Capital Property Fund at the top of its game

With income growth of a pleasing 9,13% achieved in 2011, well ahead of the expected 5% sector average, Capital Property Fund remains one of the JSE’s top-performing property stocks.

Management nevertheless pointed to a deteriorating outlook for SA commercial real estate at last week’s annual results presentation, prompting the board to lower its forecast growth in income payouts to between 4% and 8% for 2012.

The office market is the biggest worry, as cash-strapped corporate SA continues to cut back on expenses. And, like most other listed funds, Capital is struggling to keep a lid on its office vacancies.

The latter increased from 11% to 13,4% in the six months to December. That compares with a vacancy rate of less than 5% in both Capital’s industrial and retail portfolios.

Capital director Andrew Teixeira expects a further uptick in office vacancies over the next six months. Capital, which is now the third-biggest property fund, with a market cap of R15,1bn after last year’s merger with sister fund Pangbourne Properties, has a 34% exposure to offices. The latter consist predominantly of B-grade buildings.

Teixeira says the problem faced by owners of B-grade offices is the shrinking rental gap between A- and B-grade buildings. “The oversupply of offices has forced owners of A-grade buildings to reduce rentals to such an extent that B-grade rentals are no longer that competitive. So tenants are moving to A-grade space, negatively affecting vacancies.”

A sizeable 28% of Capital’s office leases are expiring in 2012. However, Teixeira says Capital’s office buildings are generally under rented (rates are lower than the market average) at a 2012 expiry rate of an average R92/m² . It’s therefore unlikely that Capital will undergo negative rental reversions (drop in rental rates when new leases are negotiated) this year. Teixeira expects office leases to be renewed at an average R101/m² .

In contrast to the office portfolio, Capital’s industrial vacancy has shown an encouraging reduction from 6,8% to 4,8% in the six months to December. Industrials comprise 50% of the fund’s book value.

Demand for industrial properties, particularly warehousing for distribution, has in recent months firmed noticeably in prime areas such as Gauteng’s Linbro Park, Longmeadow and Raceway Industrial Park.

The improved outlook for the industrial sector has prompted management to push the button on a number of new industrial developments.

The plan is also to acquire more land for warehousing developments in prime distribution nodes in Johannesburg and Durban.

Teixeira notes it’s now significantly cheaper to build new than to buy existing stock. “Developers are typically only selling the bottom 20% of their holdings. And the quality stock that is for sale is expensive.”

Management will also continue in its efforts to reduce its R2bn retail portfolio. These sales are in line with Capital’s strategy to divest from retail and increase its exposure to prime industrial and office properties in Johannesburg, Pretoria, KwaZulu Natal and the Western Cape.

About R2bn worth of retail properties were sold last year to, among others, sister funds Resilient and Fortress. Capital also owns stakes worth R1,7bn in Resilient, Fortress and the Resilient group’s Romanian-focused Nepi.

Though Capital has had a relatively strong run over the past 12 months — its share price is up 19% — and may not look cheap at a forward yield of just less than 8%, most property analysts still rank Capital among their top picks for 2012.

Capital remains Stanlib’s biggest overweight position among the 30-odd counters that comprise the JSE’s R152bn property index.

KeillenNdlovu, head of Stanlib’s property funds, says though Capital is priced roughly in line with the sector it still offers better income growth prospects than most of its peers.

“We also like the fund’s pro- active asset management approach. The group knows how to sweat its assets and unlock value for shareholders.”