Sunday

Strong momentum continues to lead the listed property sector

Strong momentum continues to lead the listed property sector higher in 2012, which was very similar to what happened towards the end of 2011. Excluding the international linked stocks like RIN, Nepi and MAS, the sector’s market capitalisation recently came within R1bn of being R200bn in size, led by share price performance, new listings and secondary equity issuances.

Listed property has been following bond yields very closely. Despite the weaker rand and subsequent increase in yields recently, SA bonds remain strong, largely taking their lead from the downward trend in US bond yields. The rolling 10 yr bond yield has still decreased by 39bps from the end of June despite a 35bps increase from its recent lows. The potential of an interest rate cut continues to be priced into the shorter end of the yield curve. Inflation expectations seem to be less bearish than earlier this year while dovish statements by the Reserve Bank point to likely interest rate
intervention if the economic and financial market signals out of Europe deteriorate further. This is leading to stronger
trading volumes within the sector, with momentum again closing in on that of 1Q12, which was very strong. Another recent boost for the sector was probably a renewed focus on potential corporate action with some potential bid premiums being priced into stocks which the market may view as potential take over targets. All of these pushed the sector to delivering a total return of 12% since the end of June, resulting in a total return since the start of the year of close to 34%, thereby strongly outperforming both equities and bonds.

August usually provides a good barometer of where we are in the property cycle as 60% of the sector’s market capitalisation is involved in reporting. The sector delivered a weighted average distribution growth of 5.9%. Trends captured within the results, which remain fairly similar to what we’ve experienced earlier this year, include stabilizing and even improving vacancies while reversions on existing tenants are mostly positive, but focus on total occupancy cost for tenants remain key driver on how much is tolerable. Landlords however need to take big rental cuts to get new tenants to commit in all three sectors. A-grade office vacancies continue to improve while B-grade vacancies are stabilising, but demand for this space is still weak. There is little scope for further value to be extracted from filling strong retail centres and overall industrial vacancies while large capital spend is necessary to reposition weaker centres
and industrial mini and midi units for tenanting. Operating cost ratios are stabilising and even improving with an increased focus on electricity and water efficiencies. With overall tenant retention ratios improving less pressure is
being placed on operating cost ratios from higher lease commissions and incentives to get space filled while bad debts and arrears are improving.

As usual the property companies continue to recycle capital into new assets. What is evident is the increased appetite for speculative developments, some of it through land banking while projects in the ground already are mostly industrial (logistic and distribution linked within park like environments) and office (in vicinity of Gautrain stations) driven. Funding margins are favourable for development projects being part equity part capital market funded and it seems that at least 150bps – 200bps margin on development yields vs. funding costs are achievable. The capital investment of some of the more recent listings within the sector continues (rural, township and commuter retail remain firmly on the radar screen with yields being paid moving into the 8% levels), which is also going hand in hand with equity issuances. Larger funds are utilising the opportunity to clean up their portfolios, leading to some churn within the sector. Africa ex South Africa is coming more into play with many companies looking to gain a foothold into the continent some or other way

With the sector running so hard over the last year it remains difficult to predict what will happen going forward. The strong correlation with bond yields points to how the fortunes of the sector will in all likelihood be very closely tied with that of the bond market. Although inflationary risks remain within the system, South African bond yields continue to trade more in line with global bond markets, which remain at low yields. I expect the sector to lose a bit of steam and move back into a narrower yield gap band. However, if interest rates remain at current levels for longer the sector should still have some level of support from yield seeking investors.