There was a time when listed property markets were a strong feature in South African balanced portfolio allocations.
Over this period, particularly looking at the post-global financial crises, listed property markets outperformed listed equity markets for a sustained period of time.
The tension between these facts is that at a fundamental level, property market rentals are earned from equity market earnings. It is therefore impossible to sustain a property market rally without strong earnings support from the equity markets that generate rental income for property companies. And yet this was the case.
Ever since, listed property markets have had their fair share of headwinds.
From the negative reports around governance, accusations of price manipulations, complex shareholder cross-holdings between companies and complex structures, as well as questionable valuations.
This saw listed property markets dropping more than 30% between 2018 and 2019. Following this was the Covid-19 pandemic, leading to economic lockdowns, business liquidations, work-from-home trends, changes in consumer patterns to online, increased vacancy rates, reduced demand and rental yields.
Due to the inflexible nature of property supply, this saw a further decline in listed property markets of more than 50%. This was a wipeout of about R300bn in market cap value in just three years on the JSE.
However, at some point in time, valuations tend to catch up with fundamentals. The one way is earnings and cash flow growth supporting valuations; the other is through destruction of value. In this case, it was more the latter than the former, but some elements of the first as well have played out.
Since then, listed property markets have cleaned up their complex ownership structures, focused on reducing debt, cleaned up underlying property valuations, adopted sustainable payout ratios funded from earnings and responded to consumer trends — focusing on smaller, localised retail outlets and property types like storage and distribution centres. The economy has also been on an upward trend, albeit at a slow pace.
Positive economic growth, decent gross fixed-capital formation, steady and reliable energy supply, low levels of inflation, moderate interest rates, increased profitability on underlying equity markets and more back-into-office work trends.
This has resulted in some positive fundamentals from property markets, including reduced vacancy rates, decent rental yields, steady income growth, healthy balanced sheets and interest coverage ratios, sustainable payout ratios and guidance, and some market confidence starting to return to the sector.
As a result, listed property markets have rallied by more than 80% from the start of 2021 to the present, creating about R200bn in market cap value over the period.
Even with this strong recovery, listed property markets are still below their 2017 highs by about 30% on aggregate. Most multi-asset portfolio managers have simply become comfortable not including property in their portfolio in a meaningful way due to some of the challenges the sector has had in the past. However, if you consider the rebasing that has occurred and you begin tracking the fundamental trends since the end of 2020, there is a strong case for property.
Furthermore, listed property markets give a clear exposure to improving South African fundamentals, as listed equity market participation in the local economy is diluted by the fact that the JSE is 60% rand-hedged. This is due to dual listings, multinationals, conglomerates and mining counters that earn in dollars.
Over the medium to long term, we will continue paying close attention to what is happening to listed property markets and continue participating meaningfully in any rallies in the sector while managing our risk exposure through high-quality counters.
• Ricardo Smith is chief investment officer at Absa Investments.