Listed Property: The Best and Worst times

The opening line in Charles Dickens’ A Tale of Two Cities — “It was the best of times; it was the worst of times” — perfectly encapsulates the current state of the SA listed property sector.
On the one hand, low interest rates and stable sector fundamentals bode well for the outlook. However, some factors present significant challenges for returns in 2014. These include poor economic growth fuelled by labour unrest; the threat to the long end of the yield curve emanating from the US Fed’s wind-down of its bond buying programme; a potential credit downgrade; and the potential for interest rates to rise as inflation ticks up.
The SA listed property sector is expected to deliver a total return of 8,8% in 2014, similar to that of 2013. For the year to date, the sector is up 3,95%.
But before looking forward, let us summarise the past 12 months. The SA listed property index delivered a subdued total return of 8,4% in 2013, of which 6,7% was income return and 1,7% capital return. As an asset class, listed property underperformed equities (Alsi: 21,4%), but outperformed bonds (Albi: 0,5%) and cash (Stefi: 5,2%). Over the past 10 years, the property sector generated an annualised total return of 22%, marginally ahead of equities (Alsi: 19,6%).
On an unannualised basis, the sector’s best performing stocks were Redefine International, New Europe Property Investments, Hospitality B, Rockcastle and Fortress B. The central theme among most of the top performing counters was the foreign currency denominated earnings.
It was a mixed year for global property stocks. The upward shift in global bond yields resulted in lacklustre returns for Australia, Asia and the US. Measured in US dollars, the best performing region was the UK (25%) and developed Europe (16%). The 24% devaluation in the domestic currency relative to the US dollar led to superior total returns for offshore property measured in rand.
The physical property market recorded a strong recovery in 2013. The Sapoa/IPD SA biannual property indicator showed that the overall commercial property market delivered a 9,2% total return for the first six months of 2013, made up of capital growth of 4,9% and income return of 4,2%. On an annualised basis, total return was 19,2%, which is above the long-term average of 15,8%.
Despite weak economic fundamentals, the demand side of property remains firm. Announced store openings by national retailers so far outpace store closings. Demand is in part being driven by developers who have low asking rentals, high tenant installation allowances and generous lease cancellation clauses. On a smaller scale, demand is emanating from nontraditional retailers such as the department of home affairs and the SA Social Security Agency.
International retailers such as Zara, Cotton On (including Factorie and Typo brands) and Top Shop (through Edcon) continued their rapid expansion in SA in 2013. Demand by international retailers will continue in 2014, with Swedish clothing retailer H&M announcing that it was planning to open several stores in SA.
Edcon is rolling out a number of new mono-branded stores such as Tom Tailor (Germany), Lucky Brand (US) Dune (UK), TM Lewin (UK), Lipsy (UK) and Mac. We expect retail space to expand by 4% in 2014. New shopping centre developments completed slowed in 2013, with the most notable openings being Cradlestone Mall (76 000m²), Secunda Mall (56800m²) and Tubatse Crossing (45 000m²). Confirmed shopping centre openings over the next three years include the Mall of Africa (116 000m²), Forest Hill (72 000m²) and Mall of the South (65 000m²).
The office sector remains most challenging, owing to changing tenant behaviour and new supply. Increasing office utilisation ratios are a structural trend in the office sector. Specifications on a number of new developments have confirmed the trend. For example, the new Standard Bank development in Rosebank is built to accommodate 5600 staff, or 11,6m²/employee. One of the methods being used to reduce space requirements is desk sharing or hot desks. Due to annual leave, sick leave, outside appointments or meetings, it is estimated that about one-third of desks are unoccupied at any given time. In such a system, workers no longer have their own desk but instead can sit anywhere. The advantages of this approach are more efficient use of existing space and improved cross-departmental communication in the office. Office demand is also being affected by the preference for sustainable, green developments.
According to the latest Sapoa office vacancy survey, about 817000m² of office space will be developed over the next 12 months, amounting to 5% of the current stock in the market. What concerns us most is that just 46% of new developments are committed to, resulting in potential increase in vacancies of 200 basis points to 12,8%. We highlight particular pressure seen in Sandton, the Cape Town CBD and Centurion.
Given current industrial vacancy rates, we expect a ramp-up of speculative industrial supply through 2015. Growing obsolescence of older stock will fuel some near-term replacement supply, as will a shortage of state-of-the-art bulk warehouses. We deduce that the SA industrial property market will expand by 4,5% in 2014. With industrial demand drivers operating at a moderate pace for the next year, broad supply-side threats are at least two years off.
Following a period of new listings, 2014 is already shaping up to be the year of consolidation. This is driven by slowing rental growth due to weak demand-side indicators, the drive to utilise the low cost of capital and cost reduction (perhaps through internalising asset and property management functions). With bond yields likely to rise further, smaller caps may find it difficult to access funding for growth in 2014, thereby opening up the possibility of corporate action.
A number of funds have either made formal offers or positioned themselves to make acquisitions. The largest potential transaction is that of sector heavyweight Growthpoint and mid-cap counters Acucap and Sycom. Should all potential deals go through, the sector could shrink by 13 in number. Though this reduces the options and active management opportunities for investors, consolidation will improve liquidity and open up the sector to potential foreign investment.
via Financial Mail