Podcast: Property Investments in SA - what now?

By Ian Anderson

In a podcast recorded with Ian Anderson, Fund Manager of the Nedgroup Investment Property Fund, we look at what’s going on with local property investments.

Listen to the podcast here.

Transcript:

Host: Welcome to the latest podcast with Ian Anderson, Fund Manager of the Nedgroup Investments Property Fund. Ian, you have an impressive track record with over two decades experience in managing listed property mandates. What are the challenges you are facing in the current environment and how has this this impacted the recent performance of the Nedgroup Investments Property Fund, relative to the index and the peer group?

Ian Anderson: Well, since the beginning of 2018, investor sentiment towards South Africa's listed property sector has deteriorated substantially. The sector has gone from darling to pariah in the blink of an eye, starting with revelations of the governance shortcomings at the Resilient Group of companies in January last year. Since then, the negative sentiment has flowed through to the rest of the sector as fundamentals have continued to deteriorate. Now we know that these fundamentals are weak, but current share prices are reflecting a decidedly worse situation than the one we currently envisage for the South African economy and the property industry going forward. This unprecedented selling pressure that we're seeing has had the most negative impact on the prices of the smaller and medium sized SA focused companies. Many of these businesses are now trading on forward income yields in excess of 15% and discounts to net asset value that are greater than 30%, some even as high as 50%. The Nedgroup Investments Property Fund has significantly more exposure to this segment of the market. And while the fund was able to avoid the initial carnage in the sector in the first quarter of last year, the past 12 months have been characterised by a significant level of underperformance.

As a result, the current one year forward yield on the Nedgroup Investments Property Fund is now over 15%. Prices have been falling, but the income has remained largely intact. This presents an opportunity I wouldn't have thought possible just a couple of years ago, but it obviously does highlight just how far these prices have actually fallen. This is not a dissimilar situation to the one we saw back in 1998 after the Asian debt crisis when prices also fell significantly. But following that, the listed property sector enjoyed a period of significant outperformance as prices recovered to more accurately reflect expectations of future cash flows, relative to other high yielding securities like cash and bonds.

Host: So, after a particularly tough 12 months in which capital values have declined by some 30%, notwithstanding that attractive gross yield in excess of 15%, investors are understandably concerned. What can investors expect from the listed property sector in general and from the fund over the short and medium to longer term?

Ian Anderson: Well, as I mentioned earlier, it's investor sentiment at the moment that is driving prices and these prices are now at all-time lows and reflect a lot more of the sentiment than fundamentals. Hedge funds have also got stuck in and taken advantage of the situation and property stocks now make up a good portion of the most shorted stocks in SA.

Many property companies have responded to some of the criticisms that were levelled at them in terms of the quality of their earnings and the risks in the balance sheets and so we think that this has significantly improved the outlook for the sector from this point onwards. So we believe that for most companies, the worst is behind them. Dividend growth rates are likely to remain low for the next two or three years, and that's just obviously a function of the weaker economic backdrop. Importantly, though, investors are being compensated for this low expected growth with substantially higher initial income yields. Even if there is no recovery in prices over the next year or 2, which is a situation we think is highly unlikely, investors in the fund will still enjoy a yield of around 15%, while the overall property markets return in the absence of capital growth will only be around 10% per annum. Some of the more obvious catalysts that we can see unlocking value or the tremendous value that we see in the short term include a further reduction in interest rates. Economists are now expecting the Reserve Bank to cut interest rates again this year and possibly a further 25 basis points again in the first half of next year. Then we also expect corporate action to drive consolidation and unlock value. I mean, if you just look at Comprop's offer for Safari, it was done at a 38% premium to the share price, revealing just how much value there is in the sector today and specifically in the stocks that are owned by the Nedgroup Investments Property Fund.

Host: So you've been consistent with your investment process and philosophy to best position the fund to deliver on its main objective, which is to produce an attractive income yield. And secondly, growth in that income stream, at or above South African inflation through a full market cycle, thus making it a very attractive building block in a portfolio where investors are drawing an income in retirement. So do you think that still remains an appropriate strategy, given the volatility investors have experienced over the last year?

Ian Anderson: Absolutely. The past year or 18 months has not unravelled the longer-term merits of investing in listed property, particularly for those investors that are building a retirement income before they retire or then drawing that income while they're in retirement. If you look at the returns of longer investment horizons and we're talking about 10 years plus, listed property has produced returns well in excess of inflation despite the sharp sell-off that we've seen since the end of 2017. The recent capital volatility has been severe, unexpected and unprecedented. Importantly, though, the income stream from the sector has largely remained intact, albeit that the growth rate has now dipped below inflation for the first time in more than a decade. As I discussed earlier, initial income yields are now the highest since 2004, even though official interest rates and bond yields are a lot lower today. While income growth may stay low and probably be below inflation for the next two to three years, investors have been compensated for that by the very attractive initial income yields on offer. So investors who are drawing an income in retirement of up to 8% of their capital or below will not have to draw against that capital, therefore, making the volatility in those prices irrelevant to the success or failure of the financial plan. Now, while, it's extremely difficult to ignore what is happening to the capital value, as long as their capital is producing more income than what is being drawn by the client, the plan remains intact and importantly, the capital remains intact for when prices invariably start to recover.

Host: You've held a fairly significant and overweight position in Delta & Rebosis in the portfolio. What do you think of the proposed merger of these two companies?

Ian Anderson: Well, at this stage, we've not had a formal meeting with either of the management teams or their advisors. We acknowledge that there is obviously some overlap in terms of the sovereign office portfolios that are owned by both companies, but we're still not convinced that a deal makes sense. This is also a view that was expressed by Redefine at the recent results presentation, bearing in mind that Redefine owns more than 20% of Delta. Again, I don't believe Redefine has met with the management teams. So we do have a meeting scheduled. We should be able to get a lot more information and then we should be able to make a more informed decision. I think it's worth noting that the recent price action in Delta is suggesting that the market is opposed to the deal and that if the two businesses were forced to walk away from the transaction, the share price of Delta might rebound quite sharply.

Host: Thank you Ian, for your time today.

Ian Anderson: Thank you