ARTICLES

Author: Kanyane Matlou, Deputy CIO and Senior PM: Listed Property at Terebinth Capital

“The tendency of investors to follow the market’s momentum and bet on whatever has worked recently is accompanied by antipathy to whatever hasn’t” Seth Klarman.

The contribution of an elevated offshore allocation to SA balanced fund performance over the past year has been remarkable, even with the rebound in SA Inc. assets since the elections and the formation of the GNU. With the S&P 500 and the MSCI World up 29.1% and 21.7% year-to-date in US dollar terms, respectively, a healthy allocation to global equities has undoubtedly proved to be the right call. However, not all offshore assets saw the same impressive performance. Global listed real estate (as measured by the FTSE EPRA Nareit Developed Rental Index) has lagged offshore general equities substantially, managing a relatively meagre 4.3% return (in USD).

To understand the disparity between offshore-listed property and general equities, it is necessary to examine the performance of the global government bond market over the same period. The FTSE World Government Bond Index (WGBI) is down 1.6%, as the US 10-year Treasury yield rose 55bps since the beginning of the year to around 4.4% currently. After a welcome descent in Developed Market (DM) consumer price inflation, which prompted central banks to commence with policy easing, renewed inflation and fiscal concerns have again led to upward pressure on long-term US government bond yields.

As a hybrid between equity and debt, offshore listed property at the aggregate level has priced off the weakness in government bonds since the onset of monetary policy tightening over two years ago, thus trading more as a yield rather than a growth asset (see Figure 1). With a reassessment of the extent of the Fed rate cutting cycle under Trump 2.0, the previously anticipated tailwinds to offshore listed property from lower policy rates and compressing bond yields now appear elusive. However, this does not imply that listed property lacks value; although the macro environment affects short-term returns (Figure 3), a key driver of long-term performance is the sustained earnings growth generated by the companies through the cycle. Put differently, while listed property can and does trade as a yield asset in the short term, it also exhibits growth asset qualities (illustrated in Figure 2) over the long term where strong fundamentals and earnings growth are better demonstrated.

Figure 1: US 10-year Treasury yield and global property returns

Source: Bloomberg

Figure 2: Property returns versus global equity returns and global bond returns

Source: Bloomberg, monthly returns covering period January 2012 to December 2024 (MTD as at 17 December 2024)

The gyration in bond yields, not only as a function of pending Trump policies, but also the resilience of the US economy and associated labour market strength, has driven volatility in public real estate markets. This has further reduced the appeal of the asset class to investors preferring stability in returns. This latter point necessitates a reminder of Howard Marks’ well-argued view that volatility is not a useful measure of risk, but rather, risk is better defined as the likelihood of capital loss1. Listed property has erroneously built up a negative reputation for being a risky asset class merely because of its volatility.

Figure 3: Periods of higher correlation to bond than equity returns tend to be short-lived

Source: Bloomberg. Rolling 12-month correlation. Equity proxy: MSCI World, Bond proxy: WGBI. Shaded regions represent period when global property-bond correlation exceeds global property-equity correlation

The limitation with index measures is that they mask the nuances at the disaggregated level. At both a regional and sub-sectoral level, there is a notable divergence in performance within offshore listed property. This divergence in outcomes underscores the importance of comprehensive bottom-up analysis. Even within regions and sub-sectors, there is significant disparity between winners and losers — an insight that may be missed without integrating a top-down perspective with in-depth bottom-up research.

As a slight digression, but key given the topic and focus for SA investors, is that one of the geographies that has outperformed the global aggregate substantially over the past year has been South Africa. The All Property Index’s (ALPI) 29% YTD return is well ahead of the global aggregate and jostles head-to-head with what the MSCI World has been able to deliver (taking Rand appreciation into account). No doubt the positive post-GNU sentiment and the compression in the SA country risk premium had a role to play, but the starting levels with respect to domestic public market valuations had been undemanding for an extended period.

1 https://www.oaktreecapital.com/docs/default-source/memos/2006-01-19-risk.pdf?sfvrsn=2

Sentiment can often drive returns despite the reality reflected by fundamentals. The recent period has coincided with elevated global inflation and interest rates, resulting in several jurisdictions delivering attractive rental growth in the high single digits, as a result of indexation, especially in Europe. As inflation outcomes remained elevated, lease clauses allowed for rental uplifts that reflected backward-looking inflation. This occurred against a backdrop of well-hedged borrowing costs that did not rise in tandem with the increase in policy rates. The latter does not mean the companies did not get disadvantaged by rate hikes, but that instead of suffering an immediate hit, increased funding costs would be spread over a few years due to staggered maturity profiles. Therefore, while rising rates at a headline level were perceived as negative for company earnings, the reality on the ground was not quite as bad as feared. Figure 4 below shows how listed real estate is one of a handful of sectors in Europe showing positive earnings revisions, counter to what stock prices are reflecting.

Figure 4: Sectoral earnings revisions for European equities

Source: Morgan Stanley

However, on the valuations side, the higher interest rate environment had an overall negative effect. The first impact was through a higher global risk-free rate increasing the discount rate at which future cashflows are present valued. Yet this aspect was not applicable to only real estate companies, but also to ordinary stocks, which were able flourish in the face of it, in part thanks to resilient global growth. The second impact was via the substitution effect. US bonds with a yield of 4% plus compare very favourably with the 1-year forward dividend yield on the offshore property index. As highlighted earlier, this limited income return lens admittedly ignores the upside presented by a growing earnings profile and thus the capital return aspect, which tends to be long-term in nature.

With respect to capital return, at the direct asset level a similar argument plays out. Valuers wrote down asset values substantially in the face of higher policy (and capitalisation) rates over the past two years. But even with a less dovish Fed outlook, there is arguably room for asset values to stabilise, as is already evident from recent company reporting. This stabilisation in valuation trends holds greater potential in certain regions, such as the Euro area, where a weaker growth environment offers more room for monetary policy easing compared to the United States. As the ECB implements further policy accommodation, the prospects for NAV growth in the region should become compelling, adding to the respectable initial yields for attractive total returns. Furthermore, stabilising asset values should help fortify balance sheets, which weakened somewhat in the face of falling values, although numerous management teams have already implemented self-help measures.

Revisiting Klarman’s quote at the beginning of this article, the macro environment has provided market participants with grounds for plenty antipathy towards global listed property. This is despite property fundamentals holding up better than feared, and more importantly, now showing signs of recovery. As argued in this article, the macro drivers are often transient, with fundamentals taking over as long-term determinants of returns. Therefore, it remains crucial to delve deep into the individual stocks within regions and sub-sectors to pick companies with the right attributes to drive sustainable earnings growth. In light of recent indiscriminate selling, investors can pick up high-quality assets managed by skilled custodians of capital, at a discount to their intrinsic value. As Klarman wisely stated, ‘the single greatest edge an investor can have is a long-term orientation’.

Glacier Research would like to thank Kanyane Matlou for contributing to this week’s Funds on Friday.

Kanyane Matlou

Deputy CIO, Senior Portfolio Manager – Listed Property

Terebinth Capital

Kanyane is responsible for listed property investments at Terebinth Capital, as well as being part of the macro unit and a member of the asset allocation committee. He joined the company in 2022 and has over a decade of industry experience, the bulk of which was gained as an investment analyst and co-portfolio manager on listed property mandates at Coronation Fund Managers. Kanyane holds a Bachelor of Business Science (Economics Honours) degree from the University of Cape Town. He has previously worked as an economist at the South African Reserve Bank (SARB) and as a trainee economist at the Bureau for Economic Research (BER).