Episode Transcript
The Finance Ghost: Welcome to episode 224 of Magic Markets. This week we're going to chat about an asset class that I think is quite close to Moe's heart - and that is property. I'm not quite as much of a fan of property as Moe is, especially not holding property directly. But I do have lots of property in my listed portfolio and we'll certainly be keen to discuss that topic. But I think, Moe, the reason we decided to do this is, well, one, because we haven't talked about property for a while, but two, because I don't think you can put tariffs on property. I think that even with Trump's immense creativity, I think he might struggle to figure out how to do that. Maybe if there's a foreign tenant in an American property - actually I shouldn't even say these things, but because it might, you know, it may come to pass.
Mohammed Nalla: Ghost, you're giving ideas to the Trump administration, maybe there's an investment case here, you should go long property in Alabama. I think that's where all these South Africans that are heading to the US are actually heading. So maybe go long residential in Alabama. I don't know.
Ghost, Yes, I like property. I've been a long-suffering property investor in South Africa directly. But the reason why I like property, forget the directly-held property, is that property is a great asset class in that it gives you an income. Usually.
It gives you exposure to the interest rate cycle. And as someone who traditionally doesn't invest in fixed income instruments, I also look at property as a proxy for bonds because traditionally what you see is that there's some correlation between bonds and the property market. If you see rates trending lower, that's usually good for valuations and you actually see that reflected very directly in the real estate sector whether that's in South Africa, whether that's in the US.
Now, that's why this discussion is relevant, because there are so many moving parts. You've discussed tariffs and I'll touch on that because yes, actually tariffs can impact the property market. I'll explain to you how. But at the same time the tariffs have filtered through into a discussion on what's happening with rates.
Just this morning at the time of recording, we had the release of US inflation numbers. It was actually a little bit cooler on a headline CPI level. And that's not to say that the long-end tail to inflation in the US is not to the upside on the back of the tariffs. But the point is that we don't know what's happening with the tariffs. It's announced this week, then next week there's a deal, then there's no deal. I think that gives you a lot of uncertainty in the market. And when you're looking at property, you're looking at a long-term cycle because people don't - if you're looking at new development - people don't sink money into new developments if they don't have line of sight on demand, if they don't have line of sight in terms of where rates go. Because that doesn't just affect the developer’s cost of capital, it also affects the ability of the end buyer. Remember if it's residential, for example, people have to go out and get mortgages to buy these properties. If rates are too high, they're not going to do that. And that crimps demand and activity in the market.
So I think that's the backdrop of the “why” we're discussing this.
And I'll start off on one point because it's probably a point that not a lot of people have considered and that's in the US you said tariffs don't necessarily affect property, but actually they do. And it doesn't necessarily affect the properties that are already kind of sunk and on the portfolio, but it affects the pipeline. How does it affect the pipeline? I've already indicated the cost of capital. That's just one dimension. But the other dimension is: what happens to input costs? Remember, if you're looking at property in the US a lot of the construction tends to be quite focused on lumber as an input cost. And if you actually see tariffs impacting those input costs, that can be lumber, it can be steel, for example, on commercial development. So there are a lot of moving parts there. If you actually see the input costs increased because of the tariffs, that's going to start to crimp demand to the extent that the developers are not able to pass that cost onto the consumer. And I think that's the important point.
I mean, one data point here from the National Association of Home Builders in the US is that they've quantified this, and they said that tariffs could add approximately $9,200 to the cost of a new home. Now, it doesn't sound like a heck of a lot of money, but I assure you, if that's on the cost of the new home, if you layer that, it's either going to eat into the developer's margin or you're going to actually see the affordability, which has already been a problem in the US, in North America in general, in many developed markets - if that affordability starts to become an issue, that's going to crimp demand.
That would then play into stocks that we had looked at on Magic Markets Premium a while ago. For example, the home builders like Lennar, D.R. Horton - those are home builders in the US. You've actually seen some of that impact come through. Some of it's related to tariffs. Others are just related to overall dynamics in the housing market, in the construction industry. But remember, that's just one segment of the market.
