By Klaus-Dieter Kaempfer
Over the last 14 years, South African listed property companies have been investing offshore as a way to diversify from the limited prospects offered by the South African economy. This process was spurred on by a confluence of a number of factors, including attractive asset pricing and yields in the immediate post-Global Financial Crisis era, continued relaxation of exchange controls in South Africa as well as the opportunity for geographical and currency diversification.
One of the regions that South African Real Estate Investment Trusts (REITs) invested in was the Central and Eastern European (CEE) region. The CEE region includes Bulgaria, Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Romania, Slovenia and Slovakia. These countries are attractive due to their comparatively fast-growing economies, as well as strong property market yields and perceived comparatively lower risks.
The total exposure to the CEE region by SA listed property counters is estimated at R202bn. The foregoing is a combination of both direct and indirect investment in the region. Total CEE exposure amongst property counters included in the JSE South African Listed Property Index (SAPY:J253) accounts for 28% of total property assets and 24% of total property assets of property counters included in the JSE All Property Index (ALPI:J803). Inwardly listed property companies such as NEPI Rockcastle and MAS Real Estate have relatively higher exposures of 100% and 72%, respectively to the region. Local counters such as Fortress REIT, Redefine Properties and Hyprop Investments also have significant exposures to the CEE region, with exposures of 37%, 33% and 32% of their property assets, respectively.
Some of the attractive aspects of CEE markets for South African investors include a relatively young and skilled population, some of Europe’s highest GDP growth rates (say in Hungary and Romania), relatively high hard currency yields within a European institutional environment.
The conflict between Russia and Ukraine has come at a time of a rebound in the economies of neighbouring CEE states of the Czech Republic, Hungary and Poland. MSCI’s CEE Annual Property Index shows that, aside from a brief interruption brought about by the COVID-19 pandemic in 2020, commercial property total returns have been on a long-term increasing trend since the global financial crisis that severely affected property markets in these economies as at 2009. Commercial property markets in the Czech Republic, Hungary and Poland had rebounded in 2021 in line with general economic activity in these countries – registering direct property total returns of 15.4%, 14.2% and 5.1%, respectively; GDP growth rates are projected to range between 3.9% and 4.1% between these countries in 2022.
Given the geographical and economic proximity, emerging European markets are the most vulnerable region to the Russia-Ukraine conflict through trade, financial links, and confidence. More importantly, through higher energy prices, because most of EM European economies are net energy importers. The elevated levels of geopolitical risks in East Europe may cause investors to re-evaluate the potential of some sectors and segments in the South African property market. With the MSCI All-Property return rebounding to 5.3% as at 2021 from -3.0% as at 2020, a steady recovery is underway.
The recovery of the retail property sector from the ravages of the pandemic and the 2021 July unrest in South Africa has been patchy and slow. The retail sector as a whole achieved a total return of 6.5% in 2021, significantly up from -4.4% in 2020 and albeit still down from the pre-pandemic performance of 7.6% achieved in 2019. One of the trends that developed within this sector during the throes of the pandemic was the widening spread of total returns between convenience format retail and very large destination retail formats. In addition, there was a widening of the spreads between rural and peri-urban versus urban shopping centres. The 2021 MSCI results show that there is evidence of recovery from the effects of the pandemic in that the spread has narrowed somewhat.
The South African office sector has been characterised by long-standing structural vacancies, which have been exacerbated by the effects of the pandemic. However, during 2020, office total returns were comparatively less affected by the Covid-19 downturn – as compared to, say, retail total returns. Office returns have rebound from a total return of -1.7% as at 2020 to 0.8% as at 2021, demonstrating the continued weak macro-economic conditions.
Industrial sector performance has demonstrated resilience in the wake of the pandemic with total returns increasing from 1.2% to 7.5% from 2020 to 2021. This sector remains robust, with performance consecutively outstripping the performance of the All Property Index. Comparatively, the industrial sector has recorded the lowest vacancy rates amongst the traditional property sectors. The strength of the sector has been bolstered globally due to a shift to distribution and warehousing to support the growth of online retail and locally by improved logistics and supply chain networks. There has also been a trend towards on-shoring of manufacturing capabilities to build-in more resilience within the supply chain for future similar global disruptions. This should continue to be a theme given the recent further disruption brought about by the invasion of Ukraine by Russia.
The performance of the residential sector has rebounded largely supported by expansionary monetary policy – which was spurred on by the onset of the Covid-19 pandemic. The foregoing is further demonstrated by the sustained upward trajectory observed in building plans passed and completed. Residential building plans passed accelerated by 50% and residential building plans completed increased by 35% compared to the corresponding period last year – on a 12 month moving basis. Residential property within the MSCI Index achieved a total return of 4.7% in 2021, up from -3.0% in 2020.
Although direct property returns are still far from their historic highs, the recent MSCI South Africa Annual Property Index results indicate that the market is steadily recovering from the ravages brought about by the pandemic.
Klaus-Dieter Kaempfer is the Head of CPF and Equity Investments at Absa CIB
BUSINESS REPORT