Vukile’s R4bn gamble in Spain

There are mixed views about South African property companies diversifying into Europe.
Vukile, the owner of Gauteng-located East Rand Mall and Randburg Square, has identified Spain as its key growth destination. Picture: Supplied

It was not long ago that South African developers and JSE-listed property companies entered former communist countries of Central and Eastern Europe (CEE) aggressively as part of their diversification ploy.

Lured by cheap debt to fund property purchases, strong economic growth and retail sales buoyed by cash-flush consumers – most South African property companies ramped up investments in CEE regions such as Romania, Poland, and Montenegro over the past two years.

Local property counters including the Resilient group of companies, Redefine Properties, Growthpoint Properties, Attacq Limited and Hyprop Investments are among the largest JSE-listed CEE investors. Their collective investments have increased the JSE real estate sector’s exposure to Europe to approximately 35% compared with 0% more than ten years ago.

However, the mid-cap (R16.9 billion) Vukile Property Fund took a contrarian move, opting not to invest in CEE regions.

“We had many concerns about CEE regions,” said Vukile CEO Laurence Rapp. “People in those regions sell their assets to South Africans but who do South Africans sell them to? Global capital is coming to Spain and there are property buyers. Whereas you are not seeing that in Eastern Europe.”

Vukile, the owner of Gauteng-located East Rand Mall and Randburg Square, has identified Spain as its key growth destination.

In 2017, Vukile joined forces with Spain-based Castellana Properties, which was founded nearly two years ago by South African Lee Morze, who has since relocated to the capital of Madrid and is responsible for finding property deals for the company.

Vukile ramped up its investment in Castellana by first shelling out R3 billion (€193 million) for it to purchase 11 retail parks across Spain in July 2017; and a further R950 million for the purchase of two retail parks in December 2017. In the process, it clinched a 98% stake in Castellana.

Unlike glitzy shopping centres, retail parks have fewer store offerings that are arranged in a row and face major traffic arterial routes with few connections to surrounding residential neighbourhoods. A typical retail park node in SA would be Woodmead in Johannesburg or Kenilworth in Cape Town.

Vukile has opted to slowly build scale to Castellana instead of buying a well-established business. This is the antithesis to the corporate playbook in South Africa, where many local companies go big in their offshore acquisitions.

The Castellana deal makes Vukile the only South Africa-domiciled property company to make substantial investments in the region to date. South African investors who want exposure to the Spanish market could invest in Intu Properties, Hammerson and Schroder European Real Estate via the JSE. However, their exposure to Spain is relatively small compared to their entire property portfolios.

In one fell swoop, Vukile’s investments in Castellana takes its exposure in Spain to about 22% of its R20.4 billion total assets as of end September 2017. The Spanish investment also boosts Vukile’s total offshore investments to more than 24%, including the company’s R1.3 billion investments in UK-focused Atlantic Leaf Properties.

This is a massive stride for Vukile, which has grown its direct property portfolio seven-fold from R1.9 billion when Sanlam Properties listed the company on the JSE in 2004 to R14.2 billion as at September 2017.

The key question for investors is whether Spain will be an earnings fillip for Vukile.

Rapp reckons so, saying Spain’s economy has recovered from the bruising 2008 financial crisis, the unemployment rate has declined steadily and consumer confidence is back in positive territory. Official statistics show Spain’s tourism-driven economy grew by 3.1% in 2017, which is above the European Union average.

The unemployment rate has recovered steadily from highs of 26% in 2013 to 16.5% by end-2017. Consumer confidence has more than doubled in the last five years.

This environment is expected to be supportive for future rental growth, occupation rates and capital appreciation on Castellana’s portfolio of 13 retail parks, which have a weighted average lease expiry of 17.6 years (with a five-year break in leases) and a vacancy rate of 5.4%. The retail parks are occupied by similar major tenants including electronics retailers Media Markt and Worten, specialty pet retailer Kiwoko, DIY retailer Aki and grocery retailer Mercadona.

Ahmed Motara, analyst at Stanlib, said Castellana’s lack of diversity in its tenant mix was concerning. He said if one of the retailers fails (for example, Media Markt and Worten, which Castellana derives about 23% of its rental income from), then its retail parks might face higher vacancies.

Another threat is Spain’s fledgling e-commerce market, which represents only 4.8% of total retail spend. Motara said further growth in e-commerce would not be positive for retail parks, given that most retailers would potentially relocate to dominant and flagship shopping malls.

He concedes that retail parks currently make for good investments.

