Apr 11, 2007: Listed Property Yields Growing
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» Apr 11, 2007: According to Macquarie First South’s Leon Allison, South African listed property will yield 9,1% one year forward, growing to a yield of 9,9% in year two. “Real growth is much higher that it has ever been in South Africa,” he says. “Effectively it is seldom that it gets as good as it is now.

“Forecast income growth is 11,6% in year one and 9,3% in year two. Forecast risk is relatively low and property fundamentals are as good as ever.

“High growth is not sustainable, so my long term view is 5% growth.”

Evan Robins, head of fixed income at BoE, expects “clean forward rolling yields for listed property of around 7,3% one year out and around 8% two years out”.

He says there have been periods in the early 1980s when real property distribution growth may have been higher but it is probably the highest real growth period for Property Loan Stocks.

When it comes to forecast income growth for listed property, Robins expects around 12,5% in year one and around 10% in year two. His expectation is based on growth on a rolling historic number.

He agrees that high growth is not sustainable though in the long term. “After about three years I use a terminal growth rate of around 4%, assuming the inflation target mid point is achieved,” he says. “But if the property cycle stays stronger for longer, this could be a very conservative figure.

“Listed property has been very volatile and can behave like an equity in the short term, so if there is any market correction, there is a risk for listed property.”

According to Allison, the main risk is sharper than expected interest rate and bond yield increases, but keeping this in mind, he expects solid returns from listed property.
According to Colin Young, head of Asset Management for Old Mutual Property Investments, it should be noted that although income growth is forecast at 9%, that this has been priced into share prices already, and that share prices only go up if companies outperform this.
Allison explains that the listed property sector has grown strongly in recent years to its current market capitalisation of R67 billion, taking into account it was less that R10 billion a few years ago.

“I foresee further strong growth in the size of the sector as more capital is allocated to listed property,” he says.

Currently the South African listed property industry is focused on adopting a Real Estate Investment Trust (REIT) structure in the next two to three years. Further consolidation is expected in the sector, and even though foreign ownership is still low at less than 2% of the market capitalisation, more enquiries are being recorded.

“The past seven years has been a party for property investors,” says Allison. “Listed properties saw a 34% total return per year at a lower risk than equities at 25%, which is unlikely to be repeated in the next 12 months.”

The key drivers of this party have been lower inflation and interest rates and lower bond yields; property rerating off a low base; the equities bubble that left investors disillusioned with equities; an ageing global population demanding lower risk assets; an emerging class of homeowners; good investor and consumer confidence; and lower tax on retirement funds on interest income.

“Forecast returns of around 15% are anticipated for 2007, although interest rate shocks could spoil the party,” says Allison.

Allison points out that listed property has a lower risk than equities but a higher risk than bonds and that it has been outperforming other asset classes, even before taking gearing into account.

“Despite excellent capital returns in recent years, listed property is really about growing income yields,” says Allison. “We assume that current
prices are fair and that price growth will therefore match income growth.”

There is a high correlation (0,90) between listed property and bond yields. Property yields have declined sharply and prices have risen due to improving property fundamentals.

Since the sell off of listed property in May 2006, the yield spread narrowed to 25 bps in July, widening to 100 bps toward the end of 2006.

The sell-off since May has not been limited to listed property but all interest rate sensitive stocks, including banks and retailers. The price declines in property have been exaggerated due to illiquidity and there has been a 14% recovery since the
low point in mid July.

“Increasing capital will flow into property globally due to strong performance in recent years and the equities bubble, ie investors grew disillusioned with property and rediscovered property as an asset class,” says Allison. “Also, the ageing
population in the US (baby boomers), Japan and Europe need more stable income than equities and more growth than bonds.

“Listed property in South Africa will grow due to strong fundamentals that lead to new developments, more listings of direct portfolios, increasing allocations to property by general equity investors, further reduction on tax on interest income for
pension funds and retirement funds, the announcement by government of a super-annuation-type savings incentive scheme, and the fact that foreigners are starting to buy South African listed property.

“So the challenge will effectively be to find enough investment grade properties.” – Kara Michaels

Source: Property24 – www.property24.co.za