SA listed property – still with something to offer investors
South Africa’s listed property sector returned 41.4% in the 12 months to the end of March 2015. The sector enjoyed a number of tailwinds throughout 2014, most notably declining bond yields and accelerating distribution growth. At the same time, a number of large South African Real Estate Investment Trusts (REITs) were included in global equity indices constructed by MSCI and FTSE. This resulted in a significant uptick in investor demand for SA listed property.
In addition, institutional investors around the world have been slowly increasing their exposure to listed property, in response to more positive views on interest rates and bond yields. In South Africa, average exposure to listed property among investment managers is extremely low by global standards, despite the sector having produced the highest returns of all domestic asset classes over the past one year, three years, five years, 10 years and 15 years.
Listed property now also features prominently in the FTSE/JSE Africa Index series, making up almost 6% of the All Share index and Shareholder Weighted All Share index. This has meant that investment managers benchmarked against either of these two indices now need to consider an allocation to listed property, even in an equity-only mandate. Listed property, as it should have done years ago, now comfortably straddles the equity and income space, offering investors the combination of a relatively high initial income yield and long-term growth in income and capital.
The combination of these factors helped bolster the prices of the larger, more liquid listed property companies throughout 2014 and the first quarter of 2015. This has prompted many market commentators to caution investors about investing in South Africa’s listed property sector and while in some cases these views are justified, the rationale for these comments is often misguided.
One of the biggest mistakes investors can make when assessing the investment merits of the South African listed property sector is to demand yields in line with or above the yield on long bonds. As distribution growth has accelerated in recent years, investors have accepted lower, equity-like income yields, which, together with the prospect of 8% to 10% per annum income and capital growth, is expected to produce returns comfortably in excess of inflation.
Those investors who are concerned by the lower income yields of the larger listed property companies should consider investing in many of the smaller and mid-sized listed property companies that continue to trade on initial income yields of between 8% and 10% and which are forecast to deliver distribution growth of between 7% and 10% per annum over the next three years. These smaller companies are also capable of producing higher returns over time as the benefits of actively managing a smaller property portfolio translate into higher distribution growth and shareholder value creation.
At the end of March 2015, the forward income yield on the Nedgroup Investments Property Fund was 7.7% before fees. This compares extremely favourably with the 5.4% yield on the FTSE/JSE SA Listed Property (SAPY) index and 5.7% yield on the index when Attacq is excluded (Attacq is a developer and does not pay a dividend to shareholders).
The Nedgroup Investments Property Fund currently has a higher allocation to small and mid-sized listed property companies and as a result, is offering an initial income yield that is 2% higher than the market. The fund is also expected to deliver distribution growth in excess of the growth generated by the overall market, building on its 13% per annum growth in distributions since launch at the end of July 2010.
The combination of a relatively high initial income yield and inflation-beating distribution and capital growth allows investors the opportunity to maximise total returns through time. Instead of just relying on capital appreciation or an income yield to generate their returns, investors in listed property can enjoy both sources of return as well as the benefits of compounding the income if it is reinvested and not consumed.
Listed property is therefore an ideal asset class for investors saving for retirement in an investment vehicle that is sheltered from tax (like a living annuity or provident fund), as well as for providing an inflation-hedged income in retirement. Unfortunately, very few South Africans have benefited from exposure to listed property in the past, but this appears to be changing as institutional investors and large asset managers continue to increase their exposure to listed property. At the same time, listed property companies are expected to continue expanding their portfolios, raising a combination of debt and equity capital to do this. The sector is therefore expected to become a larger component of the South African investment landscape. From a R5 billion market capitalisation in 1998, the sector has grown exponentially and today the combined market capitalisation of listed property companies in South Africa exceeds R500 billion.