We've also got the very large REITs. I've always said the US gives you a nice, diversified exposure to the space. You can literally go and buy a REIT that is focused on data centres, for example, or you can go and buy a REIT that is focused on cold storage, as another example. So you get exposure to micro niches. And that will tie into a second point I want to make.
I will pause now, but the point I'm going to make is just around some segmentation. What's the impact on different segments of the market? What does demand look like in those various segments, either on a macro or on a micro level Ghost?
The Finance Ghost: Yeah. So basically, the lesson from all of that is a property touches everything, because at the end of the day, this is the physical space where people need to live, they need to store stuff, and sometimes they need to work – more so these days, there was a time in the pandemic where suddenly the assumption was that no one would ever go to an office again. And you just need to draw a Zoom share price to see exactly how that played out!
Moe, down here, it seems to be that most companies are now back to at least three days a week in the office. A lot are at four days a week in the office. We each work for ourselves, so we're five days a week in the office, but the office happens to be our study at home!
What is happening up in Canada, out of interest, to your knowledge, among corporates, is it also back to a three to four days a week vibe, or is it still quite loose?
Mohammed Nalla: I think it's an important point. I'll address your question first. So up in Canada, lots of pressure from urban metros. So, for example, Toronto, the city itself has actually been incentivising employers to try and boost the number of days in office. And it makes sense, right? They want activity in the CBDs, because if people don't come into the office, they don't go out and buy lunch, they don't do their dry cleaning in the city, they don't go and buy flowers for their wife or their spouse in the city. And so the overall impact of economic activity on those urban centres is material, so they're trying to incentivise that. A lot of companies are still on three days in the office. Some of the larger firms are now moving to four days in the office. We are seeing a gradual return.
But I do think there's been a structural change in terms of how people perceive work in the office. You and I probably sit on opposite ends of the spectrum here. I know you would favour five days in the office kind of set up. I know my wife certainly does…
The Finance Ghost: No, I wouldn't. I wouldn't. I definitely wouldn't. That's a complete misread, Moe. Complete misread. I don't favour that at all. I mean, there's a reason why I still work for myself, right? It's because I didn't enjoy that life. So, no, definitely not.
Mohammed Nalla: I just assume because we spend five days a week in our home offices, that's probably your approach. It helps that it's a home office, but I think the overall trend there has been a structural shift and it's kind of swung to one end of the pendulum during the pandemic. It's now kind of swinging back, but I don't think we will swing all the way back. I think people have gotten used to some degree of flexibility and so maybe it taps out of three days, three and a half days as an average. But that's some of the trends that we're seeing up here.
Now, if we actually bring that into a sectoral approach to property. It also highlights some of the key differentiators that you're seeing because you've had pretty hard hits come through in terms of commercial real estate offices. Vacancies are higher. Think of it. I mean, even if a company has actually trimmed its number of days in the office by one or two days, the need to have a much larger office space has dissipated. So you've actually seen a decline in demand on the commercial real estate side of things. I recall probably around a year, year and a half ago, there were lots of concerns around the commercial real estate segment of the market. There were lots of refinancings that were coming up around that time and again, investors in private assets, specifically because a lot of the funding had happened in the private asset space, were very concerned around that. Now that concern seems to have been glossed over. It's kind of gone fine. And I think some of those fracture points haven't materialised quite as severely as some people were expecting.
