Listed property outlook – 2015
South Africa’s listed property sector once again confounded its many critics in the asset management industry and comfortably outperformed equities, bonds and cash in 2014. This certainly won’t be the last time the asset management industry gets their listed property call wrong, if history is anything to go by. Over the past 10 years, listed property has produced stellar returns for investors (see chart 1), despite little or no institutional support from some of the country’s largest asset managers. Exposure to listed property in South African balanced funds remains less than 4%, despite listed property now making up almost 6% of the FTSE-JSE All Share Index.
Chart 1: Ten year performance of asset classes in South Africa
Source: I-Net Bridge & Grindrod Asset Management
In 2014, the sector benefited from a low interest rate environment and declining bond yields, but more importantly, delivered significantly higher distribution growth than in the preceding five years. At the same time, institutional appetite for high quality property assets has increased across the globe and a similar trend emerged in South Africa during 2014.
2015 is expected to present many of the same tailwinds experienced in 2014 with the added benefit of lower oil and petrol prices, which should result in a strong recovery in consumer expenditure and retail sales. There is already anecdotal evidence that retail sales accelerated in January this year after the petrol price was cut by R1.27 per litre at the start of the month. Some of this benefit is likely to be countered by the impact of electricity load shedding.
The major difference between 2014 and 2015 is obviously the starting valuations.
During 2014, prices appreciated significantly quicker than incomes grew, resulting in a 60 basis points decline in nominal historic income yields and a further 50 basis points increase in the spread between the yield on SA REITs and South African long bonds (see chart 2).
Chart 2: Historic yields – SA REITs versus SA long bonds
Source: I-Net Bridge & Grindrod Asset Management
While some of the spread widening can be attributed to investor expectations of higher medium-term income growth (i.e. making listed property more attractive longer-term and therefore allowing investors to accept a lower yield today), it doesn’t fully explain the sharp rerating experienced by the sector last year. For that, a deeper analysis of individual company performance is required.
Resilient Property Income Fund was one of the star performers last year, both in terms of distribution growth and share price appreciation. The company, along with some of the other larger listed property companies made its way into a number of global indices, including MSCI’s South Africa Index. This increased the reach of potential investors to beyond South Africa’s borders and resulted in significant offshore interest in South Africa’s listed property sector last year. This increased appetite from offshore investors is unlikely to be repeated in 2015.
Not every listed property company rerated last year. A number of SA REITs delivered strong distribution growth, without a similar increase in their share prices. On a relative basis, these companies now look significantly more attractive than they did at the beginning of last year. Investors wanting access to the benefits of listed property (high initial income yield, inflation-hedged income growth and long-term capital appreciation) would be well served avoiding some of the larger listed property companies and focusing instead on the value on offer amongst the smaller listed property companies.
The major risks to the listed property sector in the short-term include the impact of load shedding on domestic growth as well as the normalisation of monetary policy in the United States, which could prompt an increase in South African long bond yields. Weaker domestic growth, as a result of load shedding, will adversely affect industrial and office landlords as smaller tenants struggle to cope in a lower growth environment.
Current forecasts for sector distribution growth in 2015 may be too low, given recent positive trading updates from both Resilient and Fortress Income Fund and consensus-beating distribution growth from Capital Property Fund (the first SA REIT to report in 2015). This would be encouraging to investors who are likely to experience more downgrades than upgrades in many other sectors on the JSE during 2015.
On the whole, short-term risks are evenly poised but with current valuations where they are, investors are likely to respond more aggressively to downside risks than they are to upside risks. For longer-term investors, South Africa’s listed property sector continues to offer a combination of suitably attractive initial income yields and inflation-beating income growth. Correlations with equities in particular have declined substantially since 2007 and an allocation to listed property in a balanced or multi-asset portfolio will deliver significant diversification benefits in the longer-term. Valuations among the smaller listed property companies continue to look compelling and careful stock selection should produce good results again in 2015.