Supporting Motara’s views are figures from US-headquartered research and advisory firm Green Street Advisors, showing that Spanish retail properties have delivered an unleveraged (debt-free) internal rate of return of nearly 6.5% on an annual basis – beating Europe’s global average of 5.5%. Peter Papadakos, managing director of Green Street Advisors, said Spanish retail parks tend to have higher returns than larger shopping malls. “We think that Spain will continue to outperform more mature markets like France and Germany in the next couple of years,” he said.

Refurbishments

Castellana plans a number of redevelopment initiatives to increase rentals, which are still below pre-economic crisis levels.

At its 13 604m2 Parque Oeste-Alcorcon retail park, which is the biggest retail park in Madrid, Castellana plans to reduce the space occupied by Worten to make room for another tenant. Castellana CEO Alfonso Brunet said after reconfiguring the Worten store, it might achieve rentals that are higher than the monthly rental rate (€20/m2) that the retailer currently pays.

Steinhoff’s homeware retailer Conforama is facing slower sales at Castellana’s 16 246m2 Parque Principado retail park in Spain’s northern town of Asturias. The retailer’s lease will not be renewed when it expires in 2021 but Castellana plans to reduce Conforama’s 6 700m2 store into two or three units. Conforama currently has a monthly rental rate of €9/m2 and after reducing its store into several units, Castellana can achieve a rental rate of €12/m2 for each unit.

Another big project is the refurbishment of its 8 000m2 Kinepolis Leisure Centre in Granada. The master plan is to reduce the restaurant offering and introduce more retailers and bolster the cinema offering. The centre will be linked – via new road and infrastructure developments – to Castellana’s surrounding Kinepolis Retail Park and Alameda Retail Park.

In most instances, Castellana owns more than 50% of the share in its retail parks. This might make it difficult for its retail developments to pass muster with other minority owners. “They do have to work with other parties to ensure a strong retail dynamic at the various retail parks. Sometimes, interests are perhaps not fully aligned between all parties,” said Stanlib’s Motara.

Negotiations for rental growth on new leases are indexed to Spain’s inflation, which is expected to accelerate between 1.4% and 2% in 2018 to 2022. This is in stark contrast to when inflation was in negative territory during the recession. Green Street Advisors’ Papadakos said even in a low inflation environment, landlords in Spain were achieving rental growth of 4% to 5% on a like-for-like basis – a rate higher than Germany, Italy and France.

As a parent company, Vukile will be funding Castellana’s redevelopment projects and further property purchases using its internal cash resources and debt funding in Spain. After all, in a low-interest rate environment in Spain, Vukile can borrow five-year debt at an interest rate of 2.7% compared with South Africa’s 9%.

Listing on the MAB and the JSE

Castellana is concluding negotiations to acquire a property that will grow the value of its property portfolio from R4.3 billion to a hefty R5.8 billion. Reaching this scale will help Castellana embark on a listing on the junior board of the Madrid Stock Exchange (MAB) in June 2018.

Over time, when Castellana grows the value of its assets to at least R17.5 billion, it might consider an inward listing on the JSE. “When the point comes for external funding, we’d like to have the option of raising the money in Spain before looking to South Africa-based investors,” said Vukile’s Rapp.

Although Spain’s real estate investment trust (Reit) market is small – with about 50 companies on the MAB each with assets below R8 billion – it remains a healthy environment for raising capital. Papadakos said if a company has “a good story to tell” and has a management team that was well regarded and experienced, it could raise capital.

Rapp, who will join the board of Castellana, said the company brings more than 50 years of collective real estate experience in Spain among its senior management that includes Alfonso Brunet (CEO), Rubén Pérez Maíllo (CFO), Pedro Diaz (development manager), Julio Garcia (head of asset management) and others.

Anas Madhi, the executive director of Meago Asset Management, said the firm will be on the lookout for the listing on Castellana, its further property acquisitions, and redevelopment initiatives. “The achievement of these milestones will confirm the scaleability of the venture and the strength of the management team, making Vukile a unique entry point for South African investors into the increasingly attractive Iberian Peninsula,” said Madhi.

The writer was a guest of Vukile in Spain.

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With Spain being a prime tourism destination, a sought after country for offshore residences and an affordable retirement destination, retail parks with good home ware offerings will continue to do exceptionally well.

This risky play in a retail overtraded market (still trying to unwind after the financial crisis of 2008) is a rand hedge play more than anything else.

Investors beware.

Agree 100%. Also, online shopping in the under 40 year old market, growing fast in Europe.

End of comments.

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