With the worst impacts of the Covid-19 pandemic having subsided, the increased interest rate cycle nearing its end and landlords finding power generation solutions, South Africa's real estate investment trusts (Reits) are likely to outperform cash and government bonds in the long term, says South Africa Real Estate Investment Trust Association (SAReits) chairperson and Growthpoint Properties CEO Estienne de Klerk.

He notes that, while returns for Reits listed on the JSE have been negative for the past five years, their performance was not unique, as global real estate firms faced the same challenges.

"We need to contextualise the performance of South African Reits because, unlike other sectors of the economy, the sector faced headwinds in the form of floods, Covid-19, riots, inflation and higher interest rates, negatively impacting the sector," says De Klerk.

However, he notes that, with a cap on interest rates expected sometime soon, investment in real estate will improve. “This will further be supported by the improved property fundamentals as evidenced by improved industrial and retail property's stronger returns.”

De Klerk adds that strong demand for industrial real estate and growth in this sector; strong letting in Cape Town and Durban where vacancies are falling; and strong performances in the retail, office and industrial sectors have come back strongly.

“The Gauteng economy remains under pressure, but supply and demand dynamics are expected to improve as businesses start to return to their office spaces as most corporates’ preferred place of work.

“The irony is that loadshedding has resulted in more people returning to their offices. Therefore, it is reasonable to expect improved demand over time, which could result in positive rental growth over the long run, particularly in offices with high green credentials,” he says.

In this regard, De Klerk says the inflationary pressure on the development cost has raised the required rentals of new developments substantially, which will support increased rentals on existing properties. “Therefore, landlords will have room to raise rent and actual returns.”

According to him, there is a 40% differential between the rentals required on new industrial properties compared with the in-force rentals on existing properties.

De Klerk also points out that, every challenge presents an opportunity. “Landlords are rolling out solar power at their properties, and there is an increase in environmental, social and governance reporting and green-building portfolios. Real estate companies can take advantage of this opportunity and, in the future, the deregulation of the electricity industry will create more avenues to improve returns.”

“Most landlords have been proactive in supplying generators and looking into other generation solutions like gas and solar. All this will contribute to an improvement in electricity supply in the long run,” he says.

The past five years have been a mixed bag for the local Reit industry, not least because of its investment strategies, but because of the macroenvironment where the sector has been at the mercy of the low-growth economy, loadshedding and high interest rates, which have affected the appetite for the asset class.

Counterpoint Asset Management portfolio manager Ian Anderson, who has collaborated with SAReits on its sector analysis, says the structure of the local Reit market is mainly characterised by above-average exposure to large malls and offices. “It is why returns were affected, especially during the pandemic.”

However, he says there is a “silver lining” in the next two to three years, and that the performance of the sector and returns will largely depend on the resolution of the power crisis and uptick in economic growth. “It will improve investor confidence and, over time, demand in commercial and industrial property.”

“Loadshedding poses a significant challenge for all South African businesses, but the property sector is likely to be the most negatively impacted, especially in the short term, given the need to spend large amounts of capital when the cost of capital has risen sharply in the last 12 months,” says Anderson.

However, he points out that many Reits are already ahead of the curve and have done a lot in this regard.

Nonetheless, Anderson says the market is concerned about the need for significantly increased capital expenditure spend at a time when the demand for space is still weak in several markets.

He explains that most Reit management teams have spent a considerable amount of time and energy improving the quality and relevance of their property portfolios, while at the same time strengthening their balance sheets.

Therefore, the industry should be able to cope relatively well with higher interest rates and produce moderate growth in profits and dividends over the medium term, says Anderson, adding that they are, however, unlikely to exceed inflation.

As such, investors should expect the income yield plus 3% to 5% a year, as a total return (between 9% and 12% a year).

Anderson concludes that, if sentiment towards the sector improves owing to reduced loadshedding or interest rates or an improvement in the economic outlook, then the large discounts to net asset value will unwind, adding a further 10% to 20% to returns over a three-year period.