How global property can boost your portfolio

By Mark Bechard Time of article published Jan 24, 2015

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Global property funds produced an impressive return of close to 30 percent to the end of December 2014. This may prompt you to consider including these funds in your portfolio – or is the party over, and will latecomers be doomed to pedestrian or even negative returns?

Managers of global property funds don’t expect performance to be as spectacular in future, but they say there is still an opportunity to earn good returns. They expect nominal (before-inflation) total returns of between eight and 12 percent a year in United States dollars over the next three to five years.

The fortunes of the rand will affect the returns received by South African investors – and, as with investments in other offshore asset classes, hedging against rand weakness is put forward as a good reason to invest in global property.

A good financial adviser will tell you that all market sectors move through cycles, while historically equities have been the best-performing asset class for long-term investors.

Fund managers admit that the recent spectacular returns from global listed property came off a low base following the financial crisis of 2008/9. The property sector was particularly hard-hit by the crisis, with some sub-sectors of the property market losing as much as 80 percent of their value, Ian Anderson, the chief investment officer at Grindrod Asset Management, says.

One reason for the big losses in 2008/9 was that many property companies – particularly in the US and Australia – had taken on large amounts of debt to finance acquisitions, he says

The recent rapid depreciation of the rand against the US dollar also contributed to local investors’ outstanding returns.

Although the factors that led to the recent out-performance are unlikely to be repeated soon, fund managers say economic factors and the characteristics of the global listed property market make a compelling case for investing.

They say your main motivation for investing in global listed property should be to diversify your portfolio, and your decision should be underpinned by sound fundamentals, rather than being a gamble on how the rand will rise or fall.

Both the South African and the global listed property sectors offer you the prospect of having both a growing, inflation-beating income stream and capital appreciation, although, in the case of the latter, not to the extent of equities.

Fund managers point to three main ways in which global property can enhance diversification and reduce risk:

* The South African market is very small. Greg Rawlins, the chief executive of Reitway Global, says that two companies account for half the market capitalisation of the local listed property sector. He says exchange control regulations mean that “too many rands are chasing too few shares”, which has resulted in “price distortions”.

* Performance in different regions of the world is uncorrelated, meaning that countries produce different returns and, when one country performs poorly, another may perform well. There are now 34 countries with recognised investment regimes for investing in reits. (A reit, or “real estate investment trust”, owns and manages a portfolio of properties and mortgages.)

* In South Africa, the listed property market consists of just four sectors – commercial, industrial, retail and hospitality – whereas there are about 16 sectors offshore. The performance of these sectors is also largely uncorrelated.

* In South Africa, the performance of listed property and bonds tends to be closely aligned, whereas the returns you earn from foreign reits may be aligned with either bonds or equities.

Managers say investors are likely to continue to earn growing returns in the global property sector for the following reasons:

* The long-term driver of the property market is economic growth, and, in South Africa, growth prospects are poor compared with countries such as the US and the United Kingdom.

* Demand for property is outstripping supply, and, although development is picking up, supply constraints will remain for some time, Rawlins says. One reason for this is that, in the wake of the financial crisis, property companies have become far more cautious about embarking on developments. Keillen Ndlovu, the head of listed property at Stanlib, says the cautious lending environment will continue to act as a constraint on supply, even as economic conditions normalise in developed countries.

* The cost of financing property developments has fallen, because of the low interest rate environment in many developed countries, he says.

* Rentals will grow, because, as the economic recovery continues, leases will be renewed at higher levels, Ndlovu says.

* Unlike period leading up to the 2008/9 crisis, much of the growth in the property market is being financed by equity investors, not via debt.

* Property has become a sought-after investment by sovereign wealth funds (state-owned investment funds), pension funds and wealthy families.

* Property companies have become leaner and more efficient since the financial crisis. The crisis led to a major shake-up in the market, with the larger and better-quality companies snapping up the assets of those that fell by the wayside.

The vast majority of listed companies in South Africa are what are known as diversified reits, which consist of a combination of commercial, retail and industrial assets. The diversified nature of reits in this country means that funds that invest in them cannot sell down or out of a specific sector if it is likely to underperform because of economic changes.

The offshore listed property markets consist of highly specialised reits. There are funds with a very narrow investment focus, such as cellphone masts, data-storage centres, apartments in a particular city, forestry plantations and hotels.

