The listed property sector delivered a total return of 5.7% for the quarter, outperforming the All Bond Index’s 3.7% but lagging the All Share Index’s 8.9% return. The correlation between bonds and listed property recovered somewhat from the prior quarter: the SA 10-year government bond yield decreased to 8.7% at end-September from 8.9% a quarter earlier, while the forward yield of the SA listed property sector saw a compression to 8.2% from 8.3% at the end of June. The historical yield of the SA Listed Property Index (SAPY) was unchanged at 6.2% from three months earlier. This saw a compression in the historical yield gap relative to bonds, ending the third quarter at 248 basis points (bps) from 269bps at end-June.

The fund’s return of 4.4% for the quarter was less than the 5.7% delivered by the benchmark; however, the fund’s performance over periods between five and 10-years compares favourably to peers and the benchmark. The underperformance during the quarter was due to value detraction from the fund’s relative exposure to NEPI Rockcastle, Fortress, Resilient, Greenbay, Growthpoint, as well as Capital & Counties and Intu. These were enough to offset the value-add from the fund’s relative positioning in MAS Real Estate, Equites, Attacq, Stor-Age and Hammerson. During the period, the fund increased exposure to Hyprop, Vukile, Investec Property Fund, Hammerson and Liberty Two Degrees, while reducing exposure to a handful of names, including NEPI Rockcastle, Growthpoint, Octodec, Resilient and Fortress B. As is usual in the listed property sector, the quarter saw just over R12.7 billion in primary capital raises across eight companies. The largest of these was Greenbay, which saw outsized appetite for an initial R2 billion target, eventually raising R4.5 billion. Resilient also came to tap the market for capital, issuing R2.5 billion worth of shares during the quarter, followed closely (in terms of size of capital raise) by MAS Real Estate with a R2 billion scrip issue. Other companies raising equity during the quarter included Hospitality (R1 billion rights issue), Equites (R1 billion), Atlantic Leaf (R815 million), Vukile (R578 million) and Sirius Real Estate (R375 million private placement).

On the acquisitions front, Investec Property Fund’s annual report revealed that the company had made its first direct entry into the UK with the acquisition of a 10% stake valued at £10 million in an unlisted fund with a predominantly supermarket focus. The entity is said to likely list once a scale of £400-500 million has been reached. Staying with the UK, Stor-Age announced the proposed acquisition of Storage King, a portfolio comprising 13 self-storage assets in the UK valued at £77 million, which will take the company’s UK exposure to 35% of the total asset base. The transaction will be subject to shareholder approval. Another company that also increased its offshore exposure is Equites, which announced the acquisition of its fourth distribution centre in the UK, taking offshore exposure within the fund to around the 25% targeted by management. This latest acquisition is a 20 000m2 distribution centre in Coventry, and will be let to Kuehne & Nagel. At a 4.8% acquisition yield, the pricing for this latest addition to the portfolio came in tighter than for the prior three acquisitions, which were bought at yields of between 5.7% and 7.2%. Meanwhile, Rebosis announced that it had reduced its stake in UK-focused New Frontier to 36% from 67%, having sold the difference to a BEE consortium chaired by Nkosi Gugushe. The acquisition by the consortium will be vendor financed by Rebosis.

In other activity, Hyprop announced the acquisition of a 53 000m2 centre in Sofia, Bulgaria via its 60% owned subsidiary, Hystead. This latest acquisition takes the size of the Hystead portfolio to €460 million - comprising four centres across South and Eastern Europe. NEPI Rockcastle announced two sizeable acquisition to the tune of over €500 million. First was the acquisition of the 66 000m2 Arena Plaza, the second largest shopping centre in Budapest for €275 million at a yield of 6.2%. Shortly afterwards, the company announced the purchase of the 82 000m2 Paradise Center, the largest retail centre in Sofia, Bulgaria. The centre was purchased for €253 million, equivalent to a yield of 7%. As far as management changes are concerned, Texton announced the appointment of Inge Pick as the company’s new CFO. Meanwhile, Greenbay saw Paul Simon resign as CFO, with Kobus van Biljon announced as his replacement. One of Kobus’s former roles was CFO of Resilient Africa.

The group of companies with June/December year-ends, representing just under two-thirds of the sector’s market capitalisation, reported results during the quarter. Distribution growth including offshore counters this reporting period came in at 12.6%. Excluding the offshore-focused counters, distribution per share (DPS) growth was little changed at 10.9% versus 11.3% by the same group of companies six months ago, but this was supported by Resilient and its sister companies. Excluding these, average DPS growth saw a slowdown to 6.4% from 7.6% six months prior.

