March 23, 2004

Why do so many investors avoid the property sector?

In the past 10 years the average annual total return - income and capital - from property unit trusts has been 17.4 percent compared with 12.1 percent from equities, 15.9 percent from bonds and 12.5 percent from fixed deposits.

Even allowing for tax at the full marginal rate, between 1994 and 2003 the total return from property unit trusts was on a par with that from equities.

There appear to be two main reasons for investor hesitation: lingering concerns about property arising from the Masterbond debacle and the poor performance of other property syndications; and a lack of understanding of the listed property sector
There are three main categories of property securities listed on the JSE Securities Exchange: property companies, property unit trusts and variable rate loan stock companies.

Although only four property companies are traded, because of the size of Liberty International this is by far the biggest sector in terms of market capitalisation. Liberty's prime attraction is that it is a rand hedge, with large shopping centres in the UK.

Property unit trusts own a portfolio of property-owning companies and direct properties, and are regulated under the Collective Investment Schemes Act.

Variable rate loan stock companies, or property loan stocks, aim to distribute income to their primarily institutional holders via a capital structure incorporating loan capital - variable rate debentures - normally linked to a relatively small number of shares - hence "linked units".

As rents rise on the properties owned by a loan stock company debenture interest paid to unit holders also rises, and this should result in an appreciation of the price of the units.

The gearing of these companies, regulated under the Companies Act, can create a higher level of risk than property unit trusts. 

In 2002 and 2003 the property sector enjoyed strong performance mainly driven by interest rates. More recently, with interest rates probably having bottomed out, there has been a downward rerating. This is normal in an overbought market.

But many of the loan stocks and property unit trusts are still trading at a premium to net asset value. There is little immediate threat of a rise in interest rates and most companies have fixed borrowings for up to three years ahead. Even if interest rates rise there will be little immediate effect.

It is unreasonable to expect the same appreciation in property stocks this year as in 2002 and 2003. But the higher yields in property unit trusts and loan stocks will tend to underpin prices.

Investors with a growth orientation should maintain exposure to the two premier retail-orientated funds, namely Hyprop (10.1 percent yield) and Growthpoint (10.8 percent yield).

ApexHi has been diversifying into the retail sector, reducing exposure to office and industrial properties. The A units are appropriate for risk-averse investors seeking a higher return than that available from bonds, while the B units not only offer a high yield but speculative appeal.

Three of the other megafunds, Grayprop, Sycom and Martprop, appear fully priced at present.

Pangbourne recently announced a 3.7 percent increase in interim distribution and appears moderately undervalued.

iFour, which is 48.8 percent-owned by Pangbourne, is a smaller fund. Given the quality of the portfolio, there are rerating possibilities, making it appropriate for the growth-oriented investor.

Metboard, which is a pure industrial fund on a yield of 13 percent, offers value at present.

Redefine, after its debacle with Arnold Property Fund last year, has recovery potential but the market will need firm evidence of this before rerating the stock.

David Cairns is a director of the Durban branch of Sasfin Frankel Pollak Securities