Locally and globally uncertainty abounds - and looks set to continue. At the same time, global interest rates seem to be at long-term lows and there is speculation about which direction rates will move in the near future. Amidst this environment, we examine the potential impact on the listed property sector.
Interest rates and listed property: where are we headed?
Interest rates globally are at long-term lows, which translates to a greater risk of interest rate hikes. The below charts show that central bank interest rates for a number of countries are currently lower than they historically were. This is not to say that they can’t decrease further – we’ve seen negative rates in some countries – but rather that there is greater likelihood of them increasing. In the local market, while the South African Reserve Bank (SARB) interest rate isn’t the lowest it’s ever been, the recent cabinet reshuffle and rating downgrade is likely to put upward pressure on inflation and in turn interest rates in the long term.
The question on investors’ minds is whether rising interest rates will have an adverse effect on the listed property market.
It is important to note that there are other factors that are more important than interest rates alone. Not to say that they don’t matter – REITs are levered and high interest rates will weigh on them. These companies tend to be quite capital intensive, and as a result are sensitive to rising interest rates. Historically investors saw property as a bond proxy because of the fact that when interest rates rise, it becomes more expensive to service debt and this affects the yield you can get on property. The key to how well globally listed property companies do will be based on supply and demand dynamics and how those lead to landlord pricing power – i.e. the extent to which high tenant demand and lower supply lead to higher rental incomes. In our local market, supply and demand will play a role, but also the extent of rand weakness or strength given the larger and ever-increasing offshore exposure of South African listed property companies.
The local property market – how local is it?
The graph below shows the SA 10-year bond yield and the dividend yield on the South African Listed Property index (SAPY). These tended to move in tandem before the latter half of 2015 – when bond yields rose, property yields would also rise; and when bond yields fell, property yields would also fall.
There was a breakdown of this relationship in recent years due to the increased offshore exposure that South African property companies have been adding to their portfolios. This increased the market’s sensitivity to how the rand is doing relative to other currencies. As at the end of March 2017, the South African Listed Property index only had 62.5% exposure to the South African market due to property companies trying to diversify away their exposure to the South African economy.
What are the trends in the global listed property space?
The global nature of listed property can be seen in the rise of the REIT structure. The REIT (Real Estate Investment Trust) structure is a listed property investment vehicle, where a tax dispensation ensures flow through of net property income after expenses and interest (Source: SA REIT Association). REITs typically pay out the majority of their taxable income as dividends to shareholders, and in turn shareholders pay the income taxes on those dividends. Over the past 10 years, more and more countries have adopted the REIT approach that originally came from the United States of America in 1960. This structure was introduced in South Africa in May 2013 as a way of creating a unified tax treatment of SA property companies. It also made the SA property market more internationally competitive because the REIT structure is seen as an international standard for property investment (Source: www.sareit.com).
The below table shows the growing number of countries that have adopted the REIT approach since it was initiated.
The influence of technology on the global real estate market continues to be a major trend that will change the real estate market as we know it. The disruption technology is causing has both positive and negative consequences in real estate. Globally, retail REITs have been under pressure because of this disruption. While Amazon recently reported positive sales growth, a number of retailers reported department store closures. Even with these, the high quality mall REITs were barely impacted and reported solid occupancy levels since closures are often an opportunity to re-lease these spaces to fresh tenants at higher rentals. Some online companies see these spaces as an extension of their digital sales channel and an opportunity to interact with their clients. (Source: Resolution Capital)
But what about the challenging environment we’re in?
This isn’t the only challenging environment the market has ever encountered. Over the last 30 years, the listed property sector globally has encountered a number of challenges, such as:
- 1987 crash, aka “Black Monday”
- 1990’s real estate crash
- 1997 Asian Financial Crisis
- Sub-prime/Global Financial Crisis
- Political uncertainty e.g. BREXIT, Trump, Zuma
The property market in general will always challenge, and trying to time it is exceptionally difficult. However, as long as you’re invested in good quality real estate and remember that listed property investing is for the long term, your investment should beat inflation over the long term.
According to Resolution Capital, real estate crashes are usually caused by excessive debt levels – but we are not seeing that in the current environment. Globally, REITs are being disciplined – many have diversified sources of debt, have staggered and lengthened their maturities, and are staying focussed on their core markets. They are generally being responsible stewards of capital.
(Source: Resolution Capital)
Why invest in property?
Listed property is an asset class that can be seen as a hybrid - displaying the characteristics of both bonds and equity. One gets an income stream from rental income and the potential for growth in that income as a result of contractual rental escalations, as well as the potential for capital growth from property prices rising. The below graph shows the quarterly split between income and price appreciation for South African listed property. The income portion is consistently positive, even during periods where the price appreciation was negative.
With the right manager, by investing in listed property you can potentially gain access to some of the best properties in a particular region or the world. You also gain access to a portfolio that offers diverse exposure to property, such as shopping malls or office space, at a much lower cost than if you had to buy into them yourself. It’s the quickest and easiest way to invest in property. It’s also an effective diversification tool in a portfolio.
Nedgroup Investments and the listed property market
To enable investors to gain access to the benefits of listed property through investing with high quality fund managers, Nedgroup Investments offers two funds:
- The Nedgroup Investments Property fund, managed by Ian Anderson of Bridge Fund Managers, invests only in South African listed property companies, aiming to achieve a high level of current income, inflation-hedged income growth, and long term capital appreciation. Bridge Fund Managers’ strategy of intentionally limiting size gives them a larger opportunity set than some managers. Because of where the value lies at the moment, as well as their small size, they are able to invest in small and mid-sized, domestic-focused listed property companies that are trading at substantial discounts to net asset value due to a lack of institutional support. These property companies offer investors attractive initial income yields well in excess of the yields on longer-dated government bonds, and growth in distributions in excess of inflation over the short and medium term.(Source: Bridge Fund Managers)
- The Nedgroup Investments Global Property fund, managed by Resolution Capital, aims to provide investors with steady medium to long-term capital growth by investing primarily in listed real estate companies and REITs worldwide. The Fund focuses on real estate in major cities globally that is in prime locations, and in markets where the supply and demand characteristics lead to landlord pricing power. While the REIT landscape is ever changing, they see their main task as remaining focused on the longer-term drivers of the sector, while being alert to actual events that will have clear implications for their investment universe. (Source: Resolution Capital)