Investing in the South African property market

…a case of regional property diversification in a globalised world

By Paul Philani Poshai

THE relationship between Zimbabwe and South Africa date back from a long time. The two economies are interwoven and inherently inseparable. Zimbabwe is one of South Africa`s largest trading partners with conservative estimates estimating that Zimbabwe imports about 50% of goods and services from South Africa.

Paul Philani Poshai who is a Property Practitioner in South Africa.

South Africa has always maintained a trade surplus with Zimbabwe since 2007 due mainly to low productivity in Zimbabwe among other things. South Africa is one of Zimbabwe`s key sources of income emanating from remittances. An estimated two million Zimbabweans live in South Africa. Going by these unofficial estimates South Africa can easily be the only country in the world to host such a big number of Zimbabweans. The strength and interconnectivity that comes from such a relationship cannot be understated. In a world that promotes multilaterism and global trade, it is key for Zimbabweans to consider investing in the South African market while furthering their investment objectives especially in line with diversification.

The two countries enjoy very cordial diplomatic relation that date back from time immemorial. Many Zimbabweans have made South Africa their second home and a lot more are considering to. Many South Africans companies have diversified using the Zimbabwean market too.  Xenophobic tensions do appear intermittently in South Africa and have made some Zimbabweans skeptical about South Africa`s ability to protect investments from people of colour. However, the government has taken various steps to proactively stop this scourge and protect private property. The rare occurrences are not reflective of the people of South Africa in general who are naturally warm, kind and accommodating.

It can only be attributed to a few nationalistic individuals. We all have that one child in our families. They cannot go down with the family name. There are also concerns around expropriation without compensation as a topic. I believe the robust discussions being driven by state institutions around the topic will result in a win win scenario for both parties and will do little to harm the South African economy. The two countries also share various social cultural and economic ties dating from a long time ago.

Each has an Embassy on the other`s territories making it easy to vet investment decisions while utilizing government agencies South Africa on its own has built a strong reputation for having strong institutions of democracy and is widely framed as the Rainbow nation. In this regard it goes without saying that investing in the South African Real Estate Market or looking at it from a perspective of diversifying an already existing portfolio is one of the best decisions one can ever make especially if you are looking for income growth, income preservation and store of wealth

You cannot go wrong with real estate! This popular saying is one of the most abused sayings of all time. It instills within the general populace a misguided sense that real estate investments are always the best investments no matter what. The truth of the matter however is that they can be very bad real estate investments. Infact they are many. Multiple reasons come up which include investing in real estate using emotions other than investment sense, investing in real estate for status which ends up backfiring spectacularly should your status change and you might want to use the real estate to get income, capital or both, absence of a proper investment objectives, investment strategy and investment philosophy among many other reasons. In short don’t just buy a property because you have money, or you like the town its situated.

Have a plan, have a basic criterion to invest in real estate a criterion. In a series of articles, I will explain the importance of making rational and measured real estate decisions that benefit you as an investor should you want. In this ensuring article I explain why real estate investment should be done in the context of logic and not borders. Real estate is often seen and acts as a diversifier for a traditional equity and bond portfolio.

Yet, while most investors and investment executives are aware of the importance of portfolio diversification, many with property investments still exhibit varying degrees of ‘home bias’, a tendency to favour domestic markets over those in other countries. As a person who studied real estate myself, I would advise an individual to buy real estate over any other asset anyday. Maybe it is because I am naturally wired to do so. In this article we explore why institutional investors and pension funds should start investing beyond borders for their own benefit.

Current Operating Environment in Zimbabwe

Our macro-economic operating environment is characterised by high debt overhang, high formal unemployment, absence of a working and thriving middle-class, high trade deficit, price instability among other factors. The Reserve Bank has responded by launching a three prolonged strategy anchored on exchange rate stability, financial sector stability as well as management of money supply. Measures like the foreign currency auctioning and export promotion, mobilization of lines of credit and broadening and deepening sources of hard currency have worked well to combat exchange rate stability have done very well in taming the runaway exchange rate and can  which be attributed to the significant increase in industrial capacity utilization and a fairly stable currency rate  especially in the black market.