The performance of these sectors is not aligned, which means that fund managers can “ride” an economic trend “hard” and then, when the economic cycle changes, switch into reits that are likely to benefit from the change. This is one of the reasons why fund managers are upbeat about investors continuing to earn good returns from global listed property.

HOW LISTED PROPERTY PERFORMED

Global real estate was the best-performing collective investment scheme sub-category over the quarter and over the year to the end of December 2014. Over three months, the average return of the funds in the sector (with income reinvested) was 10.29 percent, according to ProfileData, while the MSCI World Index returned 4.4 percent. Over 12 months, global property returned 28.14 percent, while the MSCI returned 14.31 percent.

Global real estate was the second-best-performing sub-category over the three-year and five-year periods to the end of last year, with annual average total returns of 26.6 percent (MSCI: 26.99 percent) and 20.6 percent (MSCI: 8.94 percent) respectively, according to ProfileData.

South African real estate was the second-best-performing sub-category over the quarter and over the year to the end of December 2014, with average total returns of 10.59 percent and 25.69 percent respectively. The benchmark for the sub-category, the FTSE/JSE SA Listed Property Index, returned 11.08 percent and 26.64 percent over those periods. The sub-category was the third-best performer over five years to the end of December, with an average annual return of 19.58 percent. The index returned 21.37 percent over five years.

There were seven funds in the global real estate general sub-category at the end of December 2014. Five funds had a three-year performance history and only two had a 10-year performance history. The absence of a long-term performance history for most of these funds makes it difficult to draw solid conclusions about how global property funds have performed relative to South African funds over periods longer than three years.

CORRELATION: EQUITIES OR BONDS?

There is a perennial debate over whether the performance of listed property correlates with bonds or equities. The conventional view is that listed property and bonds are closely correlated, and that when bond yields rise, listed property prices fall, and vice versa.

Keillen Ndlovu, the head of listed property at Stanlib, says research shows that the South African sector and bonds are closely correlated, but this is not the case globally, where the correlations are “all over the place”.

He says the difference between the local and the global markets can be explained by how South African listed property is valued. Here, valuations are based only on yields, because reits pay out all their income to investors. This is not the case in other countries, with the result that valuations reflect net asset value rather than yields.

Greg Rawlins, the chief executive of Reitway Global, says the extent to which global reits can be correlated with equities or bonds varies from sector to sector. Reits exposed to the healthcare, data-storage and retail sectors tend to correlate with bonds, while those in the hotel, apartment, and self-storage sectors have a closer correlation with equities.

WHAT ADVISERS SAY

Adding another layer of diversification to your portfolio is always good, and that should be your main motivation for going into global listed property, Barry O’Mahony, the 2013 Financial Planner of the Year and founder of Veritas Wealth, says.

However, he says that listed property is closely correlated with interest rates: when rates rise, returns from listed property fall. Interest rates in much of the developed world – where most listed property funds are invested – have been artificially low, and, in part, your decision will depend on where you see these rates going in the near future. The widely held view is that US rates are likely to rise.

Peter Hewett, the 2014 Financial Planner of the Year and the managing director of Efficient Advise, agrees that regional diversification is the main benefit of investing in global listed property.

He says the good returns in the sector should be seen in the context of the very low cost of financing property development. He believes that the yields from global property will fall slightly, because these costs will increase as interest rates rise.

Asset allocation decisions should always be based on your own circumstances, Hewett says. However, for the average investor who is saving for the long term, the rule of thumb is an exposure to listed property of between 15 and 25 percent, and, for the sake of diversification, Hewett says he would tilt the bias towards global (over local) property.

IMMEDIATE OUTLOOK

Global listed property currently offers better value than its South African counterpart, Keillen Ndlovu, the head of listed property at Stanlib, says. Local funds, on average, are trading at a premium of over 25 percent to their net asset value (NAV), whereas the premium to NAV for global property is six percent.

Stanlib expects a forward yield (annual return on investment) of 6.6 percent for local listed property, compared with 7.2 percent from a 10-year government bond and less than seven percent from cash. Ndlovu says the expected forward yield on global property is 3.5 percent – but that is in United States dollars.

Ndlovu say that property prospects are best in the US, because data indicates that the economy will continue to strengthen.

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