Our clients tell us that diversifying into offshore real estate, specifically medical office buildings (MOB) in the US, has given them complete peace of mind.
Usually, when people retire, they have to calculate whether their accumulated capital will be enough to maintain their lifestyle for many years. Several of our clients have sold businesses in South Africa and want to invest that capital to cover their living costs in retirement. They were concerned about having their investments restricted to South Africa, but were unsure where to find stable, income-generating investments offshore.
Diversification is essential, firstly because South Africa represents less than 1% of the world’s stock markets. An economist once suggested to me that if you were an investor who had moved to Mars and was looking back at Earth, and could choose any country in the world to invest in, would you invest all your money in South Africa? I certainly would not with all the other options available, and the data shows that the appetite that international investors have for South Africa is shrinking fast.
It is also essential because, as South Africans, we are all worried about the long-term trends of rand depreciation. Fifteen years ago, ten rand would have bought you $1.50. Today ten rand buys you 60 US cents – just over half a cup of McDonald’s coffee! When you are worrying about how much your savings will be worth in future, and whether you might want to live elsewhere one day, this is a real issue.
Money invested in the worlds default currency; US dollars will be far more stable in the longer term than money invested in Rands. It is impossible to predict what the Rand will do in the next six months. South Africa is facing significant challenges, and does not have the balance sheet to support investment into essential services like infrastructure and education, nor does it have the ability to deliver on the outcomes when it does have the funding to execute on delivery. Addressing weak economic growth and government indebtedness will take years to fix, and there is little political will to implement the solutions that are required.
Our first goal at OrbVest is capital preservation, but at the same time, we have been able to deliver total annualized returns in dollars from a five-year investment in medical office buildings in the US of about 11-13%, which is extremely good by comparison with South African property returns.
Attractive returns in dollars and local currencies
The total return consists of an 8% per annum cash dividend, plus any profit we can make on selling the building. Selling is not a perfect science, but if we can sell the building for at least the price we paid for it, we have preserved our investors’ capital and delivered a good dividend return.
It is important for investors to understand trends in cap rates. A 7% cap rate on a $1 million building means it is generating $70,000 in income a year. As large US investors move into the MOB sector, the price of buildings is going up, so the cap rate is going down ($70,000 represents a cap rate of 5.8% on a $1.2m building).
At the moment the cap rate on US hotel buildings is rising because the value of buildings is going down, reflecting the downturn in travel post-Covid-19. The cap rate on MOBs is falling gradually, after being stable for many years, so I believe our buildings in future will be generating a yield of about 7-7.5% from 8% at present. That should result in higher capital gains when we sell at the end of the period. Those gains can be as much as 50% of the original equity capital invested, because of gearing.
Here is how it works. If we buy a building for $10 million, we raise $4 million in the form of equity and $6 million through a US mortgage. If we sell the building for $12 million five years later, the return to the equity investors is $6 million, which is $2 million more, or 50% on the $4 million original investment. That is in addition to the dividends paid each year.
We have found that niche investment in the MOB sector in the US has been well received by international investors, particularly those domiciled in emerging markets, because their expectations are different from those of Americans.
International investors are comfortable with lower returns from stable assets. Their priority is dividends, and they are already worried about moving money to countries they do not understand as well as their own. They also appreciate that, over time, because of interest rate differentials, emerging market currencies are depreciating against the dollar, which enhances the income they receive in local currencies.
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This article was written by Martin Freeman, CEO, OrbVest