Reviving Property Market: Urgent Rate Cuts & Economic Reform Needed

The listed property sector is rebounding, but it needs interest rate cuts and economic reform to achieve long-term capital appreciation.

• The listed property sector rebounded recently but needs further interest rate cuts and economic reform to reach historic highs.
• Improved macro fundamentals and renewed investor interest have led to a scramble for listed property, boosting share prices.
• Long-term capital appreciation in listed property depends on earnings growth, making it a more attractive option than government bonds.

The Current State of the Property Sector: Challenges and Opportunities

Despite a recent rebound in listed property shares following the formation of the Government of National Unity (GNU), the sector remains in a holding pattern. According to Evan Robins, manager of the Old Mutual Quoted Property Fund, while positive sentiment around the GNU is encouraging, the real catalysts for growth are further interest rate cuts and improvements in domestic economic growth.

Robins notes that the property sector has lagged behind other asset classes over the past decade, with the recent catch-up attributed to an appreciation of improved macro fundamentals. This shift has sparked a scramble among asset managers for listed property investments, bolstered by falling bond yields that have positively impacted share prices.

Investors view listed property as a hybrid opportunity, offering both capital appreciation and consistent rental yields. In the short term, property values are heavily influenced by bond yields, but over the long term, performance is driven more by earnings growth. Robins emphasises that while government bonds offer fixed returns that diminish over time due to inflation, listed property provides earnings that fluctuate with the economy, driving long-term capital appreciation.

Two key motivators for increasing exposure to listed property are earnings growth and the risk-return profile. Currently, government bonds yield a real return of about 5%, which is attractive, but returns from ungeared physical property can be nearly double that.

Navigating Challenges in the Property Sector Post-Pandemic

The pandemic’s impact on the sector has been significant. Rental earnings have rebased lower than pre-pandemic levels (2017-2019), prompting capital allocators to reassess their exposure to listed property based on this new earnings reality. Robins states that the current pricing of the listed property market reflects levels last seen in the early 2010s. For property values to rise, there needs to be a macroeconomic driver, such as falling interest rates or higher-than-expected GDP growth.

Robins also mentions that further consolidation is likely as fund managers normalize their holdings in listed property. Many property generalists, previously underweight in this sector, are now trying to increase their exposure following its rapid re-rating.

Factors supporting a long-term bullish outlook for the sector include high replacement costs and low historic rental rates in some areas. Current capital values for quality domestic commercial portfolios are still below the cost of new builds, offering potential for earnings growth through improved vacancy rates and rental increases.

Looking ahead, Robins expects decent returns from South African listed property over a three- to five-year horizon, contingent on a supportive macroeconomic environment. Ultimately, the success of the property sector depends on South Africa addressing economic constraints and driving GDP growth back to 2% and beyond.