_We looked at historical returns from local listed property and also the typical methodology of assessing the required rate of return. Here we consider the likely range of returns than an investor may achieve through an investment into listed property.
The total return from listed property – as with most, but not all investments – is made up of a combination of the yield and capital growth over time_.
Traditionally property has been a fantastic investment because the largest component of the total return has been the steadier annual yield. Over the last 10 years however, except for 2008, the capital growth component proved to be a very attractive component to the aggregate return achieved.
Because property rental income is contractually based on 3,5,10 year type leases, there is a high degree of sustainability of the income into the foreseeable future. An investor therefore buying an asset yielding say a net 8,5%, has a high degree of comfort that this yield will be sustained into the future.
In South Africa leases have typically escalated at 7-9% per annum. As a percentage of a landlord’s leases expire, so new leases are being entered into. Expired leases ending after their typical period of on average 5 years may end, at, below or above the current market rates. Given the steepness of actual rentals in general from 2005/2006, many expiring 5 year leases are ending at below current levels, which gives landlords some margin of cushion when negotiating new leases, in a market that is seeing rising vacancies.
The current average yield across all listed properties is just over 8,5%. An investor should receive this into the future. The next question is at what growth rates can property companies grow their net incomes into the future.
Remember that if the required hurdle rate for property is 14%, then an investor will be looking for a perpetuity growth rate of 5,5% (income of 8.5% plus growth of 5,5%, to give the minimum of 14%)
At face value, this does appear feasible, but opinions on this do vary. One property fund manager believes that income growth over the next 5 years will approximate 8% per annum, but slow thereafter to 4,7%. Another believes that growth income will come in at 8% over the next 12 months, but thereafter will start to slow. The more pessimistic fund manager says that over an extended period of time, the growth in income for property funds should come in just lower than the inflation rate. If investors are projecting an inflation rate of 5-6% then this is the growth rates that property companies should be producing.
Aggregating a starting yield of 8,5% and growth rate in net incomes of 5-6% brings us back to the required 14% nominal return. I think if investors can achieve this type of nominal return, most will be very satisfied. The big question is how will growth rates moderate in this current environment of rising vacancies and higher costs. We will be watching reports from listed property companies over the months.