But let's go back to tariffs, because I indicated the impact of tariffs on input costs, I've shown the impact of tariffs or discussed the impact of tariffs on margins. In fact, Bank of America, I saw a report where they had said the potential reduction in earnings per share for some of the firms that operate in the construction space - in the real estate construction space - may be as large as 20%. So again, that’s telling you that there could be quite a big hit depending on how tariffs materialise. But the way I'm going to go with this is something I haven't touched on is what do tariffs do to the overall cost of goods for the end consumer? Because this then follows through - yes with a much longer tail - it follows through to the retail sector. And we know the retail sector in the US has been running very hot. We had some of the REITs there - Simon Property Group, again, another firm we've covered in Magic Markets Premium, if you're a subscriber, go and have a look at that - they've done pretty well. But if you start to see a hit in terms of prices that consumers have to pay for goods, does that crimp consumer demand and what does that do as it filters through to demand for retail space? I think there are lots of question marks around that one as well. Ghost, I haven't touched on industrials and logistics. I'll save that for my next talking point.
The Finance Ghost: Yeah, and of course it sounds like we're just shooting the breeze about all these economic trends, but this is what drives property returns at the end of the day. If people are not going to the office, then companies pull back on office space. What does that mean for landlords? While supply and demand tells you exactly what it means, if there is less demand for the space, and there's an oversupply of space, then it gets really bad really quickly. And we saw some pretty wild stuff happening in Sandton in Joburg after the pandemic.
Immediately after the pandemic - Moe, you weren't down here too much. I went up a couple of times for business. We both used to work in Sandton. We both understood that banking life, it was all very exciting and very full, other than the traffic, which I hated. Well, traffic was the least of the problems in Sandton when I went up that time because there was basically no one there. I think things have gotten a lot better since then for some of the property owners.
But a lot of office space was actually transformed into other uses to try and find an equilibrium between demand and supply. And even now you see results come out certainly on the JSE, funds that still have extensive exposure into offices and even premium grade offices are struggling to achieve what's called positive reversions. This means when someone moves out, you need to now get a new tenant in or you need to just renew the lease with the existing tenant, that's also fine. And now that new rate is sometimes lower than the rate under the old lease.
And this often happens - or basically, why this happens is because the escalations under the old lease ended up being either ahead of inflation or simply ahead of the demand for the space. And then you have this big negative reversion. So especially for smaller property funds where they are dependent on one or two major properties, a big negative reversion of like 20% can make a significant difference to return. So that's why some investors will prefer your very large property funds that have this big, diversified exposure - that's lovely, but then it also means that you are going to wear the hat of whatever that diversified exposure looks like in terms of geopolitical trends and macroeconomics. Within South Africa, there are growth areas and there are areas that are struggling.
If you go and buy Growthpoint, for example, or one of the other big ones, you're going to get a bit of everything. If you go and buy some of the more focused REITs, then you can really start to drill down on either regional exposure - there are regional specialists like Spear REIT in the Western Cape, there are others as well - and perhaps more interestingly, you get specialists per type of property. So, for example, REITs that specialize in the township economy and having shopping centres on the edge of these low income areas, which by the way Moe is an incredible growth area. It makes the property sector very interesting to try and decide what exposure you actually want.
Mohammed Nalla: You've raised such an interesting point because I always bemoan the fact that the South African market doesn't give you the breadth of exposure, the kind of exposure to micro niches. Maybe the exception there is the property sector because as you indicated, you can get very specific exposure either to sectors or geographies. And again, that's giving you very different dynamics. You’re either a growth investor, maybe you're an income investor, you get to decide where you play on that value chain.
Now, because I sit up here in North America, I spend most of my time looking at North American markets. And in fact, if we look at Canada specifically, there's recently been the bankruptcy of - the closest analogy for a South African listener would be Edgars. We know what happened with Edgars. They had lots of retail space, then they hit the wall. And that was a very painful reality. Edgar survived in some way or form though, so I think they maintained a lot of their retail space at the end of the day.
In Canada, that's a slightly different story. The company's called Hudson's Bay Company and it's a 355-year old company. Yes, that's the correct number. It's 355 years old! It's, I think, the oldest company in Canada. It goes back to the era of the Dutch East India Company and the East India Company that was run by the British, very much a colonial era company. And Hudson's Bay then transitioned from effectively being in the fur trade in the early days of Canada's formation into a large retailer. Like I say an Edgars, a department store, effectively. But they actually then hit significant headwinds in terms of just executing on that strategy. Again, I can't stress how similar this was to the Edgars story.
