Navigating real estate investments – stay put or go abroad?

Property is often viewed as a homogenous asset class, but every asset presents a unique balance of risk and reward; the decision to allocate between domestic and offshore markets is complex and demands thorough deliberation.

Nesi Chetty, CFA

STANLIB Portfolio Manager and Head of Property

South African Investors: Local and Global Property Markets

South African investors have historically been cautious when considering their allocation between local and global property markets. Between 2005 and 2017, the local property sector experienced a robust bull market which rewarded investors with significant capital growth and rising distributions and making South African Real Estate Investment Trusts (REITs) some of the top performing property investments in the world. However, since 2018 the local real estate sector has produced poorer investor returns with greater volatility, impacted by cyclical challenges and country-specific headwinds. As a result, South African investors have turned to global REITs for diversification and better fundamentals.

Against an unexciting domestic backdrop SA REITs have proactively invested in offshore property, expanding into regions like central and eastern Europe, the UK, western Europe, and more recently, the US. In central and eastern Europe, particularly in NATO members like Romania and Poland, the recovery in both retail and residential property is well underway and looks set to continue amid improving expectations for economic growth this year and next. In addition retail footfall and trading densities are set to surpass pre-pandemic levels.

Challenges in the SA Property Market

Investors expect South African property assets to generate income and capital growth despite ongoing structural and cyclical headwinds, not least sluggish growth in discretionary spending, the rising cost of living (especially energy expenses) and persistently high unemployment. Despite these challenges, SA property companies can still generate rental growth in high quality assets in logistics and certain segments of retail. The office sector has suffered a perfect storm: the COVID-19 pandemic revolutionised the world of work and forced corporates to rethink their real estate strategy; tenant retention rates appear to have stabilised but increased working from home is a new normal. Property companies also face rising cost-to-income ratios due to factors beyond their control such as municipal rates and taxes.

Like their peers in many other sectors of the SA economy, the ability of property companies to grow net operating income is being hampered by inadequate service delivery and escalating municipal, water, and electricity costs. To counterbalance these local difficulties, large South African REITs like Growthpoint, Redefine, Vukile, and Hyprop have diversified into offshore investments. However the weakness of local market conditions have increased discounts to net asset value (NAV) and diminished the banks’ appetite for exposure to the sector, making it harder for the sector to raise equity and debt capital for growth. Moreover, the rise in interest rates over the past 18 months have prompted SA property companies to strengthen their balance sheets by reducing debt and, in some instances, paying out less of their earnings in dividends.

Outlook for the South African Market

The property sector’s challenges are well understood; as a result, South African REITs are cheap relative to their historic valuations and other classes of risk assets. All else being equal, this provides a good starting point for investors looking for opportunities in the sector over the next 18 months. The difficulties facing the sector mean that there will be winners and losers, however; careful stock selection will be essential in a sector experiencing elevated volatility due to rising bond yields in South Africa and globally. However, forecasts indicate that the sector could deliver nearly double-digit returns over the coming year, most of which contributed by income rather than capital growth.

The Benefits of Global REITs in a Portfolio

The US accounts for 65% of the value of global developed market property. There are now over 400 listed US REITs, offering investors exposure to established asset classes including retail, offices, residential spaces and logistics as well as emerging sectors like data centres, senior housing, healthcare, and hospitality assets.

At the time of writing, the US Federal Reserve had paused its interest rate hiking cycle after the most aggressive sequence of rate rises in four decades. Property is a rate-sensitive sector, so the unprecedented 500 basis point increase in the Federal Funds target rate since early 2022, has predictably driven the underperformance of global property against broad equity indices over the 12 months to June 2023. As the Federal Reserve approaches its inflation and rate objectives, the outlook for global REITs becomes more positive.

South African REIT Investors: The Opportunity to Blend Local and Global Exposure

The universe of REITs listed in South Africa and across global markets give investors the tools to express nuanced views across property asset classes and geographies. The cyclical and operational headwinds facing the SA property market are priced to high yields and substantial NAV discounts, while international REITs offer SA investors diversification, access to niche subsectors, and the possibility of currency gains. Sophisticated SA investors can blend local and global REITs in their investment portfolios to achieve a balanced and diversified approach.

Ends.

About STANLIB

STANLIB, which is part of the Standard Bank Group, is one of South Africa’s largest investment managers, administering over R600 billion in assets under management (as at December 2022). The depth and breadth of the investment teams gives investors a range of options to preserve capital and create wealth. It offers specialist investment management disciplines – from fixed income to multi-asset, listed property, balanced, equity and alternatives, across a broad choice of traditional and alternative asset classes and multiple investment strategies, including active and passive management, as well as single and multi-manager capabilities.

STANLIB Asset Management (Pty) Ltd, an authorised financial services provider (FSP) under, FSP No. 719, under the Financial Advisory and Intermediary Services Act (FAIS), Act No. 37 of 2002