Strict payment of payment systems especially mobile banking platforms has also yielded mixed results. The integrity and soundness of the financial sector is a key ingredient to economic success. Some of these decisions come with dissatisfaction and discomfort for end users but they must be done ostensibly for the greater good. The reserve bank is also working at keeping money supply in check using bank policy rates and other appropriate monetary policy instruments at its disposal.

These ingredients are all key in fostering predictability of investments and reducing various risks related especially to property investment. Property investments exists within the context of the overall economy`s performance. The demand for property is derived from the production of goods and services. Proffessor Mthuli Ncube also introduced a REIT framework. Though late it is critical in putting Zimbabwe on the table of nations with regards to foreign direct property investments. They also allow for conversion of existing portfolios to a REIT and are exchange tradable therefore hedging against currency risk.

To him and his team, I say well done. It is always better to be late than never after all. The absence of meaning long term cheap mortgage finance continues to stall property development in the country with most developments being incremental in nature. The creation of such a market or at least allowing banks to dollar index interest rates is key. While many contend that the currency market and the market for goods and services are two different markets influenced by different fundamentals, the same cannot be said of Zimbabwe. Currency risk, perceived country risk, specific risk and depreciation and obsolescence continue to be the main risks that weigh heavily on our property market.

The prices of goods and services remain firmly tied to the greenback. This has also led to valuation challenges which serve only to make property market in our country less competitive. Despite all these challenges the Zimbabwean property market remains very key in regional diversification considerations depending on which sector you want to invest in. After all property is a long-term investment.

Most people prefer to invest in real estate as closer to home as possible because of behavioral issues like familiarity and herding. From a familiarity perspective people would not bother themselves about the rationality of such decision or other lacks thereof but principally they satisfy themselves with the argument that I get to see my building every day, it is easier to manage when its closer, I would never invest anywhere else because society won’t know it’s me (Status) among  a plethora of reasons. Status investing has a lot social benefits especially in small towns where there is very little real estate development activity. This social rate of return then affects the investor ability to scrutinize advantages that come with real economic return from an income yield point of view. This is especially true for commercial property than it is for residential.

From a herding perspective the general argument is basically what I would refer to as finding comforts in crowds when making investment decisions. An investor would basically look at what others are doing and follow suit just like a herd of cattle. The investor follows the assets class and may end up owning too many assets within the same asset category say residential or even commercial hence missing out on diversification. Certain real estate sectors are affected differently by economic shocks. As realtors we are land economists and our role are to make sure that you get the highest utility in income or capital terms for every dollar invested. The absence of optimized diversification strategies in portfolio building is always a disastrous stunt or rather unfortunate financial misadventure or both.

 This domestic bias tends to worsen the situation if sector related problems like high vacancies, poor covenant strength, illiquidity and specific risk begin to weigh heavily on the financial performance of the property. Hedging against domestic liabilities like inflation and interest rate risks is very key while using international real estate. Generally speaking, domestic fixed income portfolios do well to cover these risk ceteris paribus. However, if the economic environment becomes inflationary their ability to cover the other ensuing risks cause by inflationary pressures becomes rather bookish or a very uncomfortable financial experiment. It is particularly scary when it is not your money, like for example trustees of pension funds Success in this regard can be debatable. International real estate investment can save the day effortlessly when done correctly.

Real estate income is fixed with leases which take time to adjust or revert to the market. Even if you adjust with above market rentals, unstable and inflationary markets tend to wipe off the ability of real estate to perform as a hedge against inflation in both income and capital terms. The need to look at alternative markets to double hedge against this same risk albeit with different markets becomes key. Lastly the main reasons why many people tend to prefer domestic markets is because of presumed high transaction costs. These are obviously sometimes not backed up by sufficient research. Most destinations across the world are promoting citizenships by investments in estate.Whylst iam not by any means encouraging individuals and institutions to divest from local real estate, it is good financial practice for individuals and institutional investors to geographically diversify their portfolios outside country boundaries and this article basically seeks to start the discussion.

