TRANSCEND PROPERTY FUND: Residential Property: Defensive and Sustainable Investment Case

For too long has residential property, especially the rental sector, been overlooked as a highly profitable and reliable asset class for investors. With many choosing industrial, commercial or retail to generate returns, a small group has been championing the potential of residential retail. The old adage of ‘everyone needs a roof over their hood’ remains true and demand for residential property is unending, with the rental market proving to be an important part of a growing industry. In South Africa, a growing population and a shortage of formal housing makes for a booming sector. In 2019, a report from independent think-tank the Centre for Affordable Housing Finance in Africa (CAHF) found that there remains a shortage of around 2.1 million homes for around 12.5 million people in South Africa, and the roll out of new homes is not moving fast enough – a problem the government has faced since the dawn of SA democracy, and before.

Attempting to do its part in solving the problem is Transcend Residential Property Fund (Transcend), a Real Estate Investment Trust (REIT), headquartered in Johannesburg. CEO Myles Kritzinger tells Enterprise Africa that rental property in South Africa proved highly defensive and sustainable through the past two years while economic conditions have been severely impacted across multiple sectors. Often-unrivalled industry knowledge was employed to ensure sustainability.

“The focus over the last year was to make sure everyone was well and the business was intact,” he begins. “Our focus was about preserving and looking after our tenant base, making sure that they were happy. By doing that, naturally the performance of the business has remained intact as well. Another consideration for us was around cash and liquidity management and making sure cash management was appropriate and we had sufficient cash on the balance sheet to meet obligations and commitments. Those were our main priorities during the Covid experience.”

Experts in the low- to middle-income segment of the South African affordable residential rental market, Transcend has proven its mettle. Initially, the company was listed on the AltX in December 2016, before migrating to the JSE main board in February 2020 – just a month before President Ramaphosa announced a national lockdown where people would be confined to their homes to stop the spread of Covid-19. Kritzinger, who only took over as CEO in January 2021, explains how the market segment remained fruitful.

STRONG, SUSTAINABLE

“What we saw in the affordable housing space was that we were very much protected and resilient during the difficulties in the market. That comes down to two things,” he says. “Firstly, people will need a place to live – that is normally the last thing on people’s list of cuts despite the challenges of any economic environment. The affordable market is such a large pool of people who demand houses and fall into our rental target market so there is constant demand and even though units churn, the enquiries that come off the back of that far outstrip the vacate that you go through.

“We have been really lucky in that the market that we service is such a big market and a lot of people in the higher-income brackets have fallen back into that pool, where affordability might have been under pressure and people were assessing their position have dropped into a middle-income tier.

“Likewise in the bottom end of the market, there are always people progressing and growing into our market. We have been lucky that the pool of people has been big enough to keep our occupancies in place and our portfolio sits at about 95% full. Even at the worst point during Covid, we were at 89%.”

Financial strain on South Africa’s middle class is well-documented. Temporary, and sometimes permanent, salary issues resulting from the pandemic as well as a very high debt repayment portion of incomes has resulted in many moving backwards across living standard measures (LSM).

Fortunately, Transcend is known for its promise of high-quality accommodation – offering more to the market than simply a roof over the head. For this reason, the company managed to produce fantastic results in 2020, boasting 22 properties with more than 4100 housing units, and a portfolio value of R2.51 billion.

IN DEMAND

“There is high demand for affordable housing and for quality affordable product,” says Kritzinger. “A lot of what gets offered and delivered to the affordable space is sub-par. We focus our efforts around providing a quality home that can be lived in. It’s aspirational living rather than giving a room with a bed.”

Even as the company looks to grow its portfolio and become a more attractive offering for investors, the quality of accommodation is non-negotiable.

“The one thing that we always go back to is that we want to expand in a responsible way. A lot of people grow for the sake of growing and that doesn’t mean that you’re left with the same values that you had before. For us, our product and offering is around quality affordable housing and around aspirational living with secure lifestyle-type estates with affordable rentals. Our growth path is focused on sticking to that strategy,” confirms Kritzinger.

Success in the listed property sector is more than about just attractive units. Finding, retaining, and growing a client base that is happy and paying is a key indicator of portfolio health. Transcend has a stringent process when it comes to its renters, and thanks to the ongoing nurturing of this process, the people it attracts are reliable.

