the earnings downgrades, some of the recent fallout may be justified, especially considering the headwinds the sector still faces in the year ahead.

“However, given our expected return for the sector, together with the correlation to equities and bonds, listed property should form part of a balanced portfolio.”

Munzara says the retail sector is struggling because of over-supply of regional malls and anaemic demand from tenants. While companies are recording trading density growth in the low single digits, most retailers have reduced expansion plans and negotiated lower rents and escalation rates to combat lower growth in sales.

“The impact of Edcon reducing its footprint has also been felt on the market, with the brand cutting its rental bill via a combination of rental reductions and cutting back space. This will come at a cost as landlords reconfigure and re-let the space in a weak demand environment.”

The current state of listed property is not surprising considering how the country’s economic growth has declined due to structural deficiencies, says Mark Dunley-Owen, portfolio manager at Allan Gray.

“South Africa has had a property construction boom for much of the last two decades, notably in retail shopping centres and office nodes such as Sandton. But the weakened economic climate has impacted the demand for space. We expect this combination of rising supply and weak demand to result in lower rents to keep space occupied.”

Munzara is seeing value in companies in the listed property sector that have focused specialist strategies, defensive portfolios, high quality earnings and strong balance sheets.

“The preference for defensive portfolios and strong balance sheets emanates from the weak state of the economy, where rental growth and asset valuations are under pressure.”

Dunley-Owen says Allan Gray is seeing value in property companies priced below the company’s assessment of intrinsic value.

“We are seeing opportunity in companies that are run by management teams aligned with shareholders, use appropriate financial gearing, focus on cash flow rather than accounting earnings, and prioritise long-term value over short-term metrics.”

For investors contemplating investing in listed property, Munzara and Dunley-Owen say there are a few things to know about getting it right.

“A high initial yield may seem attractive, but inherent tenant risk and financial risks in the companies may be masked by this,” Munzara says.

“Back strong management teams that have a track record, as well as those that don’t underplay corporate governance.”

Investors should look out for cases where management teams are misaligned with long-term shareholders, Dunley-Owen warns.

“Investing in listed property to earn an income encourages management to make decisions that target short-term distribution expectations at the expense of long-term value, for example, refusing to sell low-quality assets because they are high yielding.

“Watch for cases where management pays out more than business generates,” he says.


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