November 6, 2004

By Charlene Clayton

If you want to invest in property without the hassle of finding a tenant, collecting rentals, dealing with body corporates and other problems, an investment in listed property could be the answer. We report on the investment options within the listed property sector.

Listed property investments consist of property unit trusts, property loan stock companies and listed property companies.

One of the advantages of listed property is that company profits can be projected with a fair degree of accuracy, because they are derived from the rentals paid by the properties in the company's portfolio.
Listed property offers several other advantages over directly-held property. These are:

You need less money to invest in listed property than to buy a physical property.
You don't need to raise a mortgage bond to invest in a listed property instrument.
You don't have to find tenants to pay rentals in order to earn an income on your investment.
You don't have the responsibility of maintaining your property.
Listed property offers liquidity and tradability, which means you can sell your listed property shares easily, while it may take weeks or months to sell a physical property. You will also incur high transaction costs, such as estate agents commission, on the sale of a property.
An investment in listed property shares gives you exposure to properties in various parts of the country and to different types of commercial properties, such as office blocks, shopping malls and factories.

Unless you are wealthy, you will only be able to afford to invest directly in one building in one city or town.

Returns from listed property
You earn returns from listed property in two ways:

You share in a proportion of the income that is earned by the listed property entity. The listed property entity earns income from sources such as rentals paid by tenants. This income is called the yield.
The growth in the value of the units listed on the stock exchange. This is called capital appreciation.

The yield and capital appreciation together are referred to as the total return on the investment.

In mathematical terms, the yield is the distribution, or income, paid out divided by the share price and expressed as a percentage. So, if your investment gives you a distribution of 20 cents at the end of the year and the price at that time is R2, the yield will be 10 percent (20c divided by 200c and multiplied by 100).

Property unit trusts
Unlike ordinary (equity) unit trusts, property unit trusts (PUTs) are listed on the JSE Securities Exchange. However, PUTs are controlled by the same law that regulates unit trusts: the Collective Investment Schemes Control Act (Cisca).

Cisca allows PUTs to pass on the income they earn to unitholders (investors) by way of distributions.

The South African Revenue Service taxes PUT distributions in the same way it taxes interest earnings.

If you are under the age of 65, you are not taxed on the first R11 000 of interest you earn. If you are 65 or older, the first R16 000 of interest you earn is not subject to tax. Interest earnings above these thresholds are taxed at your marginal tax rate.

By law, all the income earned by PUTs, less expenses, must be paid out to investors.
When PUTs started, they bought property from institutions, such as retirement funds, and individuals. The PUT companies found that it was not sensible to have a myriad of small property trusts, because this limited the liquidity that PUTs had hoped to provide to investors.

PUTs were not as liquid as had been expected, because it was primarily institutions and retirement funds that invested in PUTs (after having sold off their direct holdings in property). A spate of mergers took place in the late 1990s. Consolidation saw the number of PUT companies drop from 18 to five large entities.

Currently, the PUT sector has a market capitalisation of about R6 billion and most of this is concentrated in three large funds: Grayprop, Martprop and Sycom.

Historically, PUTs were more strictly regulated than property loan stock companies and could not, for instance, borrow money from a bank in order to buy more properties. PUTs could also not buy back the shares they issued, and could only invest in fixed property.

Today, PUTs are allowed to borrow up to 30 percent of their market values, but the level of borrowing in the sector generally is low, with the highest debt level being about 10 percent.

Property loan stock
Property loan stock (PLS) companies were introduced in the late 1980s as an alternative property investment vehicle, because at the time the legislation governing PUTs was, to some extent, outdated and inflexible. PUTs were prohibited from borrowing money to buy property and they were restricted to investing in fixed property, rather than listed property.

Unlike ordinary listed companies, PLS companies invest solely in property. As with all other listed companies, property loan stocks are subject to the Companies Act and JSE regulations and are governed by their own memoranda, articles of association and debenture trust deeds.

