ECONOMIC OVERVIEW

SA REITs are facing more challenging times with interest rates rising in a sluggish economy, and forecast sector distribution per share (DPS) growth expected to slow in the next 12 to 24 months.

Short-term interest rate rises have, in the past, had little direct impact on REITs in the near term. This is because interest rates tended to increase in a strong economy, with rising GDP growth. When this happens it mostly leads to declining property vacancies and rising REIT earnings.

However, the present rising rate cycle coincides with a sluggish economy, which is clearly negative for REITs.

GDP growth in the previous rate hike cycle averaged 4%, from 2005 to 2008. However, 2014 saw growth of only 1.5%, with forecasts of 1.9% to 2.0% for 2015/2016. Similarly, commercial property vacancies averaged 4% in the previous cycle compared with around 6% now.

In addition, since the global financial crisis, companies have been more cautious to expand and take up more space. There is an international trend for space densification in offices, increasing the number of employees per m². There is also a new supply of space around Gautrain stations, which is exceeding demand. Further, the retail sector is more saturated now than it was eight to 10 years ago. Plus, there is little room for vacancy levels to decline in the near term. So, the tailwind of previous cycles is lacking this time around.

There are indications that we can expect further interest rate hikes in the next two years, yet there are also hopes the current rate hike cycle will be more gradual given the sluggish economy. In the previous rate hike cycle there were 400bps rate hikes in 18 months and 500bps in 24 months. So far we have had 100bps in 18 months. With around 75% of listed property sector debt hedged for three to four years, the direct negative impact should be small in the short term. Nevertheless the refinancing savings of recent years will come to an end.

The sector also faces the impacts of concerning mismanagement at both council level and at the utilities responsible for electricity, infrastructure and water provision. There seems to be a lack of political will and leadership to address these issues as well as corruption. Companies consequently have to pay more (rates) for less (service delivery), and in addition have to provide the services privately. While REITs can pass on a significant portion of rates and taxes to tenants, the cost of occupancy has been rising faster than inflation, resulting in pressure on the ability to pay higher net rents.

SA REITs in general benefit from good quality management, disclosure and transparency, an attractive listing structure and capital markets, yet their competitive advantage will be eroded over time by these negative macro and socio-political factors. This has resulted in a trend in recent years by both REITs and companies in other sectors to expand offshore, driven by the above negative factors.