The defining feature for the property sector is that capital behaves very differently in South Africa, when compared to the rest of the world. Two components influence this difference. Firstly, the rand, unlike the dollar, Euro or British pound is very liquid. There is also a much higher portion of pension funds, relative to GDP, under management. This is evidenced by South Africa having some of the largest pension funds in the world, with the Government Employees Pension Fund being around the eighth largest globally.
The second component is that this liquidity is concentrated in a very tight space. In South Africa pension funds are either invested in the listed property sector, mainly through Real Estate Investment Trusts (REITS) or directly into their own property funds. Studies show that 22 to 23% of capital funds are in the listed property sector and the sector in turn has 50% of its investment offshore. This must be seen in contrast to the global trend of 5% invested in the listed property sector.
That in and of itself is not a problem. However, the issue is that the REIT sector is driven by short term incentives in the form of regular dividend distributions. The South African market has been unable to consistently develop rental growth as it has been hampered by high interest rates and weak monetary policy. This has resulted in a yield gap as it must be borne in mind that contractual annual escalations are not the equivalent of market rental growth.
In order to generate these returns, there was a need to find markets that generated returns, and with this came the flow of investment by the locally listed REITs to largely Eastern Europe and Australia. This has often begged the question, why did the European market not flood these markets with capital if they were so attractive? Firstly, the early pioneers into these markets were traders, and good traders to boot. So they spotted a good deal, and were able to close on properties with little or no yield gap. Secondly, having cut their teeth in the South African market they not only understood risk but expected risk. Our local markets had a natural affinity to those Australian and Eastern European markets while the European Union had a home market bias and different expectations, capital preservation being foremost.
In the last two years things have changed. Those markets have become more competitive with capital interest not only from Europe but also the East. The European relationship with Eastern Europe has changed with greater co-operation and a willingness to work together. The opportunities to find good deals has disappeared with more capital being available in these markets.
There are therefore a few fundamentals that have underpinned the South African property sector:
- An historical over-concentration of equity which has resulted in an oversupply in various sectors, most notably commercial office and retail
- The paradox of a fairly evolved regulatory framework but a fairly simplistic product offering with little to no evolving of capital mediation such as family funds, closed end funds etc..
- The product offering through REITs requiring short term returns from an asset class geared to long term investment
- The slow growth in the economy resulting in low rental growth
- Difficulty in competing in dollar-based economies with competitive markets
These fundamentals have made it difficult for South African investment into Sub-Saharan Africa as the investor appetite for long term returns does not exist. The product development in the form of the development of shopping centres and office blocks requires lead times that South African investors are too impatient for.
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