Listed property still offers opportunities

Listed property still offers opportunities

Despite higher bond yields and interest rates.

Over the past decade, the local listed property sector has experienced stellar average compounded growth in excess of 20%, but does the sector still have attractive longer-term return prospects in the face of higher bond yields and interest rates?

Ian Anderson, chief investment officer at Grindrod Asset Management, says the biggest driver of the excellent historic performance was the declining interest rate and yield environment.

“This meant investors were prepared to accept lower yields (i.e. pay higher prices) for their listed property investments,” Anderson says.

A secondary driver was the moderate increase in distribution growth the sector was able to produce, despite the weaker economic backdrop.

However, the sector’s performance during 2013 and in the early part of this year has been more subdued.

The table below highlights the total return of the listed property sector (Sapy index) over the last decade.

PeriodSapy total return
2014 YTD14.0%*
* As at September 9 2014

Justin Floor, investment analyst at Kagiso Asset Management, says although it is difficult to attribute short-term market movements to specific factors, the most likely reason for the sector’s weakness last year and during the early part of this year is related to bond yields rising sharply due to expectations of monetary policy normalisation (especially in the US and the UK) coupled with a fragile economic environment in South Africa.

“This would have seen listed property yields rise as well,” he says.

Floor says operationally, the operating environment remains a challenge. The office subsector remains weak (supply continues to exceed demand for space), interest rates are likely to keep on rising (albeit slowly) and landlord costs keep on increasing.

But despite challenges, analysts still believe there are attractive opportunities for investment in the sector.

Anderson says the prospects for the listed property sector remain very positive, due to the significant acceleration in distribution growth rates since the start of this year.

“Distribution growth has accelerated above 10% for the first time since 2007/08 and is expected to remain at these elevated levels over the next 12 to 18 months.”

Anderson says this would support listed property prices, even in the face of higher bond yields and interest rates.

Unfortunately for investors, a number of the larger and more liquid listed property companies have already responded to this more upbeat outlook and are fully discounting the higher distribution growth, he says.

“However there are still a number of smaller listed property companies that continue to trade at significant discounts to net asset value, on initial yields in excess of 9% and offer the prospect of distribution growth in excess of 10% per annum over the next two years,” Anderson says.

He expects these smaller listed property companies to deliver returns in excess of 15% per annum over the next three years even if the sector as a whole struggles in the face of rising interest rates and bond yields.

Floor says at current valuations Kagiso sees the local listed property sector as fairly valued, with the expected growth in income somewhat offsetting the risk of further weakness in bond yields.

“We would have a preference for companies with higher quality assets and strong management teams which we believe are more likely to defend and grow their distributions,” he adds.

He says the offshore exposure through domestic companies is increasing rapidly as management teams see better opportunities outside South Africa’s borders.

“We expect some of these ventures to be increasing contributors in the years to come. That said, we think it’s unlikely that the sector will be able to deliver the same astronomical returns as the last decade. The future is likely to normalise to lower returns,” Floor says.

Looking further abroad however Kagiso believes there is a compelling case to be made for investing in listed property markets in developed countries. Floor says it particularly likes the German residential listed property market, which looks set to benefit from extremely strong fundamentals.

Anderson says at least 15% of a retail investor’s should be allocated to listed property.

“Listed property offers investors both a high level of current income and the prospect of inflation-beating growth in income and capital over time,” he says.

Floor says the allocation in Kagiso’s client portfolios would depend on how market prices compare with their assessment of fair value, and what expected returns are priced into prevailing prices relative to other opportunities, while taking the relevant risks into account.

Kagiso currently has around 6% exposure to JSE-listed real estate in its balanced fund portfolios, having increased its clients’ exposure since the beginning of the year.



Denny Crane

Denny Crane
It's not me ... yet. Denny Crane from the TV series Boston Legal. Click on picture if you're not sure who he is!