Real Estate like any other investment class should be looked at from a global perspective. This is more likely to give the investor excellent capital and income returns. In an ever-evolving world and having learnt a few hard lessons on the impact of inflation on investments, real estate investment has gained serious attention in Zimbabwe. Pension funds are said to have more than 40% of their assets and holdings tied in real estate ostensibly to hedge against inflation and to lock and store their capital. This is despite high vacancies especially in CBD offices which negatively impact on the property`s ability to generate income and consequently achieve reasonable or desired income yields.

Most funds in this regard have high concentration risk especially with regards to office properties. The situation is particularly made worse by lack of regional continental and global risk diversification. This basically puts institutional investors at odds with beneficiaries who contend that pension funds are not paying them payouts that are consummate with their effort creating an unnecessarily acrimonious relationship between the two stake holders.

I would contend that real estate investment as a capital-intensive asset like real needs high levels of due diligence and expertise to achieve good returns. In that regard any investors feel they have better control of and understanding of their domestic market it becomes paramount these same characteristics should make investors even more keen to invest abroad to achieve efficient, optimum and profitable diversification.

While returns are half the story, the main advantage of global diversification is risk reduction. Lack of expertise, lack of foreign contacts and lack of adequate research among other issues puts investors at the mercy of a local domestic market even though underperforming. The writer contends that with the right contacts and using registered estate agents abroad, finding advice from investment advisors and realtors an investor should be able to successfully reduce domestic market related risks like volatility, inflation and uncertainty by switching to foreign markets. Property returns always differ from country to country and normally if compared over a long-time real estate has always fared better than bonds in terms of returns in stable economies. Weak economies with high inflation are characterized by high depreciation, static or negative rental growth and illiquidity and hence investors tend to demand reasonable premiums when buying real estate.

Strong economies like South Africa while presently being weighed heavily on by Covid 19 and high fiscal debt are endowed with good property nodes that continue to be resilient even when the whole economy is under stress. Nodes like Menlyn, Waterval, Sandton and Rosebank, Cliffton, Umhlanga, Cape Town CBD etc continue to give excellent returns while educational districts like Hatfield and Braamfontein also can be added on the list of very resilient locations which have a good preservation of both income and capital. Logistics related properties which include self-storage properties, distribution centers and small warehouses continue to do well across the country and have been especially boosted by the pandemic. This is however despite the fact that they are the future. Results of logistics REITS have also been testament to that.

If an investor is likely to gain from diversification in regional and international markets a good strategy would be to look at the capital city and other regional cities within provinces. In South Africa cities like Johannesburg, Durban, Pretoria, Cape town, Nelspruit, Bloemfontein, Port Elizabeth among others are a good place to start. These cities normally tend to see faster population growth driven mainly by inward migration.

This inward migration has a multiplier effect in demand for services and consequentially real estate. These big cities also boast of diversified economies which are likely to better withstand structural economic shocks. They also have better liquidity and effective demand for most goods and services. I would certainly urge an investor looking into the South African Market to look mostly at cities with good connectivity, high infrastructure development, good and proactive local governance, good retail facilities, skilled labour force and a very diversified economy. Most of the cities I mentioned earlier can be said to posses such  high quality characteristics. Investors need to be careful however in their diversification not to squander the benefit by selecting cities with pretty much the same economic drivers as this kind of diversification is not only misleading but also very deceptive.

Legislation

In conclusion I hope I have made a good case for diversifying using the South African Market using both direct and indirect real estate .What amount to invest will obviously depend on your starting point as an investor but I can guarantee you that they is something for everyone. Your risk reduction perspective should always take center stage in this regard coupled by other well-known reasons for diversification. While some investors are looking to store capital, leverage, get superior returns either way, investors would benefit from spreading their assets across diversified portfolios in international markets rather than putting your eggs in one basket.

This Article was written by Paul Philani Poshai who is a Property Practitioner in South Africa. He is contactable at paul.poshayi@gmail.com, paul@burmain.co.za and at 0027622311221/00263775766121.Burmain Properties is a registered property management and sales company according to the applicable laws of South Africa and is legally mandated to carry out such services. Paul is a member of the EAAB, SACVP and is currently doing his assessment of professional competence with the Royal Institute of Chartered Surveyors in the field of Property Valuation.