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Investors must tread with care

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Experts warn that the property sector’s outlook is currently impaired by weakening growth prospects coupled with a lack of confidence in corporate governance

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

The FTSE/JSE SA listed property index fell by 28% late last year since peaking in April 2016, and although there are currently pockets of opportunity, investors should proceed with caution, warns Kundayi Munzara, director and portfolio manager at Sesfikile Capital.

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

“The sector’s outlook is currently impaired by weakening growth prospects coupled with a lack of confidence with respect to corporate governance.

“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 due to the 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 rentals and escalation rates to combat lower growth in sales.

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

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

“South Africa experienced a property construction boom for much of the past two decades, most notably in retail shopping centres and office nodes such as Sandton. But the weakened economic climate has impacted on demand for space. We expect rising supply and weak demand to result in lower rentals 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.

Dunley-Owen says Allan Gray is now seeing value in property companies priced below the company’s assessment of intrinsic value, especially after last year’s correction in share prices.

“We are seeing opportunity in companies run by management teams that are 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 against this background, Munzara and Dunley-Owen say there are things to know about getting it right.

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

“Back strong management teams with a track record and experience to deal with constantly changing dynamics of the property industry, and 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.

“Also watch for management paying out more than business generates. In the quest to grow distributions, some listed property companies pay out more in dividends than their free cash flow, funding the deficit by issuing shares, taking on more debt or under-investing in their assets.”


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