The core message coming from management teams is that conditions on the ground remain tough, with this past year having been among the most challenging in the past decade or so. While distribution guidance was generally met, management teams are softening their outlooks, with distribution guidance going forward being adjusted towards the bottom end of previous guidance in some instances or expected to match this past year’s outcomes. On the underlying portfolio metrics, vacancies were in general mixed, with prime retail showing an uptick (albeit from low levels) after some resilience for a number of years. Trading density growth has also remained under pressure on the back of challenging trading by mainly the apparel retailers, with super-regional centres (which are mostly exposed to these players as tenants) taking strain as a result. This does not bode well for retail reversions going forward. Meanwhile, industrial and office portfolios continue to reflect the conditions on the ground; office rentals are under pressure, with intense competition amongst landlords seeing a drive for increasing incentives and negative reversions. The industrial market continues to see a cap on rentals, though logistics tenants still appear to be faring better than traditional manufacturing tenants.

As this past reporting period has shown, the slowdown in the broader macroeconomic environment continues to be a headwind for property fundamentals. Notwithstanding, within the SA-focused listed property universe are good quality companies with great portfolios and excellent management teams that deliver high quality earnings streams. Some of these trade on high single-digit initial yields, with distribution growth prospects that should at least equal inflation over the medium term. As a result, we still see the sector providing double-digit total returns that should exceed those coming from cash and government bonds through the cycle.

Portfolio manager
Anton de Goede and Kanyane Matlou as at 30 September 2017

Political developments at the tail end of the quarter weighed on the SA market as a whole, with both listed property and bonds reversing the gains achieved up until mid-March. Listed property was able to eke out a 1.4% return for the quarter, lagging the All Bond Index's 2.5% and the All Share Index's 3.8%. The correlation between bonds and listed property was once again reinforced; the SA 10-year government bond yield was unchanged at 8.9% at end-March from a quarter earlier (though it touched a low of 8.4% during the quarter), as was the forward yield of the SA listed property sector at 7.8%. Index adjustments during the quarter, however, were responsible for changes in the historical SAPY yield, which increased to 6.3% from 5.9% three months earlier. This resulted in a narrower historical yield gap relative to bonds (264 basis points [bps] at end-March vs 298 bps at end-December). The fund's return of 1.3% during the quarter was slightly less than the 1.4% delivered by the benchmark; however, the fund gained momentum over periods between one and five years, while losing some momentum over the 10-year period. The slight underperformance during the quarter was due to value detraction from the fund's relative exposure to Capital & Counties, Intu, Hyprop, Growthpoint and Resilient. These were enough to offset the value-add from the fund's relative positioning in Attacq, Equites, Hammerson, Nepi and Stor-Age. During the period, the fund increased exposure to Hammerson, Fortress B, Resilient, Stor-Age and Attacq, while reducing exposure to a handful of names, including Redefine, Nepi, SA Corporate, Hyprop and Growthpoint amongst others.

Typical of the listed property sector, the quarter saw just under R7.5 billion in primary capital raises. Investec Australia Property Fund's rights issue fell slightly short of target, with the company raising R1.4 billion compared to the intended R1.5 billion owing to only 96% of shareholders taking up rights, while Rebosis was able to raise R485 million in an accelerated bookbuild, taking advantage of the good run in its share price in recent months. Stor- Age successfully raised R400 million to part fund its acquisition of Storage RSA, while Spear REIT also came to the market with a R119 million private placement. In other activity, Nepi saw good appetite for its scrip - with its bookbuild raising R1 billion, twice the amount initially targeted, while Greenbay saw even larger appetite with a R2 billion accelerated bookbuild. MAS came to the market with a R1.75 billion capital raise, while Sirius Real Estate privately placed just over R200 million.

