Ian Fife

Listed sector yields 9%, 2%-3% for general equities

Why the big difference in yields?

“It’s general equities that seem overpriced to me. The correction is likely to come there rather than in the property sector”

— ANGELIQUE DE RAUVILLE

If you invest R1m in the listed property sector, your payout in a year is likely to be just above R90000 on a forward purchase yield of 9,1%. This compares to between R20000 and R40000 — 2% and 4% yields — you’ll be paid in the resources and retail sectors.

Only banking offers a better potential return at R103000. That’s understandable because it is just emerging from the global financial meltdown.

Why is property so underrated?

First understand that property is a different asset class from general equities. And one of its big differences is that your dividend from general equities is tax-free, but you will have to pay tax on your property income. So if your tax rate is 30%, you will get only R64000 of the R90000.

But even that begs the question: why does property pay more? General equities are valued on the expected performance of each sector, adapted to the individual circumstance of the company. But property’s steady and usually predictable growth in income has become lumped with two other income asset classes, bonds (long-term debt) and the money market.

The “risk free” rate of the RSA207 government 10-year bond that repays capital in 2020 is 9%, almost the same as listed property. Property is considered riskier but its payout can grow each year, while long bonds stay the same. If the forward yield remains 9,1% for a year and the listed property sector’s income grows by 7%, as expected, the value of the R1m investment will grow to R1,07m and the total return will be 16,1% compared with the long bond’s static 9%.

Investec Property Investments CEO Angelique de Rauville feels this relationship is about right for the moment.

But listed fund Redefine joint CEO Marc Wainer says: “The institutional investors all have their formulae. I’ve been in the business 30 years and still don’t understand them. On fundamentals, I believe the listed property yield should be around 8%,” he adds. These fundamentals include property’s strong real asset base against which the company can borrow more than most general equity companies — as much as 100% of value until the recent meltdown, now up to 80%.

The property’s security to the lender is enhanced by long-term tenant leases with fixed escalations of up to 20 years that make repayment more certain than volatile retail, banking or resources.

The unique relationship between a real asset that keeps its real value as inflation eats away the debt and turbocharges the growth of net value is revealed more clearly in direct — unlisted — property.

At 6%/year inflation, the real mortgage debt of a property will be halved in 10 years. There are signs high net worth investors are tending towards hard assets like property and art for this reason. Perhaps this is why yields on direct property investments are only slightly higher than the more liquid listed property funds.

Institutional investors are usually caught up in short-term movements in and out of property funds to enhance their reportable returns. So they are inclined to ignore this critical advantage of property investment. Listed property is a hybrid that allows them to buy and sell quickly.

Nedsec retail sector analyst Syd Vianello says the retail sector has a forward yield of 3%-4% and he expects income to grow by 10%-11%/year over the next five years or so. This would give the investor’s R1m a payout of about R312000 over six years, compared with a post-tax listed property payout of R456000 in the same time.

A banking analyst says that besides its recent turmoil, his sector is burdened by uncertainty about banking regulations and so its forward yield is just over 10%. He says there will also be strong growth over the next two years as write-downs of distressed debt improve. “I expect earnings to rise by 30%/year over the next two years,” he says. “Thereafter banks are likely to sustain single-digit to low double-digit growth.” Even so, on the analyst’s formula, a R1m investment in the banking sector could pay out about R1m over the six years.

Both he and Vianello cite the threat of increased property vacancies as business shrinks and they reduce staff or fail completely as reasons why some investors are wary of property. This and the global collapse of property have affected investor attitudes.

Cadiz resources analyst Peter Major points out that property is only 14% down from its peak in 2007. Resources are down 30%. “My belief is that, though the resource sector does look a bit expensive, its earnings and dividends will be coming off quite a low level for the next 18 months,” he notes. “So if the rand weakens even a little bit during that time, we should see 15%-20%/year capital growth in that time and a greater than 100% growth in dividends. Can property really offer that in the next one to two years? I just can’t see it.”

“People are skittish and don’t know where to turn,” says De Rauville. “I think the property sector is priced correctly for the circumstances. It is general equities that seem overpriced to me. The correction is likely to come there rather than in the property sector. But investors are beginning to nibble at property. The SA market usually lags the global property markets. The UK market has already recovered much of its losses seen over the past two years. I think it’s gone too far. But it could be that local property will start improving during the year.”

She says demand for Investec Property’s fund which invests in listed property is neutral. One pension fund that invests in her fund has begun shedding general equities and buying property.

But perhaps the strongest argument for property’s place in investment portfolios comes from Vianello and a banking analyst, who doesn’t want to be named.

Vianello began buying commercial property in northern Johannesburg eight years ago. Property is a major part of his assets. His maturing portfolio is becoming a cash cow, revealing the best of the asset class. The banking analyst also has a portfolio but it hasn’t performed as well. “I’m going to move out of it into listed investments, including listed property,” he says.

The writer and his family own shares in Capital, Growthpoint and Redefine

Source: Financial Mail