The main difference between PLS companies and other companies is how their owners fund them. When you invest in a PLS company, you buy a linked unit.

A linked unit consists of a share and a debenture (or loan). The debenture portion earns interest at a variable rate. The interest comes from the net income (income less expenses) that the PLS company derives from rental from the properties in which the company invests. The share portion makes up only a nominal value of the linked unit.

Similar to PUTs, the income from a PLS company is taxed in the hands of the investors. But the income is paid out in the form of interest on the debenture portion of the linked unit.

Usually, PLS companies distribute all their profits, mainly through debenture interest, with the balance paid out as a dividend. Distributions are paid as often as quarterly, and at the very least, twice during each fund's financial year.

The conditions and terms of the debentures, including the rate of interest and the repayment dates, are governed by the debenture trust deed. Independent trustees are appointed to look after the interests of debenture holders.

There are about 20 PLS companies listed on the JSE, and the major players are Growthpoint, ApexHi and Pangbourne.

Listed property companies
Although listed property companies have a bias towards property and property-related ventures, they are not restricted to investing in property, and they can also buy shares in other companies.

Unlike PUTs and PLS, which have to pay out all their income in the form of dividends, listed property companies can choose how much of their income to pay out in the form of dividends.

About 10 property companies are listed under the real estate sector of the JSE. The only one of any size is Liberty International, which has a portfolio of retail properties in Britain and the United States.

Property companies are controlled by the JSE regulations and the Companies Act. These are ordinary companies which issue shares to raise capital and pay out dividends to investors. Tax is paid by the com-pany, and when the company distributes its profits via dividends, it also pays secondary tax on companies.

The dividends from locally listed companies are not taxable in the hands of investors.

Minimum investment
The JSE's new JET trading system allows you to buy any number of shares you choose, unlike in the past when you could buy a minimum of 100 shares. However, because of the minimum costs of brokerage, making small investments - of less than, say, R2 000 - is not cost-effective. Investors who wish to invest smaller amounts should consider property unit trust funds of funds.

Brokerage which varies between one percent and about two percent depending on the broker, the services of the broker and the size of your investment. You also have to pay uncertified securities tax, which is 0.25 percent plus VAT on each transaction.

Investment term
Investment in listed property, particularly PUTs or PLS companies, is typically suited for investors looking for income returns over the longer term and not for speculation.

Commercial property may be set for a boom
The commercial property market may well be on the verge of a boom, which should sustain the already strong performance of the listed property sector, Colin Young, the fund manager of Old Mutual's SA Quoted Property Fund, says.

The listed property sector, which focuses exclusively on commercial property, achieved a total return of 40 percent in 2003, while the JSE Security Exchange's All Share index (Alsi) delivered 12 percent over the same period. For the 12 months to the end of September 2004, listed property returned 35.2 percent against the Alsi's 36.8 percent, Young says.

He says in 2003 most of listed property's total return (income and capital appreciation) was a result of lower interest rates rather than an improvement in commercial property fundamentals. However, Young says, the returns achieved this year have increasingly been due to improving fundamentals, which have seen growing rentals and higher occupancy levels.

The overall environment for listed property is positive, Young says, and listed property funds should continue to report strong growth in distributions (income) into the foreseeable future.

Currently, the average annual escalation on new leases is about eight percent, and the fact that this is well above CPIX inflation of 3.7 percent bodes well for the listed property sector and supports the view that growth should be sustained, Young says.

He says the liquidity of the listed property sector has improved tremendously over the past year.

The prospects for the listed (and residential) property market depend mainly on the outlook for inflation, because inflation has a direct impact on the direction of interest rates. Interest rates are important for the property sector, because they affect the cost of borrowing and, ultimately, the amount available to distribute to shareholders.

Old Mutual Asset Managers believes inflation will continue to decrease and that the prime lending rate could fall further over the medium term, Young says.

John Rainier, the former chairperson of the Association of Property Unit Trusts, and Norbert Sasse, the chairperson of the Property Loan Stock Association, assisted with information for this article.