Evan Robins 
Despite a recent rebound in listed property shares following the formation of the Government of National Unity (GNU), the sector is still in somewhat of a holding phase presently. However, more important than positive sentiment around the GNU, is the requirement of further interest rate cuts and actual improvements in domestic economic growth to drive the sector to further gains. If these factors continue on a positive trajectory, we could see the sector’s total return finally exceeding its historic high.
A hybrid opportunity
Property has been notably weaker than the other asset classes over the past decade, and the welcome catch-up over the last 12-months is largely due the market’s appreciation for improved sector and macro fundamentals. As a consequence, there has been a bit of an asset manager ‘scramble’ for listed property. This renewed investor interest, coupled with bond yields falling sharply, has supported share prices across the listed property sector.
Fund managers and retail investors view listed property as somewhat of a hybrid opportunity that offers a combination of capital appreciation and a consistent yield via distributions. Over the short-term, this sector is very bond-like due to values being influenced by bond yields; but on a longer-horizon, its performance is more influenced by earnings growth.
The ongoing interplay between inflation, earnings growth and interest rates will influence future capital allocations to the bonds versus listed property asset classes. And all else being equal, there are two main motivators for upping exposures to listed property, including earnings growth and the more fundamental risk-return argument.
Ordinary government bonds do not give you any growth – you receive a set coupon which continually loses purchasing power due to inflation whereas listed property generates earnings that will ebb and flow in line with the economy and inflation. This earnings growth drives longer-term capital appreciation in listed property.
For the second motivator, investors should expect a higher return from listed property than government bonds simply because the asset class sits higher up on the risk curve. At present you are getting a 5% real return from government bonds, which is very high, versus almost double from ungeared physical property.
The impact of the pandemic and national lockdown on listed property cannot be ignored. Although much of the pandemic-related fallout has abated, the rental earnings generated by listed property have rebased lower than they were in 2017-2019. Allocators of capital have been reassessing their exposure to this asset class through this ‘new normal’ earnings lens.
Boosting beyond normalising levels
The listed property market is presently priced back to the normal levels we last saw in the early 2010s. To get these levels higher we will need a macro driver such as long-term and short-term interest rates falling faster or further than predicted, or higher than forecast GDP growth.
Further consolidation at around this level is likely, as the balanced and multi-asset fund managers across the South African investment landscape normalise their exposure to the asset class.
A lot of property generalists were underweight the sector ahead of its rapid re-rating and they have been d trying to buy property to get back to a neutral holding. The long-term bull case for the sector is hinged on factors like high replacement costs and low historic rentals in some segments.
The capital values on quality domestic commercial portfolios are still well below the cost of new builds while there is significant potential longer-term earnings upside via improvements from the current low rental base in offices. Another significant earnings boost could come from improvements in vacancy rates.
Our fund expects decent returns from South African listed property on a three- to five-year view if the macroeconomic environment is supportive. The further out you go, the more time you allow for improving economic fundamentals to lift the domestic property sector. Ultimately, the property sector’s salvation lies in South Africa Inc addressing economic constraints and driving GDP growth back to 2% and beyond. DM/BM
By Evan Robins, Old Mutual SA Quoted Property Fund manager, Old Mutual Investment Group