Rates dilemma for commercial property

Posted On Monday, 24 October 2005 02:00 Published by
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THE commercial property market is becoming increasingly competitive with private investors, institutions and listed property funds vying for the same properties.

Nick Wilson

Property Correspondent

THE commercial property market is becoming increasingly competitive with private investors, institutions and listed property funds vying for the same properties.

Often, private buyers are able to acquire properties that the funds are bidding for as they are able to make offers at lower yields.

Individual buyers do not have to worry about the dilutionary effect of a transaction on earnings, while listed property funds have to account to unit holders and ensure that all transactions are either neutral or earnings enhancing.

But if interest rates go up in the next year — and Reserve Bank governor Tito Mboweni is already warning that they might — some private investors could find that they have overborrowed and are not receiving enough rental income to cover bond repayments.

This could create an opportunity for listed property funds to acquire properties at cheaper prices if private investors were forced to sell.

Brian Azizollahoff, CEO of listed property loan stock company Redefine Income Fund, says a large number of individuals have invested in commercial property over the past year to 18 months, "and it has become very competitive when it comes to acquisitions".

Azizollahoff says listed property funds cannot afford to dilute their existing unit holders’ interests by acquiring very expensive properties.

Private investors can pay more for a property and "wait for capital and income growth down the line", whereas a listed company will not want to dilute earnings on "day one of the acquisition".

He says while interest rates are low, private investors are borrowing at favourable rates to buy property, and even at low yields may experience "positive gearing" where income from the property is covering borrowings.

But Azizollahoff says when interest rates go up, private investors have to hope that the growth in net income from the property will continue to service their bonds. Listed property funds can weather changes in the interest rate cycle better than private investors, he says.

First South Securities property analyst Leon Allison says some private investors pay for properties with cash, but others borrow as much as they can.

He says they can borrow up to 70%-75% of the value of their properties and would be negatively affected in the event of an interest rate hike, especially if they do not fix the interest rates on their debt.

But property unit trusts can borrow only up to 30% of total assets, and while property loan stock companies can borrow more, on average they gear up to about 50% of total assets.

"Because they (private investors) have more debt and less equity to finance their property, they have higher risk," Allison says. Because of their size, listed property companies and funds can finance at lower interest rates than private investors. Listed property funds and companies also tend to fix interest rates on most of their debts.

Allison says First South Securities believes that there could be a 100 basis point increase in interest rates next year and some over-borrowed private investors could be in trouble. "This could create opportunities for the listed property sector to acquire some properties more cheaply," he says.

But Norbert Sasse, CEO of Growthpoint Properties, says private investors can also fix the interest rates on their debt and he does not believe an increase in interest rates will hurt them badly.

Sasse agrees that the commercial property market is very competitive with more buyers than sellers. He says listed property funds are finding it more difficult to acquire properties.

"From our own experience, when properties are introduced to us and we decide to make an offer, we lose more deals than we are actually able to conclude," says Sasse.

This, he says, is due to competitiveness and pricing because private investors, listed funds and institutions are pushing up prices.


Publisher: Business Day
Source: Business Day

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