For as long as the US continues with Quantitative Easing – running the printing presses – interest rates worldwide will remain low and non-cash assets will continue flourishing. It’s an ideal scenario for Arrowhead, the JSE-listed property group which hunts outside the areas where others focus. In the year to end September, Arrowhead bought two R100m-plus properties in the south of Johannesburg (both yielding over 11%) and has invested R400m in a low income residential housing development. Modelled into A and higher risk B shares like the old ApexHi, the stock attracted the attention of property specialist Maurice Shapiro of Altre. So we asked Maurice to join us today to look at the latest results with Arrowhead’s COO Mark Kaplan. As you’ll see (or read), there’s a definite opportunity here for those seeking high yields and not too concerned about Quantitative Easing ending soon. – AH Â Â Â
ALEC HOGG: Arrowhead Properties recorded a 12 percent growth in full year distributions and an increase of R723 million in its asset base for the year to end September. It made some pretty big investments in the past year, buying property in places like Selby and Crownwood – my old stamping ground in the south of Johannesburg. Joining us now to discuss the results and to give his input from an analyst’s perspective, is Mark Kaplan – he’s the Chief Executive of Arrowhead – and Maurice Shapiro – no relation to David – from Alternative Real Estate Fund or Altre. Mark, let’s kick off with you: it’s good to see you putting money into the south of Johannesburg, but I think there’s a Chinese connection there, isn’t there? Right next to Crownwood where you’re spending R112 million, is now China City.
MARK KAPLAN:  Yes, it wasn’t part of our investment strategy to invest in the area because of the Chinese development. However, I think what we found in Selby was a single tenant that is – I think – 50 percent owned by ABSA, and 50 percent owned by Standard Bank and we managed to get a long lease on that. We were also able to pick it up at a very attractive yield. I think it was around 11 percent. In terms of Crownwood, that is near Gold Reef City. In addition, as you mentioned in the south of Johannesburg, a multi-tenanted office park. We were able to pick that up at 11 percent as well, and it’s anchored by a government department – I think it’s the Department of Education – at least until 2019. That’s 60 percent of the income at Crownwood.
GUGULETHU MFUPHI:Â Why that area in particular?
MARK KAPLAN: Arrowhead’s strategy is not necessarily to focus on any particular area. We focus on higher yielding properties with appropriate risk levels and we look for sustainable revenue stream. We look to buy properties where the yield is well above our cost of funding.
ALEC HOGG:Â Maurice, the south of Johannesburg is not exactly where you would see most JSE-listed property funds going?
MAURICE SHAPIRO: I think for your bigger funds, there’s been a bigger focus on your Sandton A-grade. What we’ve actually found is a lot of B and C-grade in Sandton isn’t performing as well in the office space, and I think Arrowhead’s strategy is to pick up where other funds aren’t looking and finding attractive opportunities there.
ALEC HOGG: 11 percent is a wonderful yield when you think of what you’re getting from a bank?
MAURICE SHAPIRO: Absolutely, I think Arrowhead’s strategy has always been to buy yield-accretive acquisitions, to grow their book, as well as to grow their income. We’ve seen the most recent results, they’ve surprised the analyst community by delivering over 12 percent distribution growth – combined A and B units.
ALEC HOGG:  You mentioned A and B units and I think that’s what Gugu and I were trying to work out before we came on air. Just unpack it for us. I remember ApexHi used to have an A and a B and one was higher risk than the other was. How does yours work?
MARK KAPLAN:  It works on a similar model, adopted after ApexHi, really through our CEO, Gerald Leissner. How it works is, the first 60 cents is paid to the A unit, so it’s almost been a bond-like unit to date, until the crossover point, which is R1.20, and then they share in the distribution equally. What happens is, from 60 cents to R1.20 the B’s got all the growth so they were supercharged. I think what the market hasn’t anticipated, was that we would reach the crossover point so quickly. We listed with a forecast of 98 cents in the first year. We beat that and paid 100.58 cents. We then forecast ten percent growth for the next year. We beat that and we paid 12.36 percent, and now we’ve forecast between 11 and 14 percent for next year – well above the average in the sector.
GUGULETHU MFUPHI: And now a new investment in residential property – why now?
MARK KAPLAN: Our CFO, Imran Suleiman and I, were in America recently at the Reed Conference in Chicago. It was very interesting to see that between our developing economies and specifically as a part of the listed real estate there, the residential sector was between 10 and 15 percent, so it should naturally follow here. I’m not sure how many years we are behind them. Over and above that, we have a board that has fantastic experience in terms of residential property and we’ve come across opportunities that really fit Arrowhead’s strategy of buying yield-accretive or enhancing properties above our cost of funding and also diversifying risk.
ALEC HOGG:  There used to be listed residential property fund called Stanprop, and it was a poor performer. What makes you think that you’re going to get this one right?
MARK KAPLAN:  We’ve sort of been able to see an affordable housing area of the market that, in terms of rental growth and almost lack of supply, there’s a shortage of accommodation.
ALEC HOGG:  So you’re going down market – at the bottom end.
