Time to buy or cut loose? SA property companies report value destruction, rental declines

Commercial property returns in South Africa recorded a negative total return of -1.7% from 3.7% in H2 2019.

Furthermore, capital growth was also lowest on record reaching -5.3% with income return down 30bps to 3.7%, according to MSCI. The MSCI Index comprises of listed and private funds.

The MSCI South Africa Bi-Annual Property Index: June 2020 shows the national lockdown negatively impacted capital growth and income return.

“The property returns that we’re seeing are reflective of the impact that Covid-19 had on net income growth in H12020. Additionally, the no growth environment that landlords and tenants are operating in,” says Eileen Andrew, MSCI Vice President.

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She says with economic forecasts showing that GDP recovery will be slow, this puts downward pressure on rentals. This will hinder new tenants from entering the market, and coupled with rising vacancies will suppress returns.

Industrial sector outperforms

Data reveals that within sectors, certain property types are able to adapt to the tenant’s changing needs for space. As a result, these segments have proved to be defensive through these tough times.

Eileen Andrew

Industrial property was the top performer achieving a total return of 0.9% while all other sectors delivered negative total returns.

Hotel assets were the worst affected at -6.9% as the lockdown and associated travel restrictions had an immediate impact on the sector. Residential and office property sectors recorded total returns of -1.2% and -0.9% respectively with retail sector achieving -2.8%.

Overall, commercial property vacancy rate increased during the six months reaching 7.4%, above the 6.6% recorded in 2011.

Valuations under pressure

As a result of property fundamentals under severe strain, there is lack of growth in valuation, with little prospect to improve.

Andrew explains that valuations for commercial property are based on predicted future income growth and a capitalisation/discount rate. There has been overall negative movement in cap rates by 25bps.

“We will have to wait to see if these will move out further in the December 2020 valuations. As long as net income contracts we will continue to see valuations decrease, resulting from the Covid-19 impact,” says Andrew.

Listed property

The listed sector was trading at a discount to NAV of 43% at the end of October 2020. According to Catalyst Fund Managers, the premium was 6% three years ago. Catalyst expects property valuations to decline in the short-term due to the weak property fundamentals facing the sector.

Mvula Seroto

According to MSCI data, the current capitalisation rate of 8.3% for all property assets is 50bps below its long-term average.

“We see risks of capitalisation rates moving out in the next 12-24 months,” says Mvula Seroto, Portfolio Manager at Catalyst Fund Managers. This will be in line with increased bond yields and structural risks facing certain retail categories and offices.

Valuers historically factored in rental growth of between 5% – 6% in valuations, and Catalyst’s forecasts lower growth for rentals. This would be due to the long-term negative impact of Covid-19 on what was an already weak property fundamentals market outlook.

New leases escalations are trending lower to track inflation and likely to persist in the short to medium-term. Reversions on expiring leases in offices and certain retail categories are negative.

“Due to oversupply in most subsectors, high vacancies, and subdued market rental growth, negative reversions are expected to persist in the short to medium-term. This would impact on like for like net operating income growth,” says Seroto.

Outlook for listed sector

Catalyst Fund Managers expect forward funds available for distribution to be 13.5%. “We expect continued pressure on rent collections and elevated gearing positions to impact on the actual dividends declared.”

Growth will be moderate in line with current economic conditions, thus translating into lower market rental growth across most sub-sectors.

Seroto says their five-year annualised total return forecasts for the sector ranges between 18%-22%. However, over the short-term, markets are expected to be volatile as the impact of Covid-19 plays out.

Catalyst managers think the market is overly pessimistic and over-pricing the risks facing the sector. Listed property companies will get through the crisis, albeit not to levels seen pre-Covid-19.

“There will be some permanent value destruction, however, for patient investors, the sector shows good long-term value,” adds Seroto.

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