South African property going from zero to hero

South Africa’s listed property sector has been one of the worst-performing asset classes over the past decade, but there are key signs of operational improvement and better market sentiment. 

This emergence from a prolonged slump since 2015 is set to ensure the property sector once again becomes an engine of wealth creation for investors.

Allan Gray portfolio manager, Siphesihle Zwane, outlined some of the factors driving the property sector’s improved performance over the next few years. 

Zwane explained that the property sector’s underperformance extends beyond the period of elevated inflation rates over the past three years. 

The JSE Listed Property Index has declined in value by 32% over the past decade, following a period when it was considered one of the best ways to build wealth. 

Share prices in the sector remain highly sensitive to interest rate movements, reflecting the typically leveraged nature of property companies. 

However, Zwane urged investors to pay closer attention to the quality of underlying assets and the operational performance of the companies. 

“When you buy a company, you are buying a portfolio of income-generating properties. We focus on how those properties are trading, what the rental trends look like, and whether the operational performance supports long-term returns,” he said.

Zwane said the long-term fundamentals of property remain intact, but should always be constantly questioned to determine the value of a company owning property. 

While the sector is considered to be highly stable and a reliable source of income, it undergoes rapid changes and is highly sensitive to the prevailing economic environment. 

Property companies have come under immense pressure in recent years due to a stagnant economy and intense load-shedding impacting earnings growth. 

This was compounded by most office workers choosing to work from home in the aftermath of the COVID-19 pandemic. 

As a result, the distributable income growth of these companies has remained flat for the past three years. 

This has resulted in poor returns for investors in the sector, with most companies struggling to regain their pre-pandemic levels.

However, this is set to change, with interest rates declining and an improved economic outlook supporting earnings growth in the sector, Zwane said. 

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Zwane explained that all a property fundamentally does is facilitate economic activity, whether it be retail sales, offices, or an industrial park. 

The property enables the main activity of shopping, manufacturing, or storage. The more efficiently it does that, the more value it creates. 

The first thing Allan Gray looks for in a property company is the affordability of its buildings for the tenants, as this indicates the sustainability of its earnings. 

“If retail sales, for instance, are growing at a faster rate than rental costs and other expenses like electricity, then tenants can sustain those rental escalations. Everyone wins. The tenant stays profitable, and the landlord benefits from rising contractual escalations,” Zwane said.

The second key factor is the broader cost environment of administered prices, such as electricity tariffs, water, and property rates. 

“Administered prices, such as electricity and interest rates, are crucial,” Zwane said. “If these rise too steeply, they erode the profitability of tenants and limit the ability of landlords to charge higher rentals.”

Lastly, he said that it’s important for investors to compare properties to other available opportunities, as it may not always be the best place to invest your cash. 

“We don’t view property in isolation. We evaluate it relative to what else we can own in the market. So, if listed property trades at a meaningful discount to fair value compared to other equities, it might present a compelling case.” 

In making this comparison, there is a good chance that property can outperform other asset classes in the coming years as operational pressures ease. 

The improvement in Eskom’s performance and declining interest rates will support the earnings of property companies. 

“In the retail space, there are contractual rental escalations, and at the end of a lease cycle – typically four to five years – terms are renegotiated. We’re seeing more positive reversions than in previous years,” Zwane said. 

By contrast, the office space sector remains under pressure, weighed down by persistent vacancies, decentralisation trends, and the lingering effects of hybrid work policies. 

Zwane explained that the office space market was built for a level of economic growth that hasn’t materialised. Many properties are now empty, particularly older buildings in central business districts. 

On the other hand, logistics continues to benefit from structural shifts in consumer behaviour and supply chain strategy, thanks to the dramatic uptake of online shopping. 

While the listed property sector is no longer the high-growth vehicle it once was, Zwane said it can still play a role for investors seeking relatively stable, inflation-linked income.