MARK KAPLAN:  We’re looking at the affordable housing market, between R500 and R4 000 in terms of rentals, and we believe that there’s a real shortage of accommodation in that area. That will lead to greater distribution growth and rental increases over the longer term.
ALEC HOGG:Â Â Doubtless there is a shortage of accommodation, but the admin costs of collection must be high?
MARK KAPLAN:  It is higher. I would say the general property manager in the residential space is 6% to 8.5% in terms of property management fees, compared to between 1.5% and 3.5% on the other side. It’s a cost that one has to factor in up front and make sure that one is buying at the correct yield after all the costs have been factored in.
ALEC HOGG:Â Â Maurice, do you like that side of this business?
MAURICE SHAPIRO: I certainly like the residential side of the business. Firstly residential only makes up one percent of listed real estate in South Africa and as Mark mentioned, it’s more like 10 to 15 percent in developed markets. That said, the only other property fund with any substantial residential, is Octodec and GrowthPoint has a small portion in the V & A. I think there’s a huge demand for residential to be let. I think, also, your vacancy factor in residential is very low. It’s only one percent. It’s a very granular income stream, so once you get it right it works well.  When you have to build up that income stream it sometimes takes some time. Arrowhead is buying a fully let group of residential properties and that’s being well managed. That’s in the cost of managing it because it’s very operationally intensive. It’s already in the cost, and maybe they’ve also acquired a ten percent yield, so we see that as yield enhancing. It’s an attractive offering, it’s diversifying, and it is also a very granular and solid income stream.
ALEC HOGG:  You spent R400 million there. Gugu and I were talking…Remember last week, the property guy…(Martin Goodman)
GUGULETHU MFUPHI: Wasn’t he from Guard Risk?
ALEC HOGG:  He’s from Rentsure, but he said… What was the percentage of insurance that he wanted? Was it ten percent?
GUGULETHU MFUPHI:Â Ten percent.
ALEC HOGG:  He said if you want a guarantee that you’re going to get your money from a property client, you have to pay them an insurance policy of ten percent. That’s a lot higher than the numbers that you people are talking about.
MARK KAPLAN:  I’m sorry. Just explain the question to me again.
ALEC HOGG:  What they are marketing is that many people don’t pay their rent. Consequently, if you want to guarantee that you’re going to get your rent from residential – which clearly you put R400 million into – you have to pay a ten percent insurance premium to make sure that the money comes to you.
MARK KAPLAN:  Like I say, I’ve been involved in running a portfolio of R500 million in terms of affordable housing and student housing too, and I think it operates slightly differently – definitely in the areas that we’ll look to buy. I think the general principle is that people pay one month’s rent in advance and a deposit, so effectively, for a year’s rental you’re paying two months. I think with low vacancy rates as Maurice mentioned – around one percent – that should something go bad, you replace the tenant and fill it with another spot. That seems adequate and if you speak to any residential player in the country, I think they will confirm that, specifically in the affordable housing market.
ALEC HOGG:  So this guy’s overcharging. Is that what you’re telling us?
MAURICE SHAPIRO: I think what Mark was saying is that with your residential properties you’re putting down deposits beforehand. You do have tenants defaulting, but it’s on occasion and you have their deposit. You also have a huge demand and there’s a waiting list, so it’s easy to fill the space afterwards. That’s really key, and that’s why there’s a whole business insuring residential income, because you can make a good premium and the risk is quite low.
GUGULETHU MFUPHI: There’s an opportunity. There’s money to be made, Alec. Maurice, I’d like to bring you into the investment landscape with regard to property in South Africa. Not too long ago we saw a Chinese property developer moving into the South African space and purchasing land from AECI. When you look at our property space, are foreigners picking it up?
MAURICE SHAPIRO: I think there’s definitely far more interest from foreigners. We’ve seen, even in the listed space the percentage of foreign ownership has certainly increased. That said, as you were discussing in your prior report, was all about ‘where are the interest rates going and how is that going to play out?’ I think that’s probably quite crucial in investing in South Africa, when you start talking about that compared to investments elsewhere. We’re quite concerned about interest rates at the moment. You have to be very selective when acquiring any kind of asset, whether you’re doing it from a direct property or a listed fund/. That’s how we operate. We’re very selective in what we choose. We don’t like to own all the listed property stocks. We only want to own a few of them.
ALEC HOGG:  You’re riding a tiger though, with Quantitative Easing. If the tiger breaks loose or if they start “tapering” – horrible word for you investment types – then the game’s going to change.
MAURICE SHAPIRO: Yes, I think that’s an important element. I think, from the comments that we’ve seen out of the Fed recently in May and September, tapering was on and tapering was off. Now tapering might not be on or it’s only going to happen later. It’s very hard to get off QE once you’re on it.
ALEC HOGG:  It’s like a drug.
MAURICE SHAPIRO: It’s a drug, and it’s unlikely, given the kind of growth prospects, we’re seeing in the US that they’re going to get off the QE train any time soon. That said, I don’t believe that SA bond yields are going to suddenly go down either. I think we might actually find the opposite happening here. Just because you have money to invest doesn’t mean it’s going to find its home in South Africa. I think QE might be there for a bit longer, but the risk might still be off and South Africa might be a beneficiary.
