SA’s listed property sector could be ripe for more consolidation as a number of real estate companies on the JSE are struggling to find attractively priced assets.
More mergers look to be on the cards because yields on buying direct assets are not particularly attractive.
A landmark merger has already been proposed between New Europe Property Investments (Nepi) and Rockcastle Global Real Estate, which could create one of the largest property funds on the JSE.
"Yields on direct assets have remained stubbornly low, despite weak property fundamentals and the cost of capital for listed companies is high," said Catalyst Fund Managers investment manager Paul Duncan.
"Development yields do not compensate for the risk assumed and speculative development is even more risky, with almost zero net new demand."
Nepi, which has mainly invested in Romania, and Rockcastle, which has mainly invested in Poland, announced in 2016 that they intended to merge. The two companies had started to look for similar properties in the central and eastern European region.
The proposed transaction would be implemented through a swap ratio of 4.5 Rockcastle shares for one Nepi share. The merged entity would be called NEPI Rockcastle (NewCo).
Nepi has a market capitalisation of about R51.1bn, while Rockcastle has a market cap of about R33bn. A merger would create an R84.1bn fund.
Often when property management teams were experiencing tough operating conditions internally, Duncan said, they looked more aggressively outside their core portfolios for earnings growth opportunities. One way was through corporate activity including acquiring other companies.
"This is looking attractive to some companies because other companies are trading at higher yields on equity to them and often at large discounts to net asset value.
"The skill is distinguishing between value opportunities and value traps," he said.
"Value traps exist because when you analyse the detail, you will see that many [mid-sized] and small companies trade at artificially high yields that are a function of nonrecurring earnings, high loan-to-value ratios with legacy low interest rates, which will rise relative to peers, and overrented portfolios," said Duncan.
In terms of the deal between Nepi and Rockcastle, analysts have estimated a 2% premium to the Nepi clean price prior to the announcement, according to Cratos Capital money manager Ron Klipin.
"NewCo could potentially rank as the seventh-biggest real estate company in the Euronext Index, ranked by market capitalisation, and would be the third-largest retail-focused fund, behind Unibail and Klepierre according to Klipin.
Commenting on the deal, Anas Madhi, an executive director at Meago Asset Management, said in principle the merger would be beneficial for both parties, but that the price offered to Nepi shareholders could have been more attractive.
"The merger between Nepi and Rockcastle has been mooted for some time now, with the rationale centred around creating a dynamic, scale business with exposure in various central and eastern European markets," Madhi said.
"We like the idea of a merged company with larger-scale, retail-focused, geographically diversified and improved liquidity but do think that Nepi shareholders deserve a higher premium owing to their stellar, long-standing performance, track record and dominance in the area," he said.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.