In the ninth episode of The REIT Report on Classic Business (Fine Music Radio), Mweishö Nene, Lead Equity Analyst at SBG Securities, joins hosts Michael Avery and Alistair Anderson of Property Flash to unpack how the market values South African REITs, why the sector’s long-standing discount to net asset value has started to narrow and what falling finance costs mean for the next leg of the recovery.

The conversation opens on the valuation story. For years the sector looked cheap relative to net asset value, but investors could always point to a reason: High debt costs, weak growth, uncertain distributions, offshore complexity and the lingering trauma of 2018 and Covid. Nene’s view is that the discount is now genuinely shrinking, with the ratio of share prices to net asset value trending back towards one. He attributes the move to improvements in earnings quality, higher growth expectations and reducing loan-to-value ratios across the sector rather than a short-term rally dressed up as a re-rating, with earnings quality measured by how repeatable a company’s income is. Profits recycled from once-off asset sales into dividends do not qualify.

On methodology, Nene makes the case for yield rather than net asset value as the anchor for valuing SA REITs. The REIT framework was written to give ordinary investors access to rental-style income and requires around 75% of earnings to be paid out as dividends each year, which places stable distributions at the centre of the investment case. Valuation approaches anchored to the risk-free rate, such as the Gordon growth model, therefore work well, and SBG Securities spends much of its time unpacking the drivers of the South African and European bond markets because REIT pricing rarely deviates far from them.

Stripped down to its basics, a REIT should deliver like-for-like growth of 3% to 4% at net property income level, rising to 5% to 6% once financial leverage is applied. Combined with an average sector yield of around 8%, that points to a sustainable total return of 13% to 14% a year, broadly in line with the average of the past decade. That is lower than most equities offer, but Nene argues the downside risk is materially lower too, outside of extreme external shocks or poor management behaviour.

Offshore exposure now shapes the arithmetic, with Vukile earning around 70% of its revenue abroad while Fairvest has deliberately stayed domestic. A company split between South Africa and Europe should be priced on a blended risk-free rate, tightening the yield relative to a pure domestic counter, while sustained rand weakness flatters the net asset value of offshore holdings given the long-running inflation differential. Nene’s caveat is that neither lower euro funding costs nor currency effects can substitute for buying high-quality assets.

On interest rates, the Middle East conflict has injected fresh uncertainty into oil and inflation and prompted a more cautious stance from the SARB. SBG Securities’ house view is that cuts resume late this year or in 2027, with perhaps another 50 basis points to come. The more important point, Nene argues, is that finance costs fall regardless. Interest rate swaps typically run for two to three years, and much of the sector’s debt was fixed when the repo rate stood at 8.25%. As those swaps expire and re-price at today’s 7%, the savings flow through automatically, with the open question being whether the tailwind extends into 2028 if the SARB resumes cutting next year.

The discussion closes on the sector’s defensive qualities and the prospect of new listings. Long leases carrying escalations of 6% to 7% a year underpin the top line while fixed funding costs steady the bottom line, and solar installations at retail centres offer a growing source of cost savings as electricity prices rise. With price-to-book multiples now at parity, historically one of the key triggers for initial public offerings, Nene’s message on new listings is simple: watch this space. In the meantime he positions the sector as a store of value while global uncertainty settles.

The REIT Report is a twelve-part podcast series produced in partnership with the SA REIT Association and Property Flash.

Listen to Episode 9: https://iono.fm/e/1691491