Hudson's Bay has just gone bankrupt and there were some talks about someone coming in and rescuing them. Those talks fell through. Now there's some talks that they might just rescue the brand because again, a 355-year-old heritage, that's something that I would like to preserve just from a nostalgic perspective. But the bottom line here is when you look at the property market, it means that Hudson's Bay's very large footprint in a lot of malls across Canada is going to become vacant. And that's going to hurt that particular niche or that particular sector very, very severely.
Now let's move from Canada into the US because the last point I wanted to touch on was just the industrial and logistics infrastructure. If Trump wants to onshore into the United States, it might hit the consumer, it might hit home building. But what does that mean for industry? What does that mean for logistics? And here you've seen an interesting bifurcation in terms of just overall demand within the US because we know the US Is large geographically, right? And so you've got a different story happening on the coasts. Coastal warehouses, those are potentially under pressure, certainly properties near major ports. If trade with China and the rest of the world is going to slow down and a lot of that production is successfully - and again, big question mark here - but is successfully onshored to the US, then those properties at the ports and along the coast are going to face decreased demand just because international trade volumes have declined. I would pay attention to that. And the flip side to that is that the inland logistics hubs, those stand to actually gain. Here you may be looking at regions like Arizona, Georgia, Illinois. Those regions may actually see increased demand.
So you're going to get some sort of geographical dispersion coming through there. And then one last point is that you've got a very stark dispersion between your Rust Belt and then your Sun Belt states - and here we're talking, if you're looking at Florida, Miami, you've got Tampa, you've got Austin, Texas - those have all benefited from people moving out of centres like New York, like Connecticut, like California, high tax jurisdictions. That's played through into not just the residential market, but then also into the office space because companies have been moving their headquarters to that space. There are lots of these different moving parts.
I don't necessarily think that you're going to throw the baby out with the bathwater and that the entire sector actually comes under pressure. I had a very quick look just on a year-to-date performance across the sector. And what stands out for me here is that certain home builders have been very hard hit. I think they're amongst some of the worst performers in the sector. I was surprised, I think D.R. Horton was actually only a minus 8%. Not a terrible look there. But then if you're looking at certain sub-niches, companies that have done well, Prologis - that's another stock that we've covered here at Magic Markets Premium - they focus on data centres. And the demand for data centres up here in North America will blow your mind. I mean, it's the centre of AI investment in the western world. That demand is really strong and a player like Prologis giving you a strong exposure in that space. Obviously you've got other stocks, for example, Realty Income, they've done really, really well and they're famous for being the monthly distribution payer.
So I would say you need to apply a very nuanced lens to your exposure. It's not as simple as just going and buying the overall S&P 500 Real Estate Index. Just pay attention to some of those sub-themes. I don't have the answer in terms of where this goes, but I think there are a lot of thought starters that I'm going to be watching and that will be informed by how the overarching macroeconomic picture evolves, Ghost.
The Finance Ghost: Yeah, I think from my side maybe as we start to bring this to a close, just an update on how the South African funds are performing. So this year, the local property sector has basically been flat. And I think what's happening is that the market has somewhat lost faith in rate cuts and when they might happen. No one's quite sure what the macroeconomic story is.
What's also definitely happened is the South African 10-year bond yield. I had a look since the start of the year, it's up about 175 basis points, which is a pretty substantial move. Yields up mean prices down - of bonds, that is, and also of property prices and anything else that is priced off essentially a yield curve. Bond returns then become higher in terms of yield-to-maturity and thus investors are not willing to pay up as much for REITs because they're looking at this and saying, well, if I can get high tens on a bond, then the REIT needs to give me high single digits and then I'm willing to take a view on growth. So even though you get stuff like net operating income growth in these REITs, what you inevitably see in these situations is that the share price actually goes sideways.