“It is a good story for us that people have continued to pay their rent,” says Kritzinger. “One of the big things that we benchmark ourselves on, that we use as a key market metric, is around cash collectability of debt, and also how big our arrears are and how big our debtors book is.

“Our cash collections have always floated at around 97-98% even during Covid. Our arrears currently sit at around 3% of total revenue. It hasn’t been something that has got away from us and we have managed to keep things under control.”

AMBITIOUS EXPANSION

Keeping tenants happy, and advancing the portfolio at the same time is a challenge for anyone active in the sector. But Transcend holds the vision of expanding its assets and its strategic residential properties, across all of South Africa. With this in the mind, Transcend is on the lookout for appropriate opportunities at all times and Kritzinger says there are multiple prospects under investigation and he is hopeful these can be pushed through in the New Year.

“We are very much on growth trajectory and we have two target properties that fit the profile of our existing portfolio. We are going through a capital raise at the moment and we want to execute on those by Jan 2022. That’s 442 units at around R253 million. We are looking to open the pipeline with similar types of product where we can double up the fund and the business over the next two to three years,” he says.

These assets fit the profile for Transcend, matching its existing portfolio of units that are expected to achieve steady rental income growth and capital growth over time.

The new units will also fit into the company’s additional growth strategy surrounding upgrades and improvements to the portfolio which will see a number of buildings EDGE certified – a green building certification system focused on making buildings more resource-efficient. Environmental benefits are twinned with potential cost savings for tenants creating an important offering.

“The new units will be EDGE certified,” details Kritzinger. “The big strategic shift over the last two years has been around sustainability and greening our portfolio. We are going through a process right now where we have registered our entire portfolio for an EDGE certification which was rolled out by the International Finance Corporation (IFC). We have had a bit of experience with green housing and we took a focus saying that it is something we want to incorporate into our business. It is something we see as relevant and important, not only to the company going forward from a sustainability angle, but also to the tenants in terms of benefitting them through the savings and efficiencies on consumption. A lot of those savings manifest in a cost reduction in utilities for the tenant base. There’s an opportunity in that, if we green our portfolio and our homes, and if the tenant uses it in the right way, they could save around one month pre rental on an annual basis – and that is a good saving.” 

Transcend registered its full portfolio in September and has allowed 18-24 months for all units to be EDGE or Green certified.

“Everyone has been brought back down to earth, and affordability and earnings are a key consideration for people so wherever we can give back, that’s a good thing,” says Kritzinger.

SOLID SECTOR

As the company looks to drastically bolster its portfolio size in the coming years, Kritzinger is clear that focus will remain on the traditional core business: “We are a specialist residential fund. We only focus on residential property and we are only a rental fund. We don’t buy and sell, develop, build or get involved in construction. We only buy stabilised rental stock which is used for housing, and we generate income from that,” he confirms.

While others are active in the development aspects, Transcend’s laser focus is what has driven its major success over the years and what will drive its growth in the future. By attracting quality tenants, greening the portfolio, and adding carefully considered new assets, Transcend is building a legacy that will benefit stakeholders and shareholders alike.

“There are others in the residential fund market in SA but product-wise they are slightly different, located in CBDs and typically high-density, more affordable but catering for the lower end of the market, in the informal wage sector. Our tenant base is characterised with secure employment in the formal work sector,” says Kritzinger.

“In the South African market, residential property and residential rental is a very small component of the bigger property sector which references industrial, commercial and retail. There are a few of us who are going through the process of formalising the residential market and standing as specialist residential property owners or landlords,” he adds. “What has been interesting over the last two years is that residential versus other subsets of property has outperformed those subsets of the bigger property industry on every single level. Whether it’s occupancy, arrears, collections, income growth and escalation, whatever it is across all of the different metrics, residential has outperformed all. It comes back to the fact that residential rental is defensive and resilient as an asset class, even during times of volatility. We continue to perform the way we have set out to perform and that has manifested itself during the Covid period. A lot of people have catch-phrased quality affordable residential as a Covid protected investment which is a nice way to label it.”  

Through the challenges of the pandemic, the difficulty identifying new opportunities, and the hesitancy for many investors to look first at residential property, Transcend has achieved excellent results and is confident about the journey ahead.

“Our ultimate aim remains unchanged: we shall endeavour to grow the business responsibly by providing quality, affordable residential rental units in desirable locations to ultimately generate sustainable growth in distributions for our shareholders,” Kritzinger concludes.