Experts cautious on listed property
The FTSE/JSE SA Listed Property Index (Sapy) delivered a negative return of 4.66 percent in the fourth quarter of 2015, and the average return of the sector was minus 2.14 percent, according to ProfileData. But the Sapy out-performed the FTSE/JSE All Share Index (Alsi) over the one-, three-, five-, seven- and 10-year periods to the end of last year, returning 7.99 percent, 14.02 percent, 17.02 percent and 18.31 percent respectively.
Listed property is regarded as something of hybrid asset class. As with equities, investors have the potential to grow their capital over the long term, while, as with bonds, they can generate inflation-beating income.
The Sapy was established almost 14 years ago, and since then it has out-performed the other asset classes of equities, bonds and cash, Kamil Maharajh, an investment analyst at Glacier by Sanlam, says. The Sapy has returned 13.3 percent a year, while the Alsi has returned 11.5 percent, the All Bond Index (Albi) 9.5 percent and cash, as measured by the Short-term Fixed-interest Index, 8.1 percent (indices rebased to 100 in March 2002), he says.
Since 2002, the only time the cumulative capital growth of the Sapy dropped below that of the Alsi was in August 2008. Thus, the Sapy has provided better capital growth than the other asset classes over the long term, Maharajh says.
The Sapy comprised 22 shares with a total market capitalisation of R393 billion, or 3.8 percent of the Alsi, in December 2015.
The index’s market capitalisation is dominated by a few large companies, with the top four accounting for 50.8 percent of the index in December.
The small number of shares and the dominance of a few large shares make it difficult for large unit trust funds in the listed property sector to move in and out of positions as swiftly and efficiently as they would like and thus actively manage their risk, Maharaj says. For example, if a fund with assets under management of about R6 billion wanted exposure of 10 percent to any of the smaller shares, it would own between 10.6 and 29.3 percent of the nine smallest companies in the index. This would pose liquidity problems if the fund wanted to sell these shares.
Maharajh says many of the 38 funds in the sector are benchmark-cognisant, constructing their portfolios according to the index and then taking relative over- and under-weight positions. There are a handful of benchmark-agnostic funds (funds that pay no attention to the benchmark), such as the Absa Property Equity Fund and the Nedgroup Investments Property Fund. These funds behave differently to most of the other funds in the sector when markets are more volatile.
In terms of income, listed property has delivered, on average, 2.7 times the dividend yield of the Alsi, while the yield from the Albi has, on average, out-performed the Sapy by 1.1 times since 2002, Maharajh says.
Although the yields of the Sapy and the Alsi are gradually converging, with the Albi remaining relatively stable, listed property has consistently delivered higher, albeit more volatile, levels of income relative to the Alsi, he says. “However, it is becoming increasingly difficult to determine for how long this trend will continue.”
The current [January 19] dividend yield of the Sapy is 5.5 percent, versus 10 percent from the Albi and 3.4 percent from the Alsi.
Ian Anderson, the chief investment officer of Grindrod Asset Management, says the operating environment for property companies has become much tougher and the risks for investors have increased. However, he says, the only low-risk asset class is cash, which does not protect your income from inflation.
Anderson says exposure to listed property remains essential for long-term investors who want an inflation-beating income, and Grindrod has retained the maximum exposure to the sector across its portfolios.
However, he says that buying the market (all the shares in the Sapy) will not deliver a good yield, because the index includes property development companies that do not pay dividends and foreign companies that have no South African assets and trade at very low yields.
The yield on the Sapy has been decreasing over the past two years as more companies that pay little or no income have been included in it, he says.
Anderson says the Sapy is trading on a forward yield of about 6.42 percent, while the yield on the 10-year government bond is 9.57 percent. If property developers, foreign companies and domestic companies with significant holdings in foreign companies are excluded, the forward yield on the Sapy rises to 8.63 percent, he says.
With careful stock-picking, he says it is possible to construct a property portfolio with a starting yield of more than 10 percent, with income growth that at least matches inflation each year. In addition, investors earn returns on their capital.
Zayd Sulaiman, an investment manager at Catalyst Fund Managers, says that, following the recent pull-back in pricing, the property sector is offering attractive yields, citing 10.4 percent from SA Corporate, 9.95 percent from Octodec and nine percent from Growthpoint. He favours companies with quality property portfolios and management teams with a track record of excellent capital allocation.
Although distribution growth is not as good as it was in the past, when investors could expect double-digit income growth, investors can earn starting yields of nine or 10 percent, with income growth of inflation plus one or two percent a year.
He says the sector’s negative performance in the fourth quarter was largely a result of the rising interest rate environment in the United States and the plunge in the markets after President Jacob Zuma dismissed Nhlanhla Nene as finance minister.
Depending on your view of the capital markets, the sector overall could still prove to be expensive. However, if long-term bonds remain at current levels, the sector is looking attractive compared with two months ago, he says. There are individual shares that are providing good long-term value.
Anderson and Sulaiman say further rand depreciation could both benefit and harm the sector.
On the plus side, the valuations and distributions of local companies – including Growthpoint, Resilient, Redefine, Texton and Rebosis – that have acquired significant assets offshore will increase, because they generate rental income in US dollars, British pounds and Australian dollars.
The sector’s exposure to offshore assets is between about 30 and 35 percent, Sulaiman says.
On the downside, Anderson and Sulaiman say, rand depreciation will fuel inflation and higher interest rates.
Higher interest rates will make it more difficult for property companies to raise capital at relatively low cost in order to grow their earnings by acquiring other companies and properties. It will also put the retail sector – to which property companies have significant exposure – under pressure as imports become more expensive and consumers cut back on spending.
However, Anderson and Sulaiman say the retail sector has proved to be resilient in the face of difficult trading conditions.
Anderson says the retail landscape is dominated by large corporates that can withstand downturns and afford to keep paying inflation-related rentals. A characteristic of commercial property in South Africa is that leases have built-in annual rental escalations of inflation plus a few percentage points. He says major tenant failures will become a problem if interest rates are increased aggressively, but Grindrod does not currently believe this is likely.
But Lourens Coetzee, an investment professional at Marriott, which launched the first listed property fund in South Africa in 1996, is far more bearish about listed property.
Marriott’s Property Income Fund has produced the lowest returns over all of the sector’s measurement periods to December 31. Over three years, it returned 6.1 percent, compared with the Sapy’s 14.02 percent. It was the only fund with a negative return (minus 1.19 percent) over one year, according to ProfileData.
Coetzee says the fund’s under-performance is a result of Marriott’s conservative asset allocation and under-exposure to smaller, illiquid property stocks, which is informed by its view that the sector is overvalued and that the outlook for listed property over the next decade is poor.
He says the major risks facing the sector are demanding valuations, deteriorating fundamentals and rising bond yields. In a rising interest environment, property companies’ future debt obligations will be more expensive and will put additional pressure on consumers and businesses. This should translate into below-average income growth for the sector, which is not justified by current valuations.
Coetzee says Marriott believes a significant sell-off of property shares is in the offing, and, for that reason, the fund holds only the shares of large, liquid companies (for example, Growthpoint and Redefine). The fund has the maximum exposure permitted by its mandate to cash: 15 percent. In addition, the fund has hedged its exposure to property by buying futures contracts, which have reduced its effective exposure to property from 85 percent to 60 percent.