Niche property players may be a better option in the current environment

The listed property sector globally has been significantly impacted by the fallout from the Covid-19 pandemic. In 2020, the sector was sold off on the back of strict lockdown regulations which placed severe pressure on the office and retail segments of the market. Vacancies have continued to increase both in retail and office and in many instances, may be very difficult to fill even as the world normalises. Some of the defining impacts of the pandemic has been an acceleration in the “work from home” or “work from anywhere” movement, as well as the rapid adoption of e-commerce. It remains to be seen if business travel picks up to pre-Covid levels.

Niche areas of the market have held steady and have even seen demand increase during this period. Storage and residential property have held steady, while warehousing and logistics and data centres have seen a spike in demand. We do not foresee this changing even after the world moves on from Covid-19 and believe there is a firm thematic underpin which will continue to drive growth in distributions from these names.

Besides the larger niche sectors with thematic support, other areas of this space include healthcare, education, and student housing.

South African niche Reits

While certain large-cap Reits like Growthpoint invest in niche areas of the market, these investments are typically small in comparison to their tradition property portfolios. The only two specialist niche Reits listed on the JSE are Equites and Stor-Age.

Equites (EQS)

Equites is a South African property fund manager and developer, focused on high-quality industrial assets at the top end of the industrial property sector with selective exposure to office property. The company aims to provide investors with pure exposure to high-quality logistics properties let to investment-grade tenants both in South Africa and the United Kingdom.

We have a positive outlook on the logistics/warehousing and high-tech space considering the growing importance of centralised distribution and exponential growth in online shopping globally. Demand for modern high-quality property will continue to drive rentals higher in the short to medium term. Equites’ pipeline of projects is strong. In the UK, the company has partnered with developer Newlands and has recently signed agreements to develop a super-hub for luxury goods retailer Hermes and a last mile fulfilment centre for Amazon. In South Africa, Equites recently concluded the purchase of Shoprite’s distribution portfolio.

Because of the specialised nature of the property portfolio, leases are typically very long, and renewal success quite high. Equity boasts a strong balance sheet, low overall cost of funding, and is expected to deliver superior distribution growth as structural support for its portfolio of properties maintain momentum.

Stor-Age (SSS)

Stor-Age Property Reit is a locally listed real estate investment trust. The firm is focused on the ownership, acquisition, development, and management of prime self-storage assets in South Africa and the UK. The group derives its revenue from renting out self-storage units and from providing ancillary products (such as packaging materials and locks).

Self-storage generally requires low levels of ongoing capital expenditure and maintenance and net operating income is uncorrelated to traditional drivers of property as an asset. This area of the market generally boasts stable demand and can even be regarded as counter-cyclical in that demand for storage may increase during periods of economic pressure.

Stor-Age is the market leader in South Africa and holds significant brand strength. Different to traditional storage space, Stor-Age looks for properties with main road frontage, good access, near retail nodes, in middle-to-upper income residential areas. We like the quality of the portfolio, management, and operations, as well as its accretive pipeline. The market remains highly fragmented, which does provide future consolidation opportunities for the group, provided it meets their quality criteria.

SA Niche Reits have outperformed the Listed Property Index over the last 5 years

*Annualised

Offshore options

There are more options in the offshore space when it comes to investing in niche areas of the property market. We zone in on a specific option that enjoys a market leading position in the exciting data-centre space.

Equinix (EQIX)

Equinix is the world’s largest digital infrastructure company by market capitalisation. One of the newer REIT sectors, data centres has been a key growth area among US Reits. Data centres provide critical infrastructure – power, cooling, and physical rack space – to a variety of enterprise customers with different networking and computing needs.

Equinix offers both exposure to property and technology. It has 211 data centres in over 26 countries allowing access to the data storage industry in a globally diversified manner. Equinix has over 9 700 customers across a diverse range of businesses. The move to working from home and the downscaling of businesses will see increased demand for data storage and server space.

Because of its size relative to the rest of the market, there are ample opportunities for mergers and acquisitions on top of organic growth. Debt is quite high relative to portfolio value but is manageable relative to operating income.

Concluding remarks

The importance of diversification was magnified during the pandemic. The allocation of capital into different areas of the market is essential when looking to reduce overall portfolio risk. Niche Reits offer a further opportunity to invest in areas of the market with thematic support with less exposure to cyclical elements.

While these companies may trade on average lower distribution yields than the rest of the sector, it is important to balance this metric with expected growth in dividends, which should be superior to traditional Reits medium term.

Nicholas Riemer, investment education head, FNB Wealth and Investments.