March 19, 2004

Mark Twain once wrote: "Invest in land because they ain't making any more of it." He must have known a thing or two about Ricardian rent!

He also probably never foresaw the emergence of the internet entrepreneur who would start auctioning off plots of land on Mars long before the first manned trip to the red planet.

I want to talk not about investing in the dirt itself, the price of which has already skyrocketed to the blue heavens in South Africa.

I want to talk about investing in the shares of the companies that erect valuable structures on the dirt and earn income from letting them out on long-term leases

Traditionally, South Africans (institutions and individuals) have tended to invest directly in property and sell it later for capital gain.

It didn't help that on the JSE Securities Exchange the property sector was small, and the shares were relatively illiquid. It's the same old irony: you only buy what you can easily sell on to someone else.

But the times, they have changed.

Market capitalisation has risen from under R5 billion in the early 1990s to over R20 billion now, and traded volume has soared from about R600 million in 1995 to about R6 billion now.

The figures include property unit trusts (PUTs) and property loan stock (PLS). The difference between the two is that the former has some restrictions (such as gearing) meant to protect the investor. PUTs are also exempt from the notorious capital gains tax and assets are limited to direct investment in property.

So why should you bother about investing in property-based investment vehicles like property income funds?

The first simple answer is: as a normal and sensible attempt at diversifying investment portfolios to manage risk exposure. 

But there is more.

Pound for pound this sector churned out returns of about 35 percent in 2003, well in excess of the JSE's 16 percent. So it need not make any apologies on performance! It is particularly suited to investors who need yield income in the present and capital appreciation over the longer term, based on upward movement in the underlying share prices.

And why get into it now? Well, you may have missed the most opportune entry point in the cycle but still better now than never.

We are pretty much at the bottom of the interest rate cycle, and this is always good for property fundamentals.

Low interest rates will drive earnings and underpin capital growth. The yield on the R153 government bond is just over 9 percent while the weighted yield (by market cap) of PUTs and PLS is well over 11 percent.

With an estimated forward income yield of 10.5 percent and capital appreciation of 3.5 percent over the next 12 months, property should outperform bonds over the period, not to mention that leviathan - inflation!

Large new listings are expected this year, and should help improve trading liquidity and enhance fund management opportunities.

Other advantages relative to physical property are: greater tradeability, more accurate and timely valuations, no property management hassles, fewer investment costs and ease of calculation of return on investment.

The main risks include: capital fluctuation; sensitivity to exchange rate movements that affect the bond market, which in turn is correlated with property yields; inflation surprises; and possible overdevelopment.

All in all, it's not too late to get on the train to earn some income and watch your capital appreciate over time.

So before you invest in a slice of Mars, at least wait until they find that elusive water, and give property income funds a chance.

Vincent Malunga is the director of ventures and alternative products at Stanlib Wealth Management