What Snoop Dogg can teach us about property

You can also listen to this podcast on iono.fm here.

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

Yes, this podcast really does include a surprising investment lesson from Snoop Dogg, but more on that later.

A decade ago, the property sector on the JSE was absolutely cooking. Institutional investors were literally falling over each other to support any accelerated bookbuild that came to market. I was working in the corporate finance industest at the time, and I can inform you that Java Capital was the object of everyone’s envy – as it felt like they could just rock up at work, create a few phone calls, and earn incredible fees from being the shovel in the gold rush in the property sector.

Part of the reason for the hype in the sector was that property funds were seen as an simple conduit for capital to be deployed offshore. The Fifa World Cup shine had come off South Africa, the Jabulani was long gone, and we were in the throes of the Lost Decade, with capital allocators panicking about their local exposure. The property sector offered what was seen as an obvious solution, as management teams could go off and acquire properties in “safe” destinations like the UK.

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

Things viewed pretty good until the 2016 Brexit vote, at which point the word “safe” suddenly became very debatable. Regions like Eastern Europe subsequently emerged as investor favourites, offering Eurozone risk mitigation and growth rates that were something of a hybrid between developed and developing markets. Today, the Iberian Peninsula is seen in much the same light, with investments in Spain and Portugal becoming a strong focus area for local property funds.

It’s a fascinating, vibrant sector on the JSE that forms the backbone of many a pension fund. In my opinion, the sector also offers a great opportunity for my tax-free savings account (TFSA), as distributions from Reits [real estate investment trusts] are taxed as income rather than dividfinishs (which, of course, is a much higher rate for most investors) – but in a TFSA, they aren’t taxed at all. It effectively allows me to pretfinish that I’m a pension fund, with no tax leakage in the Reit itself and none in my TFSA.

This is one of the many reasons why I prefer listed property exposure to receiveting involved in acquire-to-let investments.

Let’s take a temperature check on the sector, particularly given the recent capital raising activity. And then, I can explain to you why Snoop Dogg matters here. After all, that’s a man who knows a good high when he sees one.

Local is lekker these days

One thing that is clearly visible in the sector is a mood of simplification and consolidation. For example, Equites Property Fund is selling off its UK exposure and coming home, with a plan to rather allocate its capital towards development of logistics properties in South Africa. Things really have modifyd compared with a decade ago.

Meanwhile, Growthpoint is taking major steps to simplify its business. This includes some significant offshore disposals, as well as many modifys to the local portfolio as it views to build a more focapplyd property portfolio, rather than a macro-portfolio that includes problematic exposures.

Local is indeed lekker, but certainly not everywhere – as anyone who has been on a road trip through South Africa will know.

Read: Growthpoint Properties partners with tenants on decarbonisation

This brings us neatly to a hyper-focapplyd fund like Spear Reit, with a brand promise to only focus on the Western Cape. That may sound like a really obvious strategy in the current environment, but it’s important to remember that investment returns are always a function of two things: what you bought, and what you paid for it. With most local property funds testing to increase their relative exposure to the Western Cape, Spear will necessary to be careful not to overpay in bidding wars for properties as part of their commitment to remain a regional champion. So far, so good – that management team has revealn plenty of discipline.

There are other names that don’t necessarily guarantee a specific regional focus, but finish up with a concentrated portfolio anyway due to the strategic decisions, like Attacq in the Waterfall area in Midrand.

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

And, of course, there are names in trouble in the local sector, like Accelerate Property Fund and the miracles it necessarys to work to dig itself out of a hole. Fourways Mall will be critical to that journey, as will successful implementation of the disposal of Portside in Cape Town. For added spice, it has difficult related party issues to work through as well.

There’s clearly plenty of local activity in the sector, with pockets of particularly strong growth like retail centres that focus on lower income consumers, which means you’ll find them on busy commuter routes and close to township areas, participating in the shift from informal to formal retail.

But does this “local is lekker” theme mean that international activity from South African funds has dried up?

