Listed and commercial property: where to from here?

The South African listed property sector has been the worst performing asset class on the Johannesburg Stock Exchange (JSE) this year, so where to from here for listed and unlisted property?

The locally listed property sector index is down by some 50% for the year and has shown no sign of recovery.

Property’s poor performance is not only a direct result of the fall-out from the Coronavirus (COVID-19) pandemic, but also the acceleration of a longer-term trend. At the start of 2020, the listed property sector had already declined markedly since 2017.

Over the past decade, it has been increasingly clear that the commercial property sector was due for a correction.

High valuations have not been supported by South Africa’s stagnating economic growth since 2012. Property values, especially retail property, had become very expensive in real terms by historic standards. Office and industrial property valuations were also expensive by their own historic standards albeit less so than retail.

The commercial property sector began to experience a gradual and long overdue correction from 2017, which was sped up by COVID-19 as the lockdown put pressure on tenants of retail, offices and hotels.

Working from home and e-commerce were growing trends affecting the property sector before the pandemic. Coronavirus has simply accelerated their impact. The growth of online shopping threatens the retail property business as fewer people buy from malls, although the major retail challenge remains the weak economy’s impact on consumer finances. Working from home, to some extent, threatens office space demand.

Technology is less of a threat to industrial property which has benefited from the growing demand for warehouses to hold inventory for online retailers.

In South Africa (SA), we find industrial property is a far more affordable property segment than retail – which contributes to its faring better.

The constraints on the physical property market are reflected in the significant price drop of the JSE Listed Property Index. But there have been winners and losers in the individual companies that make up the index.

Retail focused companies such as Hammerson and Hyprop Investments, which have expanded offshore, have struggled. Industrial-focused Equites Property Fund and Store-Age, which as its name suggests focuses on storage real estate, have done well by comparison. The self-storage property sector is holding up well perhaps because in a recession tenants under financial stress move home to their parents and store their household goods. Businesses that close may store furniture and equipment in the hope that they will re-open. Self-storage benefits from the “4 Ds”, namely Death, Displacement, Disaster and Dislocation. This can imply that it holds up relatively well in tougher times albeit not being entirely recession proof.

Listed property shares are now trading significantly below net asset values. Declines in physical commercial property evaluations will probably follow suit, albeit more gradually, unless economic growth picks up quickly.

Residential property buyers are more sensitive to interest rates and tend to be emotional about owning a home. With three repo rate cuts this year, first time buyers are piling into residential property. Working from home is to some extent encouraging this trend, but many people will return to offices as many corporates are locked into leases. Office space won’t just disappear, but companies will often allow for more flexible workspaces such as floating desks that require less space, and likely reduce their space requirements gradually over time.

Property cycles and “super-cycles” are often incredibly long and slow.

Following the 2008/9 global financial crisis, the overall national property all vacancy rate continued to rise until 2011 before it started declining in 2012. The COVID-19 recession is far deeper than that of 2008. So we could expect the listed property sector and the physical commercial property market that underpins it to be constrained for the next few years.

This is probably a time to hold listed property rather than to sell – but know that recovery might take many years.