And as an investor, that's when you just sit back and you bank the yield, remind yourself why you invested in this thing and then just wait for things to actually improve from there. So, how much yield are you actually banking? Well, the big ones tend to trade in the 8% to 9% range. The more speculative REITs are more in the double-digits. If your South African 10-year bond is giving you around 10.7% yield to maturity, pure equities would then need to give you roughly a 16% return on equity somewhere there, even though very few of them do, by the way, as a total return. Your property stocks would then need to be somewhere in the middle. It's seen as a hybrid between pure equity and bonds. So inevitably, they need to give you a few hundred basis points of capital growth, along with that dividend that you're expecting to see. Still, easier said than done at times.
As I mentioned, there are pockets of growth at the moment. The township-adjacent malls are doing quite well. They're catching that trend of formalisation of retail trade. Industrial remains strong. Office still facing weakness. But the TL;DR I think is last year was very, very strong for the South African property sector. I was happy to call that one correctly and put my money into that and just catch that wave beautifully in my tax-free savings account specifically. I bought some property ETFs because then I'm getting the yield tax free, so that 9 or 10% or whatever is banked. There's no tax in the middle, which is lovely. The ETF yield is a bit lower because of some of the big funds in there, but it's somewhere around there.
This year, however, you don't have the GNU sentiment boost. If anything, I think there are a lot of disappointed people. You've got all of the macroeconomic risk - thank you, Donald Trump. You've got worry around when interest rates will come down, if they will come down. Whereas last year the expectation was firmly I think for cuts. So this year, I don't think will be nearly as good as last year. I think I wrote about that at the start of this year actually and just said to people, look, I don't think property is going to even remotely do again in 2025 what it did in 2024.
But I'm fine with that. For me, it's an asset class in the listed space that I'm happy to be exposed to. Good yield, some capital protection. And the best thing of all about listed property is it is liquid. If I decide to sell it, I can just press a button as opposed to contacting an estate agent and waiting four months and paying horrible fees and all the rest.
Mohammed Nalla: Yeah, Ghost, I think bringing it to a close, you've raised some very important points. I think I actually had the question and you've answered it, which is what kind of yields are you earning on South African real estate? At around 8% for some of the largest ones, I think that's fair. If I compare that to the US, some of the larger funds are probably giving you around 5% to 7%, there and thereabouts. At the higher end of the spectrum, 7%, those would be slightly more niche players. The very large ones, if you look at Prologis, for example, very niche, that's priced as a growth stock. So there you would expect - share price performance has been pretty decent, but the yields are compressed there. You're getting around a 3% yield. Again, not as attractive on the yield basis, but you're playing that for the growth that could come through in the sector.
If I look at that critically and I say, 8% in South Africa with the idiosyncratic South African risk that comes through as well as the currency risk that comes through, versus a 5% to 8% in the US in hard currency - yes, lots of geopolitical risk coming through there as well. I would almost favour global real estate over South African real estate.
Lots of factors to look at here. How geared are some of these companies, what does the balance sheet look like? So it's not as simplistic as just comparing the yield, but for me, I'm still quite comfortable with my exposure to global real estate cycles.
You've also hit the nail on the head - I think the prospects for rate cuts in the US, obviously that's dissipated a little bit given the tariff risk. But if that goes away, then the prospect for rate cuts and pretty decent rate cuts start to come through strongly and that could give you some sort of impetus on the share price. South Africa doesn't necessarily have the same benefit simply because if you actually see some currency risk come through, that mitigates the story because inflation could start to come through as well. So that's why the rate cycle and the outlook for the rates are so important when looking at the sector.
For now, I certainly favour global real estate over South African real estate, just given some of those dynamics at play.
Unfortunately, that's where we've got to leave it this week. Let us know what you thought of the show. Hit us up on social media. It's @MagicMarketPod, @FinanceGhost and @MohammeDNalla, all on X or go and find us on LinkedIn. Pop us a note on there. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
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