Reluctant Bond Market Dries Up South African Property Deals

  • Mergers and acquisitions drop as finance charges surge
  • Property yields not high enough to cover borrowing costs

A record run in takeover deals in South Africa’s real-estate industry is coming to an end.

The risk of a recession and a downgrade of the country’s credit rating to junk, interest rates at their highest level in six years and plunge in the rand has all but shut the bond market to property companies. Borrowing costs now exceed the rental income the firms receive from shopping malls, according to Growthpoint Properties Ltd. Chief Executive Officer Leon Norbert Sasse.

That’s slowed mergers and acquisitions, with the value of deals in the sector falling 27 percent this year from the first quarter of 2015, according to data compiled by Bloomberg. Average yields on rand-denominated bonds have jumped more than 130 basis points over the past year to 9.26 percent, resulting in losses on South African debt of 20 percent, the biggest decline among 31 emerging markets monitored by Bloomberg.

Mergers and acquisitions decline to lowest level since second quarter of 2014
Mergers and acquisitions decline to lowest level since second quarter of 2014

“The bond market is really not conducive to funding,” Sasse said in an interview in Johannesburg, where the company is based. “You’re making a loss pretty much from day one,’’ he said. Sasse forecasts that it may take a year for sellers to lower asking prices to compensate for higher financing charges and the weaker currency.

Real estate companies are struggling with rising vacancies and unpaid rents with growth in Africa’s most-industrialized economy forecast by the central bank to slow to less than 1 percent this year.

Rental Yields

The country has been knocked by the worst drought in more than a century, falling commodity prices and weak demand from its biggest export market, China. Investor confidence in South Africa has been reeling since President Jacob Zuma fired two finance ministers in the space of four days in December, causing the currency and bonds to plunge. The rand weakened 1 percent to 15.6711 per dollar by 9:35 a.m. in Johannesburg, extending losses over the past 12 months to more than 20 percent.

Growthpoint, South Africa’s largest property company by market value with a portfolio worth more than 110 billion rand ($7.1 billion), could probably borrow at rates of about 9.5 percent, the CEO said. That compares with rental yields across the company of less than 8 percent in the year through December, Sasse said.

Companies will need to increase rentals to boost yields that “continue to remain reasonably low for premium-rate property in all sectors,” Henry Playne, head of capital markets in South Africa for Jones Lange LaSalle Inc., a real-estate services firm, said in an interview in Johannesburg. “There will be a lead time of anywhere from six to 12 months where sellers have to wake up to the new normal that their properties’ yields must increase.”

Tighter Lending

A more conservative approach by banks on lending is also hurting deal flow, said Des de Beer, the CEO of Resilient REIT Ltd., which owns retail and industrial properties in South Africa.

The number of transactions in the property industry declined to 15 deals worth a combined 10.1 billion rand this year, compared with 20 deals totaling 13.83 billion rand in the first three months of 2015, according to data compiled by Bloomberg. There were 90 deals done last year worth 107.3 billion rand, the highest by deal count on record and biggest by value since 2010. 

Deal-making is also being hampered by a commercial property market that’s too expensive, according to Darren Wilder, CEO of Cape Town-based Fairvest Property Holdings Ltd.

Expanding Abroad

Investors including Redefine Properties Ltd., the country’s second-largest Real Estate Investment Trust, are increasingly expanding outside of South Africa for better returns and to profit from the weakening rand when earnings abroad are translated back into the local currency.

“Our geographic diversification works for us, whereby the windfall from currency gains serves as a safety net from the domestic pressures,” CEO Andrew Konig said in an interview in Johannesburg. “The cost and availability of capital in South Africa is an even bigger challenge for smaller, less liquid property owners and developers and new development activity will slow.”

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