How the SA property sector compares to the global landscape, Nosibusiso Nqgondoyi, Head of Property and Hedge at Old Mutual Multi-Managers

2020 has been a challenging year for local property. In this Market Matters Podcast,  Nosibusiso (Busi) Nqgondoyi, Head of Property and Hedge at Old Mutual Multi-Managers, shares her insights on how the local listed property sector compares to the global landscape, from a diversification perspective. She also discusses what the future holds for this sector and the benefits for investors who are prepared to exercise patience as they await a recovery. For more information visit www.ommultimanagers.co.za

Transcript

Ian Fraser  00:01

This year is definitely one for the record books. 2020 has indeed been a turbulent time on many fronts, given Brexit, the COVID-19 pandemic, and the US elections, to name a few. As we approach the end of the year marked with many challenges and uncertainties, there might be a widespread reluctance to make firm plans for 2021. 

In this Market Matters podcast series, we explore the most prominent economic themes with investment analysts from Old Mutual Multi-Managers. They help us make sense of the equity, property, and fixed interest markets, and also share insights on how diversification could be the key to survive next year and beyond.

Ian Fraser  00:43

Let's talk now to Nosibusiso Nqgondoyi, who is the Head of Property and Hedge at Old Mutual. Having begun her career in financial services in 2006, Busi's worked as an investment analyst, as a fund manager, as a portfolio manager, as head of research. That's quite a string of titles going on there, Busi, welcome to the podcast. 

Nosibusiso Nqgondoyi  01:06

Hi, Ian. Thank you for the warm welcome. I am very excited to be here today. 

Ian Fraser  01:11

It's great to have you, let's get stuck straight in because we're talking property. That's your buzz. And, of course, the sector is really in the spotlight at the moment in so many different ways, investors are looking at property. With the past year, the absolute bloodbath in the sector. We're seeing in the residential sector that people are now opting not to rent but to buy because interest rates are good. You know, there's all sorts of interesting stuff happening in the commercial sector, in the industrial sector. 

So, really, I'd like to cover all of these things, and chat more about them. But let's take a snapshot, if you will, put up our metaphorical camera. And from your point of view, have a look now at what the property market is doing at the tail end of 2020 and COVID. Where are we at, Busi?

Nosibusiso Nqgondoyi  02:00

Yes, Ian, so what you're seeing, really like you said, I mean, this year has been a very challenging year for local property. There's been largely a bloodbath, borrowing from your word. 

Ian Fraser  02:14

Ja. 

Nosibusiso Nqgondoyi  02:14

And yes, the local listed REITs space is under pressure. And it has been under pressure even before COVID. And this is owing to a number of factors, including the oversupply in the space, specifically the two biggest sectors being retail and office, which accounted for roughly 80% of the sector. And the low economic growth also means that these poor demand prospects to take up the excess space that we see, all of this continues to fuel a lack of investor interest towards estate. 

Investors worry that in the absence of a rebound in economic growth, rental collections are likely to remain under pressure, which doesn't bode well for rates, cash flows, and income growth going forward. On the other hand, we are likely to see COVID-19, which has been playing out for the better part of this year, continue to have a negative impact on long term rentals and vacancies, whereas the operating costs are growing at a higher rate than operating income within REITs. But key is that many of these companies have weak balance sheets. That basically means that they have too much debt, while there is uncertainty around property valuations, which impacts the asset side of these companies' balance sheets. 

And lastly, Ian, if you just look at local REITs, they have benefited from the substantial exposure that the sector has to central Eastern Europe. But this region has had to again contend with lockdowns, as a second wave is currently hitting Europe. 

Ian Fraser  03:58

Wow, that paints a [clears throat] rather bleak picture, I'm afraid, and I can attest to what you've said, certainly from a local point of view. I headed into central Sandton the other day to go and do some work, and the hustle and bustle, the business of the area, was noticeably lower. You know, people are just - there are people that are active, certainly, but I think office spaces have taken a massive knock, and you look at companies that have taken massive office spaces. 

I mean, that landscape has just been demolished, it's changing rapidly, isn't it? 

Nosibusiso Nqgondoyi  04:34

Yes, definitely, Ian. I mean, with most of us working from home, office is all the more under pressure. And if you just look from a vacancy perspective, we're seeing national vacancies at almost close to all-time highs within office, specifically at around 15% levels. And there are certain nodes that are more under pressure than others, like you mentioned, Sandton, which is the most pressured node nationally, with vacancies close to 16% levels. 

Ian Fraser  05:07

So, Busi, the picture really in the commercial sector is not looking terribly good. But I want to take a global view now and have a look at what opportunities might be existing. Because it's all been a bit of doom and gloom up until now, where are the green shoots? Where are the opportunities starting to present themselves, if any? 

Nosibusiso Nqgondoyi  05:26

Ja, so despite the negative backdrop that I just painted now, Ian, we have seen both positive and encouraging signs that things are not as bad as initially anticipated. 

Ian Fraser  05:39

Great. 

Nosibusiso Nqgondoyi  05:40

For one, the recovery in rental collection rates has been faster and better than expected, and currently sits at about 90% levels. Also, with the Reserve Bank having aggressively cut interest rates, we have seen a decline in average borrowing costs, which will support earnings growth in the near term. We are also seeing declines in additional new supply across sectors, which is also positive for the sector. 

