Urbanisation and demographic changes in emerging markets will result in significant growth in property investment in the next six years, this according to the PwC Real Estate 2020 – Building the Future Report 2014. Whilst global stock is expected to increase by 55% by 2020, the expansion will be the most substantial in emerging markets where economic growth will lead to improved tenant quality and property rights. This will be particularly true in cities like Cape Town, where there is a well-managed government and an increase in city dwellers.
Over the past 10 years, the South African commercial property sector has shown an impressive combined capital and income return of 18.2% per annum, and according to the SA REIT Association, has been the best performing asset class over the past 15 years to 2013 when compared to cash, bonds and equities. 2014 was no different with the property sector showing returns in excess of 26% for the year. Even more fascinating is the low volatility at which this return was earned relative to the equity and bond market.
The nature of one’s total return consists of both capital growth and income return, with the latter providing a ‘cushioned landing’ for unfavourable capital growth years. The Investment Property Databank (IPD) outlined that in the past two decades, capital growth has only been negative in two years, with the total return achieved in these negative capital years not falling below 5% (highlighted in the graph below). Commercial property has therefore proven itself to be a resilient investment and an excellent vehicle for preserving wealth in tempestuous economic conditions.
In light of the above, directly held commercial property forms an important component of a well-balanced investment portfolio, and provides investors with true diversification from the bond and equity markets. Commercial property is also popular in retirement planning, as investors are able to purchase a passive annuity income stream that is well hedged from inflation through contractual lease agreements and rental escalations. In addition, as one’s rental income grows, the capital value of a property typically also increases, preserving and creating wealth through the capital gain. The other major advantage of directly held commercial property is the ability to leverage the property purchase using bank borrowings when at the stage of building up one’s portfolio. For example, with a R1 million capital investment, one could typically purchase a R3 million sectionalised office. Capital growth is then earned on the R3 million as opposed to only the R1 million, effectively tripling the capital return.
It is important to note that direct commercial property investment is not necessarily for every investor and one of the biggest considerations when making the decision is one’s investment time horizon. The assembly of a commercial property portfolio should be seen as a long-term tool for wealth creation and retirement planning.
One needs to be in it for the long haul to truly reap the benefits, given the relatively higher initial transaction costs compared to other asset classes.
Broadly, there are two ways in which to invest in commercial real estate – either by investing directly (e.g. assembling a diversified portfolio of directly owned commercial, retail or industrial properties) or by purchasing shares in a listed vehicle such as a Real Estate Investment Trust (REIT). The table below contains some considerations for when deciding which option is most appropriate for one’s circumstances:
The advantages of directly held property are becoming increasingly popular, particularly because the average PE ratio on the JSE is now close to 19 times, whereas it has averaged 12 – 14 over the past few decades. One has to carefully consider whether these valuations will be supported by the earnings numbers, given South Africa’s feeble economic growth forecasts and economic headwinds, or whether earnings disappointments lie ahead, along with a market correction. We are currently seeing an increase in volatility in valuations on the JSE.
In our view, the current market represents a good opportunity to re-evaluate one’s portfolio balance and realise some of the strong capital gains that have been made in the stock market, bearing in mind capital gain considerations. Looking forward, we believe that certain attractive commercial property investment opportunities will begin to materialise. Against this backdrop, investors should be in a position to take up these value purchases as they arise.
Should you be interested in investing in directly held commercial property contact John Witter or David Sedgwick on 021 425 8586.