Investing in South African inner cities

In the past decade or so, the inner city of Johannesburg has undergone extensive regeneration thus boosting investor confidence.

Investors including the likes of commercial banks, private property developers and established entrepreneurs who have invested in the development of new high rise buildings in the form of hotel apartments, office blocks and residential units, says Paul Jackson, CEO of TUHF.

Established 15 years ago, TUHF provides access to finance for entrepreneurs, from all walks of life, to purchase, and subsequently convert or refurbish buildings in the inner cities of South Africa for affordable rental residential units.

Paul notes that there has been public-private partnership in mixed-used developments that provide social facilities, which have been integrated into new commercial and residential developments. “The transformation narrative, is that, the incentive has empowered individuals to take advantage of the opportunities, having invested in sectional titles which are now generating an income,” he says.

It was also this transformation narrative that led to TUHF hosting its first Inner City Property Conference in October 2018 that brought together property industry players including developers and agencies, property managers, brokers, listed property funds, investors, delegates from government and the public and private sector.

“When we started developing the concept for the conference, the aim was to create a thought-leadership platform between various stakeholders, including the City of Johannesburg’s representatives – to activate growth and investment opportunities contributing to regeneration initiatives in the inner city,” he says.

In light of the current state of the South African economy, he believes there is need to create more vehicles for collaboration with government in order to run successful businesses, and contribute meaningfully to the growth of our economy. He points out: “The vision for inner cities is to create environments where people can live, work and play through densification, mixed-use buildings and affordable housing, and so the UDZ initiative realises this vision and is key in
accelerating inclusive growth in the inner city.” Paul says some of the valuable insights from the inaugural conference were the regeneration narrative – envisioning a city skyline characterised by cranes, as it becomes a construction site for new developments as well as the concept of massive-small – addressing opportunities for ordinary people to become property entrepreneurs, and the out-of-control hike in administrative and municipal rates, which will continue to be an issue in 2019.

Investors in the inner city

As with most investments, investors always want to know if there is money to be made in the inner city, and the answer is yes, with experts saying investors would do well to remember that property is a long-term game. Those invested in the inner city,

like IndluPlace Properties Limited, the first residential focused REIT listed on the main board of the Johannesburg Stock Exchange has approximately a third of its property portfolio located mainly in the inner city of Johannesburg.

According to IndluPlace CEO, Carel de Wit, these properties’ performance are similar to other areas in terms of returns, vacancies and tenant behavior, pointing out that returns are very property specific with lots of variance, but typically between 9% and 12%.

According to the company’s 2018 annual report, Indluplace’s property portfolio comprises 9,788 residential units and 18 163m2 of retail space in 176 buildings in Gauteng, Mpumalanga, KwaZulu-Natal and the Free State.

Speaking to Asset, Carel explains that they have more investments in Gauteng because they saw the best value and most opportunities as well as a diversity of properties.

“Over the last few years, property yields in the Western Cape have been very competitive, and we are still looking for opportunities where there is long-term demand for rental properties,” he says.

Furthermore, says Carel, while most of their acquisitions have been funded with capital raised from property investors, they have also been supported by Absa, Investec and Standard Bank and their current LTV is around 30%.

“This is encouraging for inner city investors as banks may have previously viewed the Johannesburg inner city as high risk (although Absa has been supporting inner city developments for some time),” he says. Since listing in 2015, IndluPlace has managed to acquire nearly 9,800 units in diverse locations, offering different units types across a range of rental levels with fund investors having fully supported this growth, and were rewarded with competitive distributions, notes Carel.

“We feel that the sector is still underrepresented on the JSE and see lots of opportunities in the local market, however, the rate of growth will be dependent on the cost of capital.”

With a market capitalisation of R2.4 billion, IndluPlace has increased the value of its properties to R4.3 billion with 78% of the portfolio located in Johannesburg, 10% in Pretoria,5% in Vanderbijlpark, 5% in Witbank/Mpumalanga, 1% in KwaZulu-Natal and 1% in Bloemfontein.

Carel says the focus is providing affordable rental units with average monthly rentals across the portfolio at just under R4,500 per month ranging from R1,500 to R12,500 per month depending on the building and unit size being rented.

Lease agreements are typically 12 months and tenants come from very diverse backgrounds, typically young families as well as those who have lived in the same building for 20 years.

Challenges facing investors in inner cities Managing urban growth, and hubs for economic growth in the inner city – such as, education and healthcare, and strengthening partnerships between the public and private sector to establish adequate resources to build-up city infrastructure is a key challenge according to Paul.

He says factors such as rapid urban population growth which results in inadequate basic services and the degradation of the environment, evictions and displacement of individuals and high levels poverty in urban areas due to lower-income groups migrating to the city are some of the challenges.

For Carel, crime outside their buildings and unreliable municipal accounts and queries not being resolved are the main challenges. Despite this, he says there is still strong demand for well-priced, professionally managed properties in the Johannesburg inner city.

IndluPlace remains opportunistic and plan to grow their portfolio substantially in the future. “We have assembled a diverse fund including some student housing but will remain focused on the more affordable end of the market as this is where we can have the biggest impact in South Africa while providing investors with competitive returns,” he says.

Access to finance

For investors wondering where to access finance to fund their investments, Paul says TUHF specialises in lending money to reasonably priced housing projects in areas of urbanc decline, where commercial banks dare not tread.

“We generally give preference to small-tomedium sized apartment buildings that are clean, safe and will offer good returns. “Based on the collateral value of the building, TUHF can lend up to 80% of the loan value, and our loan facility has a 15-year term, with interest and raising fees at market-related rates,” says Paul.

He explains that they provide mortgage finance ranging from R100,000 to R30 million, for the purpose of creating affordable rental units. This involves refurbishments of existing buildings, or conversions of existing office blocks into residential use, and new build projects.

“TUHF has lending criteria which inform our disbursement process, therefore, potential investors applying for a mortgage with TUHF need to have a keen interest in property ownership, have a good understanding of the area they want to invest in, and most importantly, have the right characteristics – be honest, reliable and hard-working as this will help them manage their properties,” says Paul.

With a current loan book of R2.9 million, TUHF’s vision is to achieve a R5 billion loan book servicing every major city in South Africa. He points out that they’ve consistently grown as a business for the past 15 years – focusing on profitability while keeping an eye on development. However, he notes that in 2018, they experienced slow market conditions during the first six months.

The second half of the year, they saw a huge uptake in deals and disbursements, as a result, they managed to disburse R503 million during the period. By year-end (2018), the company exceeded its targets with a net profit after tax of R44 million and ROE of 16%.

“Our branch profitability outside of Johannesburg has steadily grown their contribution to our loan book, and our Gauteng operation, where the bulk of our portfolio is based, continue their strong performance. “The Johannesburg branch is responsible for 69% of the R503 million disbursement, and our regional branches making up the other 31%.” Paul adds that commercial success and development impact will remain at the core of TUHF in 2019, pointing out that they plan on achieving this through, sufficient and diversified debt capital which is key to their
business, well-performing branches becoming profitable, improved client experience and portfolio management, reduced prepayments, and increased disbursements in reaching their R5 billion loan book target.

Paul has the following tips for those wanting to invest in the inner cities of South Africa:

• As a new entrepreneur, rather start off small and grow big. Do not over-extend yourself, until you are experienced.
• When identifying an area to invest in, do the research, and most importantly, walk the streets.
• Be patient when identifying a building that is right for you.
• Have a clear idea of what you are looking for, for example, the price versus product.
• Work hard, it pays off.

Download Article: Asset Magazine – Feb 2019