This article first appeared in the 4th quarter 2018 edition of Personal Finance magazine.
The controversy surrounding the Resilient stable of companies has harmed the credibility of the listed-property sector and caused the FTSE/JSE South African Listed Property Index (Sapy) to be the worst performing asset class since the end of last year. The index lost 23% in 2018. So should investors still consider investing in listed property as part of a diversified investment portfolio?
For investors not to lose faith in South Africa’s listed-property sector, one has to understand the issues surrounding the Resilient stable and assess whether these issues are prevalent across the sector and if there are still pockets of value for investors.
The Financial Sector Conduct Authority (FSCA) has been investigating Resilient, Nepi Rockcastle, Fortress and Greenbay since March after short-seller Viceroy released damaging reports on Resilient in January, followed by 36One Asset Management in February. The FSCA’s market abuse department’s investigation is studying possible insider trading and price manipulation in the Resilient group companies’ shares as well as false and misleading reporting regarding the group. These shares have dropped significantly in price and have adversely affected the Sapy.
Look out for the performers
According to Lourens Coetzee, an investment professional at Marriott (a boutique asset management company that specialises in dividend-growth investing), there are still pockets of value in the property sector. He says that the underperformance of the sector does not detract from the merits of investing in listed property. “The key is to ensure that you are investing in the highest quality property companies with strong management teams, and not to overpay for these assets.”
Coetzee believes that listed property still remains a compelling asset choice for investors who are looking for high levels of starting income that will grow over time.
He refers to the Marriott Property Income Fund, which according to ProfileData, was the best-performing South African real estate general fund over a one-year period on August 31, 2018, delivering a return of 5.9% over the year and 4.4% annualised over three years.
Value in active management
“We have actively managed our property funds to ensure that we only hold what we consider to be the highest quality, most liquid real estate investment trusts (REITs), companies that own and often operate income-producing properties. These companies have strong management teams, clear disclosure, relatively good corporate governance and the most secure dividend outlook. This is very different from holding all the funds in the property index relative to their market capitalisation and free-float factor,” Coetzee says.
The Sapy has largely been held back by the severe share price losses of the Resilient companies. The stable made up over 40% of the index and has fallen approximately 30%.
Coetzee says all the Resilient companies implicated in the speculation were excluded from the Marriott fund due to concerns about valuations and corporate governance.
Two of the biggest listed-property companies are Growthpoint and Redefine Properties.
Growthpoint is a quality South African REIT that is performing well in a tough environment. The company draws the majority of its income from rentals (often linked to inflation), which are paid out as regular dividends and which are aligned to forecasts.
According to Growthpoint’s financial results for the 12-month period, its dividend grew 6.5%, in line with expectations. Growthpoint has forecast that its dividend growth will slow to 4.5% in the 2019 financial year.
Evan Robins, a senior portfolio manager at the Old Mutual Investment Group and manager of the Old Mutual SA Quoted Property Fund, believes it is unrealistic to expect strong growth in the current economic environment. However, he still believes the sector is not expensive and that the returns are more than adequate, as long as the economy does not deteriorate. But there is still a difficult period ahead.
He says the risk with investing in exchange-traded funds is that they track indices that blindly hold large positions in overvalued companies. He says there are fewer risks when you buy shares whose valuations you are comfortable with, especially when prices have come off sharply, as seen recently in listed-property.
Advantages of listed property
There are many advantages of investing in listed property, with investors exposed to diversified types of property including industrial, office, commercial and residential space. There are over 40 property unit trusts, loan stocks and REITs listed on the JSE that offer the benefits of real estate ownership without the problems of being a landlord. A big advantage is that the shares are fairly liquid and easily traded compared with physical real estate.
Listed property shares produce returns through the rise or fall in their share price over time, resulting in capital gains or losses. In addition to share price growth, investors receive regular income distributions from the rental income (often linked to inflation) that the property companies earn. Property shares are less risky than other equities because of the relatively stable rental income streams.
If you want to diversify your investment portfolio and require medium-to long-term capital and income growth, you are likely to benefit from investing in listed property. However, the price of listed property can be volatile from time to time, as we’ve seen over the last 12 months, and therefore it would be sensible to have a medium- to high-risk appetite and a long-term view.
You should expect short-term volatility, but over the long term prices should increase in line with the rental growth.
Coetzee says there has traditionally been a strong relationship between local government bonds and listed property. When bond yields fall, the rand strengthens and property prices rise. When the rand weakens, property prices fall and bond yields tend to rise. This is because property rentals are generally linked to the yields on long-term government bonds.
Robins says that over longer periods listed-property shares separate from bonds, because property companies can they can lose value or grow in value, depending on their business strategy over time. They operate more like equities over the longer term and it is therefore a more appropriate way to view this asset class.
Also, he says the relationship between listed property and bonds has weakened in recent years because of the property sector developing and investing in offshore assets.
Robins says that South Africans appear to be obsessed with dividend growth, but, even with flat dividends, the South African property market offers good returns.
With low growth prospects for the SA economy and the weak rand, many investors may want to consider investing in listed property offshore. Offshore listed-property investments offer diversification of geographies, hedging against the rand and lower funding costs.
Coetzee says that investors can access offshore listed-property funds by investing in unit trusts or in underlying investments through retirement funds. Investors can also access offshore property through Marriott’s hybrid structure in the Marriott First World Hybrid Real Estate Fund.
The First World Hybrid Real Estate Fund is a regulated, pound-denominated fund that invests in a combination of physical real estate in the United Kingdom and listed REITs. It focuses on distribution warehousing in the UK. The benefit of the hybrid model is that you get returns linked to UK real estate with less volatility than publicly-quoted traded REITs as well as better liquidity and pricing certainty than typical physical property investments. The fund returned, net of all fees and expenses, excluding the investment management fee, 8.9% in pounds in the 12 months to August 31, 2018 and 7.9% a year over three years.
Robins says that it is easier to invest offshore in listed property than directly in physical property. He says it is liquid, diversified, has no additional investment charges and is often cheaper than direct property. “There is obviously heightened risk in the UK at the moment and although listed UK property is also cheap, UK residential property is under pressure.”
MARRIOTT PROPERTY FUNDS
Marriott Property Income Fund
A minimum initial investment of R500 is required, with minimum additional investments of R300. Income dividends are paid quarterly. Tax is dependent on the investment option that you choose: unit trust or retirement fund. Unlike dividends from equities, which are subject to a flat withholding tax of 20%, dividends from listed property investments are taxed at your marginal tax rate.
Investment costs comprise an asset management fee of 1.16% and transaction costs of 0.12%, resulting in a total annual fee of 1.28%. Financial advice costs, which are negotiable with your adviser, include a maximum initial fee of 3% and a maximum annual fee of 0.5% on unit trusts or 0.75% on retirement funds.
Marriott First World Hybrid Real Estate Fund
A minimum initial investment of 25 000 UK pounds is required, with minimum additional investments of 10 000 pounds. Income dividends are paid quarterly.
There is a total expense fee of 1.72%. In addition there is an annual transaction charge of about 0.2% for acquiring underlying physical properties. Advice fees are on top of that.