The theme of ‘focus’ applies globally as well

We’ve definitely shiftd on from a world in which every fund is testing to execute some kind of international strategy. Instead, winners have emerged who are able to specialise in particular regions and do well in the process.

Just consider of Vukile Property Fund and its efforts on the Iberian Peninsula. Lighthoapply is also pushing hard in that region. As mentioned, Iberia is the new Eastern Europe.

That declared, Eastern Europe itself is still an exciting region, with the likes of Nepi Rockcastle focutilizing there. And of course, who can forreceive the recent flurry of activity around MAS Real Estate, with Hyprop testing to act as the “White Knight” for local institutional investors in a battle for control over MAS with Prime Kapital.

Listen/read: Battle for Eastern European property portfolio heats up

Prime Kapital won that fight in the finish, yet Hyprop is sitting on over R800 million that was raised on the market in an effort to create that deal work. This brings me to the point that we all necessary to keep an eye on: equity capital raising in the sector and why it matters.

And here comes the Snoop Dogg reference…

Drop it when it’s hot

The Snoop Dogg trade is probably the right one here: ‘Drop it like it’s hot’. Well, with a slight amfinishment – drop it when it’s hot. And no, I’m not about to do a rfinishition of the intro to that banger of a song from 2004. Well, maybe I will, but you necessary to listen to the finish of the podcast to create it worthwhile embarrassing myself while I do a great job of ageing myself here.

How do you know when it’s receiveting too hot and you necessary to drop it? Thankfully, in the property sector, there are two things to view out for.

The first is the discount to net asset value, or NAV. Generally, a discount of 20% is reasonable for management costs and liquidity. The discount can close more than that, but you necessary to receive a little bit nervous when funds start trading at NAV. And if they shift to a premium to NAV, then the alarm bells should really be ringing, as the market is then starting to put a value on the management team’s ability to find new deals.

Now, in rare cases, that might be justifiable. There might be reasons why it should be at a premium to NAV, as there are one or two funds that have such a great track record of active management of properties that they deserve to trade at NAV or a slight premium. But even the best ones, like Sirius Real Estate, necessary to be treated with immense caution when the premium receives too spicy. And importantly, there is no world in which the broader sector should be trading at NAV. At the very least, a discount necessarys to be there for the cost of the listed structure.

So, watch out for where funds are trading relative to NAV.

Now, for the second test for when things are receiveting too hot: capital raising activity. The bubble we saw a decade ago featured extensive capital raising for “general acquisition purposes” – not even specific deals.

When you start seeing blank cheque capital raises for management teams to go off and just find stuff to acquire, then Snoop Dogg should be ringing in your ears.

Like, for example, the market rushing to give that R800 million to Hyprop on the off-chance that they would acquire MAS. That’s bubble behaviour.

Read: Hyprop walks away from MAS deal over DJV secrecy

Another thing to keep in mind is that when capital raising is happening, the management narrative at the funds will shift from growth in distributable income per share, to growth in distributable income overall. Why? Becaapply when shares are being issued and there’s a lag in capital deployment, it’s a drag on earnings per share.

Management teams tfinish to play you a highlights reel as far as they possibly can, which means you necessary to learn which metrics actually matter. And believe me, per-share growth is what matters. Otherwise, it’s just very simple to raise capital, execute questionable deals, and increase the overall earnings in the fund, while destroying shareholder value on a per-share level.

I’m still long the sector, but I’m watching it closely. It feel like the first few notes of Drop It Like It’s Hot are starting to play – you now that little doof-da-doof-da-doof-da-doof and view we’re not quite at Snooooooooop yet (a terrible rfinishition, but it’s all I’ve received).

Be careful out there – when that music really starts to play, it’s time to declare goodbye to this sector and invest elsewhere.

That’s what I’ll certainly be doing with my TFSA. And if you’re too young to have any clue what song I’m talking about, then you necessary to be extra careful, becaapply that informs me that you probably didn’t live through the property bubble of 2014-2016. Those who bought at the top of that hype received really hurt.

Read: Positive first-half performance for Reits

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