Real Estate Investor Magazine South Africa November 2013

SMART MOVES BY IAN ANDERSON Despite The Tough Economy Listed still delivers results S hare prices in South Africa’s listed property sector have declined by about 15% since May. The sharp decline was sparked by fears that the US Federal Reserve (Fed) would ‘taper’ its bond purchase programme. The threat of reduced bond purchases sent US Treasury yields soaring and placed upward pressure on bond yields throughout the world. The Fed’s actions also impacted South Africa’s listed property sector, as many investors value listed property on a yield-relative basis. Listed property companies exhibit equity-like characteristics as they produce profits (rental revenues less expenses less borrowing costs) that grow over time at a rate above inf lation. However, they also offer a high initial income yield, comparable to the yield of a government or corporate bond. If bond yields rise, the yieldrelative investors start demanding higher yields from listed property. This is achieved through lower share prices, but ignores the fact that, unlike bonds, listed property companies produce income streams that grow over time. Despite the tough economic backdrop of the past five years, listed property companies in South Africa have delivered remarkably robust earnings growth. Distribution growth bottomed out in the second quarter of 2013 at approximately 5.3%, but has since accelerated to 6.8%. The prognosis for 2014 and 2015 suggests further acceleration in distribution growth rates towards 8%. Listed property thus offers investors a current income yield of more than 7% AND growth in that income of between 7% and 8% per year. Most l isted proper t y companies have delivered distribution growth in excess of market expectations over the past six months, primarily due to lower borrowing costs, cost containment, proactive property management and income-enhancing acquisitions. With interest rates having stayed lower for longer, the listed property sector has enjoyed historically low borrowing costs from traditional lenders like banks. Listed property companies are also accessing the debt capital markets through domestic medium-term note programmes, which makes accessing capital easier and cheaper. The recent rise in bond yields is likely to place upward pressure on borrowing costs, but interest rates are likely to remain unchanged for the next year. Increasingly, South African listed property companies are internalising their management SA Listed Property Sector Distribution Growth 25% 20% 15% 10% 5% 2004 50 South Africa’s listed property sector has been able to attract highly-skilled and talented property managers and asset managers. This has resulted in innovative strategies to retain and attract tenants, driving vacancy rates lower. Brand awareness and advertising campaigns are also helping in this regard. Over the past three years, the sector has raised a signif icant amount of new capital to fund acquisitions, developments and redevelopments. With lower borrowing costs and most companies able to issue new equity capital at a premium to net asset value, the cost of funding the sector’s expansion has been lower than the acquisition or development yields achieved. This means each acquisition or development has increased the income base from day one, driving inf lation-beating distribution growth in the sector. With lower share prices and higher borrowing costs, this is likely to be less of a factor going forward, but should nevertheless contribute to distribution growth over the medium term. The reasons for the recent sharp sell-off in listed property have nothing to do with the fundamental driver of long-term capital growth. Distribution growth is expected to accelerate towards 8% in 2014 and 2015 and, coupled with an initial income yield in excess of 7%, listed property continues to look attractive relative to other asset classes. Year - on year % change 0% teams. By doing so, staff overheads can grow at rates substantially below that of the rental revenue in an ever-expanding proper t y portfolio, allowing for profit margin expansion and operating leverage. RESOURCES 2005 2006 2007 2008 November 2013 SA Real Estate Investor 2009 2010 2011 2012 2013 Grindrod Asset Management www.reimag.co.za

Real Estate Investor Magazine South Africa November 2013 | Page 54