In terms of personnel changes within the sector during the quarter, Arrowhead announced the appointment of Mark Kaplan as its new CEO following the passing of former CEO, Gerald Leissner, at the end of 2016. Mark was also appointed CEO of Arrowhead subsidiary, Gemgrow, following the conclusion of the deal with Vukile and Synergy. Rebosis also made changes to its executive management, with former board chairperson Andile Mazwai appointed as the fund's COO, while Kameel Keshav resigned as CFO, replaced by former Texton financial director Marelise de Lange. In other activity, Texton announced its intention to internalise its management company for an amount of R180 million. The proposed internalisation will be subject to a number of conditions, including shareholder approval - of which the company has received indicative support from 40% of eligible voters. Texton also announced that financial director Brigitte de Bruyn has resigned from the company, and will vacate her position after 30 June 2017. Meanwhile, Capital & Regional CEO, Hugh Scott-Barrett is set to retire, with Lawrence Hutchings (previously at Blackstone Australia and Hammerson) to serve as his replacement. In acquisitions outside the country, Resilient and Greenbay announced the joint acquisition of two retail centres in Portugal, Resilient's first foray into direct property in Europe, which the company had hinted at in recent months. Meanwhile, Attacq exited its investments in Cyprus and Serbia, opting to have its exposure to the region via one vehicle, being MAS Real Estate in which Attacq is the anchor shareholder.
SAPOA released its office vacancy survey for the fourth quarter of 2016 during the quarter. The survey showed that office vacancies increased to 10.7% in December 2016 from 10.5% a quarter earlier. Of the four office grades, P-grade space was the only category to see an improvement in vacancies, while the other three categories saw weaker vacancy trends. Of the five metropolitan areas, Port Elizabeth and Pretoria registered improvements in vacancies during the quarter, while Johannesburg and Durban saw an increase in vacancies. Cape Town office vacancies were unchanged from the previous quarter. Asking rents were 8.3% higher over the last 12 months versus 8.0% in the previous quarter. In terms of office space under development, a high degree of concentration remains - with 10/53 nodes accounting for 89% of all developments. Almost half this space is in the Sandton node, with Gauteng as a whole being home to 94% of all the office space under development.

The first reporting season of the year took place during the quarter, with results announcements from companies representing just under 60% of the sector's market capitalisation. Including offshore counters, distribution growth averaged 9.3%, ranging from a low of -16% (in ZAR) for Mara Delta, going up to a high of 16.6% for Hyprop. Three domestic counters saw negative growth in distributions, with two of these (Tower and Texton) being due to once-offs in the base that will no longer be paid out going forward. The other counter - Emira - experienced an increase in vacancies in its office portfolio that was previously guided to. The stronger rand over the period weighed on the results, with distribution growth averaging slightly higher at 11.0% excluding offshore counters. Excluding Resilient and its sister companies, dividend per share growth for the local counters registered 7.7%, a touch lower than the 8.8% registered by the same group of companies six months ago.

Underlying metrics from the companies that reported results indicate that although fundamentals have not had a wheels-off deterioration, conditions remain challenging across the various sectors given the broader economic backdrop. Vacancies have generally held steady across the different companies (with the exception of Emira), but rental renewals remain under pressure. As has been the case for the past 18-24 months, negative reversions in the office sector continue to prevail as landlords compete for limited tenants given the lack of new demand, while a similar tale plays out (to some extent) in the industrial sector despite low vacancies. After holding up relatively better than the other sectors, retail is starting to show signs of strain, with weaker trading densities coming through from the major landlords, in turn putting downward pressure on renewals. In the residential space, landlords are starting to see tenant pushback on rental increases as affordability thresholds are reached, with inflation-type increases now expected compared to high single-digit figures in the recent past. Management teams have generally taken these headwinds in their stride, and save for Emira, no material decline in core earnings is expected. Of some comfort going forward is the likely peak in the rate-hiking cycle that has been reached, which should provide some reprieve to the sector going forward. The recent reporting period has shown that the listed property sector is not immune to the challenging economic backdrop the country is facing. However, while a number of underlying metrics indicate some strain, these have not been enough to derail the sector's distribution growth prospects, and we continue to expect at least real growth in distributions over the medium term. On the other hand, recent developments on the political front may likely prove more material to the sector's rating for the remainder of the year and potentially beyond. With the ruling party's elective conference still some months away, further bouts of volatility remain likely. However, given the initial yields the listed property counters trade on, as well as the expected real growth in distributions, we remain of the view that total property returns should exceed those of government bonds and cash over the medium term.

Following two consecutive quarters of negative returns, SA listed property experienced a recovery during the fourth quarter, with a return of 1.3%. This was ahead of the ALBI’s return of 0.3%, as well as the ALSI’s -2.1%. With the correlation between bonds and property having broken down in the prior two quarters, the fourth quarter saw the correlation return somewhat; the SA 10-year government bond yield increased by 26bps to 8.9% at end- December, owing in part to the increase in the US policy rate, while the forward yield of the SA listed property sector rose by 10bps to 7.8%. Listed property’s total return for 2016 came to 10.2%.

