South African listed property was the best-performing asset class over the past decade, but investors should prepare themselves for substantially lower returns in future, an independent investment consultant told the annual IPD South Africa Property Investment Conference, held in Cape Town last week.
The FTSE/JSE SA Listed Property Index produced a total return of 21.5 percent a year over 10 years to the end of 2014, out-performing equities (17.6 percent), bonds (8.5 percent) and cash (7.4 percent).
The South African investment property market has been one of the best performers over the past decade, according to the IPD Global Property Index. The index captures the direct returns (net income and capital growth) of professionally valued properties in 25 countries. (IPD is a subsidiary of MSCI, which provides market indices and equity analysis tools.)
Jill Compton, the vice-president for multinational business development at MSCI, told the conference that, based on an analysis of annualised returns over the past five years compared with returns for 2014, the South African property market was at the top of its cycle.
Dries du Toit, an independent investment consultant and a former chief investment officer at Sanlam Investment Management, said listed property investors can expect total returns of roughly between eight and 10 percent a year over the next 10 years.
But two active managers, while agreeing that investors should tone down their expectations of what listed property will deliver, say it will be possible to out-perform the market if one invests with an active manager who knows where to find good value in the sector.
Du Toit says the reason for the out-performance of listed property over the past decade was the drop in the prime lending rate, which peaked at 25 percent in 2000. Interest rates fell because the government’s monetary policies broke the back of high inflation.
He said the other reasons for the good performance of listed property were:
* Lower capitalisation (cap) rates, which meant that the prices of property shares rose much faster than distributions of income. The cap rate is a ratio between net expected operating income and current market value. It is an indirect measure of how fast an investment will pay for itself.
* Better-than-expected distributions by property companies.
* Gearing (debt compared with equity) of 30 to 40 percent. Gearing, or borrowing, can be used to boost a company’s return on capital and income.
The good performance of listed property was largely a missed opportunity for retirement fund members, Du Toit said. Regulation 28 of the Pension Funds Act permits funds to invest up to 25 percent in listed property, but, according to the Alexander Forbes Pension Fund Watch, the average fund had an exposure to listed property of only three percent over the past decade.
Du Toit said exposure to listed property largely explains why some of the smaller, boutique asset managers recently out-performed the established asset managers. He said they “got property right”, increasing their listed property exposure to 10 or 15 percent, and, in the case of Grindrod Asset Management, 25 percent.
He said listed property’s total return of 21.5 percent a year was made up of an income yield of seven percent and price growth (capital appreciation) of 14.5 percent. In future, income yields will still be fairly good, at about 6.5 percent, but price growth will be substantially lower, at about 2.5 percent. Therefore, investors can expect a total return of about nine percent a year over the next five years.
Ian Anderson, the chief investment officer of Grindrod Asset Management, says he agrees that returns from the listed property sector as a whole will probably not exceed 10 percent. But he says investors will be able to earn annualised total returns of 15 percent over the next five years if they do not “buy the market” (invest in an index) but invest via an astute active manager who knows how to find good value. Anderson says there are still a number of shares that are trading at significant discounts to their net asset value.
Keillen Ndlovu, the head of listed property at Stanlib, says the SAPY is likely to produce average annual total returns of between nine and 12 percent. However, he believes Stanlib will be able to out-perform the index by between one and two percentage points as a result of careful stock picking.
Ndlovu says one of the difficulties with trying to project SAPY returns, compared with its historical returns, is that the nature of the index has changed significantly over the past three or four years, with the inclusion of offshore companies and non-dividend-paying developers.
More than a quarter of the earnings in the index are now generated offshore, and further falls in the value of the rand could well enhance the return of the index.
Du Toit said he believes that, over the next five years, unlisted commercial property will provide the best risk-adjusted returns, beating equities, listed property, bonds and cash. He expects unlisted commercial property to produce a total return of about 14 percent a year, beating expected returns from equities and listed property (eight to 10 percent), bonds (seven to nine percent) and cash (six to seven percent).
He says only very wealthy people can invest directly in commercial property. However, some life assurance companies have funds where you can choose an underlying fund that invests directly in commercial property.