And then I think, most importantly, is that most companies are retaining earnings, and only paying out the minimum required for them to retain their REIT status. And in some instances, we have seen the likes of Hyprop, having successfully sold down or sold assets to pay down debt. And maybe just lastly, Ian, I mean, banks have also been very lenient with local REITs, given the challenging environment. So, I believe that all of this is favourable, and bodes well for the near-term outlook for the sector. 

Ian Fraser  05:40

Ja, the banks are a big one, aren't they? The favourable lending rates, having a bit of a softer attitude to try and stimulate growth, that is a big one. 

Nosibusiso Nqgondoyi  06:51

Yes, certainly, the fact that banks have been lenient to local REITs is great for the space, because it really buys them time to sort out their balance sheets and pay down debt, which is the key risks that is facing the sector currently. 

Ian Fraser  07:06

Busi, I want to turn our attention... you mentioned Eastern Europe just a few minutes ago, and I want to just take a global view, maybe somebody is interested in this as well, and how it all affects us here in South Africa. 

How does the local sector, our property market, compare to the global sector, specifically from a diversification point of view? Like, I'm interested to see that picture. What that's in your opinion? 

Nosibusiso Nqgondoyi  07:30

Yes, I'll use our benchmark as an example. 

Ian Fraser  07:35

Okay.

Nosibusiso Nqgondoyi  07:35

So, our benchmark of choice for local REITs is the FTSE JSE All Property Index. 

Ian Fraser  07:41

Okay. 

Nosibusiso Nqgondoyi  07:41

And in our view, this offers better diversification than its predecessor, which is the SAPY Index. We have seen an improvement in the sector from original diversification point of view, with currently more than 50% exposure to central Eastern Europe, and the balance locally. However, there remains very little diversification at sector level, with retail still accounting for roughly 60% of the sector, while, for example, the two largest companies make up 30%. 

And in contrast to what you see globally, you are not only getting regional diversification, but also the opportunity to invest in diverse industries and sectors across the global economy. You are getting exposure to more than 10 different sectors, with no single sector making up 20% of the index. And the benefit of the diversification that we see in the global space was again emphasised with the extreme market selloff that we saw in March on the back of COVID, where there was a huge divergence in terms of sector returns. 

For an example, you saw that data centres, cell towers, and logistics being clear beneficiaries during this environment and really benefiting from e-commerce. And this this sector's effectively cushioned global REITs from the pain that was felt in the other sectors, being retail logistics and the office space. So, and I mean, if you compare to the local space, we have very little to no exposure to these sectors.

Ian Fraser  09:26

Interesting. I find that very fascinating in terms of the diversification, and also if you step back and look at it, the fact that nobody saw that online would take over this year, as much as it has, and impact those retail investments. Really, you know, it's been a complete about face turn from the beginning of the year where we were kind of "on track" in inverted commas before COVID. And now we sit at the end of the year looking at things completely differently. 

So, I'm really interested to know, off the back of that answer, what might lie ahead? Obviously, you're planning for next year, you've got some thoughts. And I always like to ask people who I chat to, to look into their crystal ball, and to potentially make a prediction as to what you are doing from an Old Mutual point of view.

Nosibusiso Nqgondoyi  10:15

Yes, Ian, I wish I could sit here and tell you that it's all a bed of roses that lies ahead. 

Ian Fraser  10:22

Ja, me too. 

Nosibusiso Nqgondoyi  10:23

However, the path ahead remains challenged and uncertain, particularly the next two to three years. As I said earlier, as these companies continue to focus on paying down their debt and fixing their balance sheets, and also you need the local economy to start growing again, for the operational environment of these companies to improve. 

But we however believe that the negative news are more than priced in at current valuation levels, with the potential for double digit earnings growth, given the low base effects. Investors that are prepared to look through the next four to five years could be handsomely rewarded, should there be a re-rating in the sector. Stock picking, however, remains very important going forward, Ian.

Ian Fraser  11:13

Okay. Ja, I think you've answered admirably, considering the fact that, you know, what's gone on, and what is about to go on is anyone's guess, really. You know, we didn't know what was to come and we don't know in the next year or so, or even two years, as you say. 

So, let's hold thumbs, I suppose, that's the best we can do. I think everybody locally is trying their best to make the best of a bad situation. I do hope that 2021 potentially turns out to be a little bit more smooth, as opposed to a bumpy ride. And I hope that you make some very informed decisions that go the right way, Busi.

Nosibusiso Nqgondoyi  11:50

Thank you, Ian, we are certainly hopeful that the challenged environment that these companies are finding themselves will improve going forward. Thank you.

Ian Fraser  12:03

Head of Property and Hedge at Old Mutual, Busi, thank you so much for being with us today on the podcast. 

Nosibusiso Nqgondoyi  12:08

Thanks, Ian. 

Ian Fraser  12:13

Old Mutual Multi-Managers are a specialist investment boutique within the Old Mutual Group, South Africa's largest and most established financial services company. They offer affordable investments that blend together the best of South African and offshore asset managers. Old Mutual Multi-Managers is a division of Old Mutual Life Assurance Company (South Africa) Limited, a licensed financial services provider and life insurer.