Unit trusts in property must be carefully weighed

Posted On Wednesday, 18 February 2004 02:00 Published by
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Unit trusts that invest in listed property instruments have performed strongly during the past two years, although a downward correction has been evident since the middle of December.

Unit trusts that invest in listed property instruments have performed strongly during the past two years, although a downward correction has been evident since the middle of December.

After the decrease of 550 basis points in the bank rate, investors and fund managers are increasingly pursuing high-yielding assets and, in particular, listed domestic property instruments that are offering income yields of about 11 percent.

Many base their investment strategy on the asset classes that were top performers over the past year, and on the assumption that this will continue

However, like any other asset class, listed property is not easy.

Unlike other equity investments, the earnings growth of property shares plays a less determining role in share price movements.

In the past seven years the earnings growth of the JSE Securities Exchange's property unit trust sector was less than 1 percent a year on a compound basis (4.4 percent a year in the first four years and minus 3 percent a year in the following three years).

Listed property shares are therefore regarded as a type of long-term interest-bearing bond.

It is no coincidence that the earnings yield on the JSE property unit trust sector is virtually a mirror image of the yield to maturity on the Bond Exchange's long-term, interest bearing bond index.

The average 160 basis points historical difference (currently about 127) between the earnings yield of the JSE property unit trust sector and the return on long-term, interest bearing bonds can be attributed to the risk premium that the market attaches to property shares relative to long-term, interest bearing bonds.

The wealth of the investor in listed property shares depends to a large extent on the direction taken by long-term interest rates in South Africa.

Long-term interest rates worldwide have turned upward as capital markets are starting to discount stronger global growth and an end to the disinflation cycle. 


South Africa is nearing the stage where the economy will start improving, while the downward pressure on inflation will decrease substantially. It is probably a matter of time before the capital market starts discounting this, and long-term interest rates start a new upward cycle.

The capital risk on property shares is increasing.

The earnings yield on property shares is likely to follow the rising trend in long-term interest rates, with the resultant decline in property share prices. This decline can be countered only by sharp rises in the earnings of property companies, but this is unlikely.

The markets for the type of property in which listed property shares usually invest are under pressure, mainly because of an oversupply of floor space, while escalation rates are following the downward inflation trend.

The downward trend in the earnings of property companies during the past three years will probably continue over the next year and exert further downward pressure on property share prices.

The possibility of oversupply of listed domestic property shares is increasing as some of the large local institutions have started listing new property companies.

This is not surprising as direct properties are trading at higher rates of return than the earnings yield on domestic listed property companies.

The institutions therefore immediately earn capital gains on their surplus properties.

The liquidity of listed property shares is limited and any negative news, such as a sharp rise in long-term interest rates, could cause the market to overreact.

Unit trusts investing in listed property instruments do have a place in a well-balanced investment portfolio, but there are times when the exposure to such funds should be reduced according to changes in the relative risks.

 

Prieur du Plessis is managing director of Plexus Asset Management


Publisher: Business Report
Source: Business Report

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