Rates down, confidence up, what's next?

As we approach the final quarter of 2024 it is an opportune moment to reflect on the views I shared at the beginning of the year and to highlight the key themes that will shape the local property market as we calibrate to a new macroeconomic and political landscape.

Earlier this year I published an article titled “Where to for property in 2024?” wherein I identified two key factors, amongst others, that were likely to influence the property sector in 2024:

1.?????? Global and local interest rates; and

2.?????? The rationalization of operations and balance sheets in the REIT sector.

Rates

Last week the U.S. Federal Reserve (Fed) announced a 50bps rate cut, announcing the start of a much-anticipated rate reduction cycle. A day later, as anticipated, the South African Reserve Bank (SARB) followed a reduction in the REPO rate from 8.25% to 8.00% offering a collective sense of relief. While a 25bps reduction in interest rates, in nominal terms, may not be the most impactful, the interest rate market is pricing in a further 75-100bps reduction over the next five quarters to December 2025 signaling the potential for more relief ahead.

Lower rates = positive for real estate

REITs

In recent weeks, a number of SA REITs have published their results which, on average, confirmed that performance over the last year was neutral to positive. This reaffirms my prior assessment that the efforts of the REIT management teams, in a high rate environment, to improve operations, extract and design for enhanced efficiencies and improve the strength of their balance sheets by reducing gearing is starting to pay-off.

This sentiment is shared by capital allocators, as listed property continued to be the top performing asset class for the first half of the year (up nearly 9.5%) with some actively traded REITs such as Attacq, Growthpoint, Redefine and Vukile, all generating total returns in excess of 35% over the last 12 months. Looking forward, the REITs are poised for continued operational and financial improvements as (1) the impact of lower interest rates starts to filter through (REITs are generally hedged so this may take up 18-24 months to materialise) and (2) the lower inflation environment coupled with efficiencies should see a tapering in cost growth.

What’s GNU?

Understandably, in the run-up to the national elections, both public discourse and the private conversations in boardrooms were dominated by the implications of different election outcomes. While opinions on the Government of National Unity (GNU) may vary the one thing we should all be proud of as South Africans is our commitment to democratic processes - a free, fair, non-violent election is not a foregone conclusion for even some of the most established and mature democracies globally.

Local and national government volatility is inevitable over the next few years, however, for those looking to distinguish the signal from the noise, I’d recommend focusing your attention on the progress being made on certain structural reforms under Operation Vulindlela^ - a joint initiative by the office of the Presidency and the National Treasury aimed at critical areas of our economy such as electricity, transport, water and digital communications.

We’re still in the opening chapter of the GNU regime, so a review or extrapolation of how things will play out in future is perhaps little presumptive. That said, anecdotal evidence points to an increased level of investment activity and capital expenditure in the property sector with a number of large projects being given the greenlight in recent months. This has led to an increase in order books of the construction firms and there seems to be renewed enthusiasm in industries that interface with the built environment.

Liquidity as a leading indicator

In the context of local commercial real estate (CRE), it is crucial to understand the capital market cycle, the availability of liquidity, and its influence on supply and demand dynamics.

The supply side of the market comprises of developers and property private equity investors who primarily focus on bringing on new supply of institutional grade properties to the market. Their business model is premised on raising capital from private investors with the intention to develop new assets, aggregate portfolios and then achieve a liquidity event through sales to REITs, large asset managers and pension funds.

On the demand side, you have the REITs and institutions, these entities are yield focused, have long term/evergreen investment horizons and benefit from scale. Their business model is premised on raising large sums of capital from the equity and debt capital markets which they use to acquire and aggregate large income producing portfolios.?

If we look at CRE in SA between 2000-2018 (despite the impact of the global financial crisis) the real estate sector benefited from a high liquidity environment and the listed property market experienced a secular bull run – during this period the REITs were net buyers of assets and proved to be highly efficient conduits for cost effective capital into the sector. With increasing demand from the REITs, developers on the supply side were able to bring new stock to market with the conviction they would have natural buyers of their income producing portfolios. During this period the CRE market and REIT sector experienced rapid expansion.

In stark contrast, over the last 6-7 years we’ve been in a liquidity constrained environment, REITs and institutions have had challenges in raising capital and in turn they have become net sellers of assets. This lack of liquidity has meant that developers have not been able to rely on the institutional market to secure an offtake (as a result many developers have had to reengineer their business models to be longer term holders of assets as the liquidity cycle has been less favorable).

I’ve generally steered clear of trying to call the precise top or bottom of a particular cycle, however, recent activity in the sector gives me good cause to believe that we are trending towards a more liquid environment. The listed property sector has performed well over the last year, while this is positive, it is reflective of REIT units exchanging hands between investors – for me (1) the strong investor appetite demonstrated in several oversubscribed rights offers, (2) well supported DRIPs (dividend reinvestment plans) and (3) narrowing spreads in the debt capital markets over the last few months are leading indicators of 'fresh' capital returning to real estate. Should this momentum continue, in addition to a longer-term rally in REIT equities, we can expect an uptick in greenfield activity and general M&A in the sector.

What's next?

While challenges and uncertainty remain, a better macroeconomic outlook, increasing capital flows, reduced load shedding and a post-election mindset focused on building the economy all leave me feeling refreshingly upbeat about the prospects of the property sector in SA - so as we look ahead to 2025 and beyond, I find myself reflecting on the words of the legendary investor Peter Drucker: “The best way to predict the future is to build (create) it”

RK

Disclaimer: The views expressed are solely me own and do not constitute, financial, investment or legal advice. All information provided is for informational purposes only and should not be relied upon for managing financial decisions.?

?^ https://www.thepresidency.gov.za/node/4892