The fund’s return of 1.4% during the quarter was better than the 1.3% delivered by the benchmark, with the fund returns gaining momentum over five and ten years, but slightly losing some over one and three years. The outperformance during the quarter was due to value-add from the fund’s relative positioning in Equites, Redefine, Fortress B, Hyprop and Resilient. These were enough to offset the value detraction from the fund’s relative exposure to Capital & Counties, Intu, Attacq, Growthpoint and SA Corporate. During the period, the fund took part in Liberty Two Degrees’s IPO and participated in Equites’s capital raising, while adding to its positions in Stor-Age and Attacq. We trimmed exposure to a handful of counters, including Growthpoint, Redefine and Arrowhead.

A number of companies came to the market during the quarter to raise capital. Among them was Liberty Two Degrees, which raised R2.8bn as part of its IPO, while Equites saw good appetite for its paper, raising R1bn. Safari placed R726m with select investors during the quarter, with the proceeds intended to reduce gearing and allow the company to fund its development pipeline. Meanwhile, SA Corporate raised R600m, partly to fund the pipeline in its recently announced JV with Calgro M3. In other activity, Schroder European Real Estate also looked to raise capital during the quarter, but fell short of its targeted €100m, raising only €17m, while Atlantic Leaf saw sufficient appetite for its £20m bookbuild.

With Accelerate raising just over R700m in a private placement to partly fund its acquisitions in Central and Eastern Europe (CEE), Growthpoint also finally announced its entry into the region following months of signalling. The sector’s largest counter bought a stake of just over 25% in Globalworth, an AIM-listed Romanian office specialist, for €186m. Meanwhile, the two SAlisted companies with a sizeable presence in the region, Rockcastle and New Europe Property Investments (Nepi), confirmed that they were in merger talks - with an envisioned swap ratio of 4.5 Rockcastle shares for every 1 Nepi share. The new entity will be listed on both the JSE and Euronext, and it is expected that the transaction should be concluded by June 2017. The current CEOs of the respective companies are expected to be joint CEOs of the merged entity. Other corporate action during the quarter saw the majority of Pivotal shareholders approve the company’s acquisition by Redefine, while similarly at Lodestone, shareholders voted in favour of Fortress taking over the company. At Texton, management changes saw former MD Nic Morris take over the reins as CEO following the resignation of Angelique de Rauville during the quarter, while the market was sad to hear news of the passing of sector stalwart, Gerald Leissner. Mr Leissner occupied the role of CEO at Arrowhead and was chairman of the Stenprop board at the time of his passing.

SAPOA’s office vacancy survey showed that vacancies were unchanged at 10.5% in September 2016 from a quarter earlier. Of the four office grades, B-grade space was the only category to see an uptick in vacancies, while the other three categories saw occupancy improvements of 10bps (A-grade) to 60bps (P- and C-grade space). Of the five metropolitan areas, Johannesburg and Pretoria were the only ones to see an increase in vacancies during the quarter, with the other three (Cape Town, Durban and Port Elizabeth) seeing an improvement in occupancies. Asking rents were 8.0% higher over the last 12 months, compared to 9.1% in the previous quarter. In terms of office space under development, there remains a high degree of concentration, with 10 out of the 53 nodes accounting for 85% of all developments. Some 44% of this space is in the Sandton node.

The final results season of the year concluded during November. Similar to the group of companies that reported a quarter earlier, distribution growth was broadly in line with expectations, with underlying contractual escalations - coupled with a continued focus on managing costs - underpinning net property income growth. Though vacancy performance was broadly mixed, landlords continue to hold on to the majority of their existing tenants, though some have had to see a fall in rentals to achieve this. Management teams remain of the view that opportunities for external growth within SA’s borders are limited. While the rest of the African continent previously received attention as a potential target, this view has been tempered over the past year as various challenges reduced the attraction of some destinations. SA companies are either cutting back planned investment in some countries, or struggling to gain traction in raising funds for their platforms. On the other hand, Eastern Europe remains a favourite for local companies, largely due to the positive funding gap. Amid an increase in political risk across the globe, next year’s elections across the core of Europe and the implications for the sustainability of the Euro Area will be key for the fortunes of many of these countries.

Although the local listed property sector has been affected by the lacklustre economic environment, landlords have thus far generally been able to protect rental streams. We remain of the view that the sector should continue to deliver real growth in distributions. While the market breathed a sigh of relief as SA survived the recent round of sovereign credit ratings reviews with its investment rating intact, this may have only bought some time given the negative ratings outlook. In the meantime, political uncertainty is likely to continue over the next 12 months as the ruling party prepares to choose its next leader at the end of 2017; the ensuing political manoeuvring ahead of the December 2017 conference could prove to be a source of uncertainty for the bond market, with some knock-on effects for listed property. Outside of these, we view the listed property sector’s current valuations offering value over the medium term.