2022 was a bruising year, characterised by the Russia-Ukraine war, geopolitical tensions, rapid inflation rises and rate hikes across most of the world. Property returned 0.5% for the year, underperforming both bonds (4.2%) and equities (4.4%). During the last quarter, the sector rallied by 19%, driven by exogenous events which included the downside surprise in US inflation, and the UK government reversing the previously announced unfunded tax cuts. Locally, the outcome of ANC national elective conference resulted in lower perceived political risk.

As inflation in key economies remained elevated, central banks across the world began to unwind their stimulative stance by hiking interest rates and tightening quantitative policy. Higher interest rates and bond yields bring about higher borrowing costs for governments and companies, thus reducing economic activity and the outlook for equities. From a property perspective, in theory, when bond yields rise, the discount rate and opportunity costs for property investments increase, causing less capital to flow into the sector. Subsequently, the market becomes less competitive, and asset prices fall. However, it must be appreciated that valuations and capitalization rates are long-term estimates and only if the increase in bond yields are expected to be long term in nature, should valuations decline.

With respect to the impact of inflation on the sector, generally, property offers some protection given the long-term nature of lease contracts, which includes annual escalations or a link to inflation. Other indirect impacts of higher inflation include higher occupier costs for tenants and reduced disposable income for consumers, creating some pressure. Interest expense has increased, however, 80% of the sectors interest rates are hedged for an average of 3 years. This will reduce the volatility of cash flows and provide more stable income. Significant construction cost inflation should prove to be positive for existing landlords as it reduces the profitability of new developments thus current properties become more valuable. Company results and SAPOA data have also indicated that a peak in vacancies and reversions may have been reached. Therefore, considering all the aforementioned factors, and given that the sector is trading at a 30% discount to net asset value, we believe that there is a decent margin of safety currently priced in.

Locally, South Africans have had over 1,900 hours of power cuts in 2022, equivalent to 79 days - making it the most load shedding-intensive year to date. Landlords have responded aggressively by increasing their investments in solar projects. For example, Resilient REIT is targeting to self-produce 50% of their energy requirements by 2027. This could prove to be a tailwind amidst rising operating costs, particularly considering the yields quoted on solar investments of between 15% and 30%. On the political front, amongst much upheaval, the ANC NEC elections concluded on a positive note, with all the elected top 6 members being significantly more aligned and unified than the previous incumbents. Although the sector is relatively well protected in the current environment, we remain cautious in our approach to managing property investments. Quality portfolios, defensive sectors, specialist management teams, and conservative leverage ratios remain at the forefront of our investment process. In South Africa, we prefer defensive sectors such as logistics and storage, thus our investments in Equites and Stor-age, as well as non-metropolitan, non-discretionary retail which include Vukile and Resilient. Growthpoint offers a stable earnings yield benefiting from geographical and sectoral diversification. Globally, we feel relatively more optimistic about the longer-term prospects in CEE & Germany, thus our positioning in Sirius Real Estate, MAS Real Estate and Nepi Rockcastle.

The Marriott Property Equity Fund currently offers a dividend yield of 9% with earnings growth of 4% over the medium term.