There was a time when South Africa’s listed property executives could walk on water.
In the middle of the past decade, Reits trading at premiums to NAV had discovered how to turn water into wine by issuing expensive paper, buying cheaper property, growing distributions, rinse and repeat. The sector raised about R250bn in equity between 2010 and 2017 as it expanded.
For a while, the flywheel spun beautifully. Until it didn’t.
Some shares reached extraordinary premiums to NAV — Nepi Rockcastle was at one stage at about 79% and Resilient about 35%. Then came questions about cross-shareholdings, distributable income, accounting treatments and whether growth was quite as organic as advertised. Allegations around the Resilient stable were contested. An independent investigation later cleared key directors of misconduct relating to insider trading and share-price manipulation, but the episode changed how investors looked at the sector.
That history makes group CEO Norbert Sasse’s final Growthpoint results rather more interesting than the prosaic headline rise of 4.3% in distributable income per share suggests.
Sasse leaves Growthpoint preaching almost the opposite gospel.
Since 2016 Growthpoint has sold 214 properties for R19.9bn, reducing its local portfolio from 471 properties to 302 and its lettable area by 26%. Sasse offers perhaps the most useful property lesson of his career when he tells the FM that owners hold buildings too long. They become emotionally attached even after the investment has delivered its targeted internal rate of return. Time then becomes the enemy as ageing assets demand capital while incremental returns deteriorate.
The late US billionaire Sam Zell would have approved. Zell’s great obsession wasn’t buildings. It was capital. He earned the nickname “the Grave Dancer” after making a fortune buying distressed real estate from owners who had overborrowed, run out of liquidity or simply mistimed the cycle, and then selling when capital and optimism returned.
Growthpoint appears to have rediscovered both principles.
Its South African debt has fallen from a peak of about R42bn to R33bn. Local loan-to-value is down to 30.2%. Yet the portfolio it retained still generated 4.4% like-for-like net property income growth. Sasse says about half this year’s earnings improvement came from lower interest costs, and half from operations. Crucially, the lower interest bill wasn’t simply a gift from the Reserve Bank; Growthpoint sold assets and used the cash to extinguish debt.
Governance risk
Consider Discovery’s Sandton headquarters. Growthpoint sold its 55% interest for R2.3bn. The disposal will dilute next year’s distributable income per share by about 1%, which superficially looks daft, but this is perhaps the purest example of this new discipline.
“The dynamic you speak about is a one-year forward earnings dilution of 1%,” Sasse says. “But the reality is, you could potentially see a 2% or 3% or 4% dilution if you held on to it for much longer and you didn’t get the outcome on the retenanting or the releasing of that building.”
Discovery’s building, he explains, was designed specifically for its tenant, with huge floorplates and an extraordinary six parking bays per 100m². It is also now considerably over-rented after years of 7%-8% escalations.
His conclusion is that “the forward returns were probably going to be lower for us than the historic returns. And it was the best thing to do to dispose of the asset.”
That is capital allocation in its most unsentimental form. And therein lies the broader lesson for the recovering Reit sector.
Investors should be delighted that balance sheets are healing, vacancies are falling and distributions are growing. But they should become nervous the moment rising share prices recreate the temptation to manufacture growth through cheap equity and expensive acquisitions.
The other lesson in Growthpoint’s numbers is that location risk in South Africa is increasingly governance risk. Gauteng office vacancies sit at 18.6%, against much tighter markets in Cape Town and KZN, and the valuation divergence is equally stark. “It’s all about governance,” Sasse said, pointing to the deterioration of infrastructure across Gauteng. His formulation is memorable: “It takes longer to fix something than it took to break it down.”
The absurdity is that landlords increasingly have to become miniature municipalities. Growthpoint operates 98 solar plants, 55 boreholes and 178 water-backup facilities, while “still paying rates … probably double the amount of rates you paid seven years ago”, Sasse says.
There is one potential spoiler: the bond market. Long-dated US, UK and European yields have surged to levels not seen for decades, while local bonds have, remarkably, been comparatively benign. For Reits this matters because bonds compete with property for income-seeking capital, while the risk-free rate ultimately anchors property discount rates and financing costs. A persistently higher global cost of money could put upward pressure on cap rates just as landlords begin enjoying lower domestic funding costs.
Zell understood that real estate ultimately comes back to supply and demand and to what you paid. Perhaps that is the lesson as the old Growthpoint bulldog finally leaves the kennel. Property investing works best when it becomes boring. Buy well. Finance conservatively. Sell when the return has been made. And never fall in love with the bricks.
