Property Insights from Snoop Dogg

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Welcome to the Supernatural Stocks Podcast on Moneyweb with your host The Finance Ghost – your weekly guide to local and global insights for investors and traders.

This episode includes an unusual investment lesson from Snoop Dogg, but more on that later.

A decade back, the JSE property sector was thriving. Institutional investors were eager to engage with any accelerated bookbuild that hit the market. During my corporate finance tenure, Java Capital was highly sought after, effortlessly collecting substantial fees during the property sector boom.

The sector’s excitement came from property funds being seen as a straightforward method to invest capital offshore. As the shine of the Fifa World Cup faded and the local economy faltered, capital allocators grew wary of their domestic exposure. The property sector seemed to offer a clear solution, enabling management teams to acquire properties in “secure” markets like the UK.

Listen/read: Property stock picks and more insights from Stanlib’s Nesi Chetty

Things looked promising until the Brexit vote in 2016, which raised questions about the notion of “safety.” As a result, regions like Eastern Europe gained popularity among investors, delivering a blend of Eurozone risk mitigation and growth rates between developed and developing markets. Nowadays, Spain and Portugal are viewed similarly and are attracting local property funds.

The JSE property sector remains intriguing and vital for numerous pension funds. Personally, I consider it an excellent investment for my tax-free savings account (TFSA) since distributions from REITs [real estate investment trusts] are taxed as income rather than dividends, a significantly higher rate for many investors. Conversely, in a TFSA, they are tax-exempt, allowing me to gain without tax deductions.

This is a major reason I prefer listed property over traditional buy-to-let investments.

Let’s analyze the current state of the sector, especially in light of recent capital raising endeavors. Then, I’ll clarify why Snoop Dogg is relevant here. After all, he recognizes a good high when he sees one.

Local is lekker these days

A noticeable trend in the sector is simplification and consolidation. For instance, Equites Property Fund is selling off its UK assets to emphasize developing logistics properties in South Africa. The landscape has dramatically changed compared to ten years ago.

Meanwhile, Growthpoint is actively streamlining its operations, which involves significant offshore divestitures and adjustments to its domestic portfolio to create a more concentrated focus rather than a diversely macro-portfolio that contains challenging exposures.

Local is indeed lekker, but certainly not everywhere – as anyone who has traveled through South Africa would know.

Read: Growthpoint Properties collaborates with tenants on decarbonisation

This brings us to a highly focused fund like Spear Reit, which vows to concentrate exclusively on the Western Cape. While this strategy may seem straightforward now, investment returns always hinge on two factors: the purchase itself and the price paid. As other local property funds sharpen their focus on the Western Cape, Spear must tread carefully to avoid overpaying amid intense bidding for properties, a task they seem to be managing well thus far.

Others may not focus on a specific region but still maintain concentrated portfolios due to strategic choices, like Attacq in the Waterfall area within Midrand.

Read: SA property sector witnessing ‘green shoots’ – Standard Bank

Some players in the local sector face difficulties, such as Accelerate Property Fund, which is grappling with considerable challenges ahead. The success of Fourways Mall and the effective execution of the Portside sale in Cape Town will be crucial for their turnaround, complicated by intricate related-party issues.

The local sector is thriving, with strong growth occurring in retail centers that cater to lower-income consumers, often located on busy commuting routes adjacent to township areas, capitalizing on the transition from informal to formal retail.

But does this “local is lekker” trend suggest that international pursuits by South African funds have stalled?

The theme of ‘focus’ extends globally as well

We have undoubtedly moved past an era where every fund was chasing some form of international strategy. Rather, the successful ones are those who specialize in particular regions and flourish as a result.

Take Vukile Property Fund’s initiatives on the Iberian Peninsula, along with Lighthouse’s activities in that region. Iberia has emerged as the new Eastern Europe.

Nevertheless, Eastern Europe continues to be an attractive destination, particularly for Nepi Rockcastle. Additionally, the recent developments surrounding MAS Real Estate and Hyprop’s attempts to act as the “White Knight” for local institutional investors in their struggle for control with Prime Kapital are noteworthy.

Listen/read: Battle for Eastern European property portfolio intensifies

Prime Kapital ultimately triumphed, while Hyprop now holds over R800 million raised in the market to support that deal. This brings me to an important point: we must keep a close eye on equity capital raising within the sector and its repercussions.

And here’s where the Snoop Dogg reference comes into play…

Drop it when it’s hot

The Snoop Dogg trade might come into play here: ‘Drop it like it’s hot.’ However, with a slight twist – drop it when it’s hot. I won’t be singing the intro to that classic 2004 hit, but do listen to the podcast’s conclusion to witness my embarrassing performance!

How can you tell when it’s time to drop it? Thankfully, there are two signals to keep an eye on in the property sector.

The first is the discount to net asset value (NAV). Generally, a 20% discount is reasonable to account for management expenses and liquidity. If funds start trading at NAV, it can be concerning, and a premium to NAV should raise alarms, signaling that the market values the management team’s ability to uncover new opportunities.

In rare instances, a premium may be warranted for funds with successful management histories. However, even the best, like Sirius Real Estate, should be approached carefully when their premiums escalate. The overall sector should ideally never trade at NAV; a discount is vital to account for the costs associated with being publicly listed.

Thus, monitor where funds are trading relative to NAV.

The second indication that things may be heating up is increased capital raising activity. The bubble we witnessed a decade ago was marked by rampant capital raises for vague “general acquisition purposes” – often not tied to specific transactions.

When you notice funds seeking blank-cheque capital just to find things to acquire, it’s time to heed Snoop Dogg’s warning.

For instance, the market granting R800 million to Hyprop merely on the possibility they would acquire MAS – that’s bubble behavior.

Read: Hyprop withdraws from MAS deal over DJV secrecy

Keep in mind that when capital raising occurs, management narratives often shift from increasing distributable income per share to increasing overall distributable income. Why? Because sharing newly issued shares while waiting for capital deployment negatively affects per-share earnings.

Management usually emphasizes favorable metrics, so it’s crucial to discern which figures truly matter. In this case, per-share growth is essential; without it, capital can easily be raised, leading to questionable deals that boost overall fund earnings while diminishing per-share value.

I remain optimistic about the sector but stay vigilant. It feels like the opening notes of Drop It Like It’s Hot are beginning to play – that unmistakable doof-da-doof-da-doof-da-doof, and while we’re not yet at Snooooooooop (a subpar performance, but it’s all I’ve got).

Exercise caution – when that music starts playing seriously, it’s time to step back from this sector and reallocate your investments.

That’s precisely what I intend to do with my TFSA. And if you’re too young to recognize the song I’m referencing, please be extraordinarily careful, as it suggests you’ve likely missed the property bubble of 2014-2016. Those who entered the market at its peak suffered considerable losses.

Read: Positive first-half performance for REITs

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